Myth: Carter ruined the economy; Reagan saved it.

Fact: The Federal Reserve Board was responsible for the events of the late 70s and 80s.


Carter cannot be blamed for the double-digit inflation that peaked on his watch, because inflation started growing in 1965 and snowballed for the next 15 years. To battle inflation, Carter appointed Paul Volcker as Chairman of the Federal Reserve Board, who defeated it by putting the nation through an intentional recession. Once the threat of inflation abated in late 1982, Volcker cut interest rates and flooded the economy with money, fueling an expansion that lasted seven years. Neither Carter nor Reagan had much to do with the economic events that occurred during their terms.


In 1980, the "misery index" -- unemployment plus inflation -- crested 20 percent for the first time since World War II. Ronald Reagan blamed this on Jimmy Carter, and went on to win the White House. Reagan then caught the business cycle on an upswing, for what conservatives call "the Seven Fat Years" or "the longest economic expansion in peacetime history."

Were either of these presidents responsible for their fortune with the economy? No. Carter battled the peak of an inflationary trend that began in 1965. In the following chart, take special notice of the long, slow climb in the inflation column:

Year    Inflation  Unemployment (1)
1961      1.0%      6.7%
1962      1.0       5.6
1963      1.3       5.6
1964      1.3       5.2
1965      1.6       4.5  < Vietnam war spending increases
1966      2.9       3.8
1967      3.1       3.8
1968      4.2       3.5
1969      5.5       3.5
1970      5.7       5.0
1971      4.4       6.0
1972      3.2       5.6
1973      6.2       4.9
1974     11.0       5.6  < First oil crisis
1975      9.1       8.5
1976      5.8       7.7
1977      6.5       7.1
1978      7.6       6.1
1979     11.3       5.9  < Second oil crisis
1980     13.5       7.2
1981     10.3       7.6
1982      6.2       9.7
1983      3.2       9.6
1984      4.3       7.5

In 1965, President Johnson started increasing deficit spending to fund the Vietnam war. This fiscal policy (as predicted by Keynesian theory) increased inflation and reduced unemployment.

Unfortunately, inflation is a self-fulfilling prophecy. If business owners expect it, and raise their prices by the anticipated amount to compensate for it, then they have created the very inflation they fear. This process forms a vicious circle -- inflationary expectations and price increases feed off each other, with the potential of creating hyper-inflation. Unfortunately, economic theory at the time was such that economists didn't know how to stop it, at least safely.

Growing inflation in the 70s received two huge boosts: the first comprised the late-1973 and 1979 oil shocks from OPEC (the Organization of Petroleum Exporting Countries). Soaring oil prices compelled most American businesses to raise their prices as well, with inflationary results. The second boost to inflation came in the form of food harvest failures around the world, which created soaring prices on the world food market. Again, U.S. companies that imported food responded with an inflationary rise in their prices.

All this was accompanied by a growing crisis in monetary policy at the Federal Reserve. Traditionally, the Fed has fought inflation by contracting the money supply, and fought unemployment by expanding it. In the 60s, the Fed conducted an expansionary policy, accepting higher inflation in return for lower unemployment. It soon became clear, however, that this strategy was flawed. Expanding the money supply created jobs because it put more money in the hands of employers and consumers, who spent it. But eventually businesses learned to expect these monetary increases, and they simply raised their prices by the anticipated amount (instead of hiring more workers). The result was that the Fed gradually lost its ability to keep down unemployment; the more money it pumped into the economy, the more businesses raised their prices. As a result, both inflation and unemployment started growing together, forming a twin monster that economist Paul Samuelson dubbed "stagflation."

Stagflation happened to reach its peak on Carter's watch, spurred on by the 1979 oil shock. How Carter can be blamed for a trend that began a decade and a half earlier is a mystery -- and a testimony as to how presidential candidates often exploit the public's economic ignorance for their own political gain.

However, Carter did in fact take a tremendously important step in ending stagflation. He nominated Paul Volcker for the Chairman of the Federal Reserve Board. Volcker was committed to eradicating stagflation by giving the nation some bitter medicine: an intentional recession. In 1980, Volcker tightened the money supply, which stopped job growth in the economy. In response to hard times, businesses began cutting their prices, and workers their wage demands, to stay in business. Volcker argued that eventually this would wring inflationary expectations out of the system.

The recovery of 1981 was unintentional, and with inflation still high, Volcker tightened the money supply even more severely in 1982. This resulted in the worst recession since the Great Depression. Unemployment in the final quarter of 1982 soared to over 10 percent, and Volcker was accused of the "cold-blooded murder of millions of jobs." Even high-ranking members of Reagan's staff were vehemently opposed to his actions. Congress actually considered bringing the independent Fed under the government's direct control, to avoid such economic pain in the future. Today, economists calculate that the cost of Volcker's anti-inflation medicine was $1 trillion -- an astounding sum. But Wall Street demanded that Volcker stay the course, and that may have been the only thing that saved him.

In the late summer of 1982, inflation looked defeated, so Volcker sharply expanded the money supply. Once as high as 14 percent in 1981, the Fed's discount rate fell from 11 to 8.5 percent between August and December 1982. Within months, the economy roared to life, and took off on an expansion that would last seven years. Because the recession had been so deep, and the number of available workers so large (with not only laid-off workers waiting to return to work, but also a record number of women seeking to join the workforce), the recovery was guaranteed to be long and healthy.

Interestingly, Volcker was transformed from villain to hero after the victory over inflation. His reputation and integrity were so unquestioned that when his term as Chairman came up for renewal, Reagan renominated him with overwhelming popular approval. Another interesting tidbit is that although Volcker's intentional recession was a classically Keynesian approach to combating inflation, he did so under the name of "monetarism". (The policies recommended by the two theories converged at this point.) Milton Friedman, the creator of monetarist theory, and other conservatives were pleased that the Fed had finally converted to monetarism. However, they were outraged in late 1982 when Volcker threw off the cloak of monetarism and openly returned to Keynesian policies for expanding the economy. Most economists now accept that the Fed was not monetarist at all during this period, and that the label was merely political cover for drastic but necessary action.

Of course, conservatives have a far different interpretation of these events. Let's review their arguments:


According to conservatives, increasing taxation and regulation under Carter stifled the economy. Reagan's 1981 budget (the only one not to be declared "Dead on Arrival" by House Democrats) contained across-the-board, supply-side tax cuts that allowed entrepreneurs to invest and increase productivity. Reagan also slashed regulations, unshackling the entrepreneurial spirit of American business.

There are several problems with this historical spin. First, total federal taxation under Carter rose by an insignificant 1.7 percent of the Gross Domestic Product:

Federal tax receipts and spending (percent of GDP) (2)

Year    Receipts  Spending
1978     18.5%    21.3%
1979     19.1     20.7
1980     19.6     22.3
1981     20.2     22.9
1982     19.8     23.9
1983     18.1     24.4
1984     18.0     23.1
1985     18.5     23.9
1986     18.2     23.5
1987     19.2     22.5
1988     18.9     22.1
1989     19.2     22.1

To claim that such a minor increase could produce crippling stagflation is to ascribe to the economy an extraordinary sensitivity to taxation. Although many conservative laymen would gladly accept such a notion, it is not one entertained by serious economists. West Germany in the 1980s, for example, had a total taxation rate of 39 percent of its GDP (compared to 29 percent of combined government taxes for the U.S.), and during that decade Germany was an economic powerhouse. If even a few percentage points are the difference between Carter's stagflation and Reagan's boom years, then by all rights West Germany should have been dead.

But that's only the general level of taxation -- what about the top rate? Although the top rate for income taxes was 70 percent under Carter (where it had always been, since Kennedy), Carter gave the rich the most sacred tax cut they hold dear: a capital gains tax cut in 1978, from 39 to 28 percent. Thus, Carter gave the rich their first tax cut in 15 years. According to conservative theory, this should have nudged the economy in the right direction, not sent it into the worst economic crisis since the Great Depression.

Conservatives also criticize Carter's promotion of expanded government regulations. But Carter actually began deregulating during his term; in 1978, he deregulated airlines; by 1980, he was deregulating trucking, railroads interest rates and oil. All are fundamental to the economy's operations. Carter also set up the deregulatory machinery that Reagan would later use to slash regulations almost in half by the end of his second term. Again, Carter's actions should have nudged the economy in the right direction, not sent it into the worst economic crisis since the Great Depression.

And yet, there is no evidence that regulation was even the cause of the period's stagflation. The economies of Western Europe are far more regulated than the U.S., and their productivity has been growing faster than ours:

Percent of U.S. individual worker productivity (U.S. = 100%) (3)

                1950s  1960s  1970s  1980s  1990
United States   100%   100    100    100    100
Canada          77.1   80.1   84.2   92.8   95.5
Italy           30.8   43.9   66.4   80.9   85.5
France          36.8   46.0   61.7   80.1   85.3
Germany         32.4   49.1   61.8   77.4   81.1
United Kingdom  53.9   54.3   58.0   65.9   71.9
Japan           15.2   23.2   45.7   62.6   70.7

Furthermore, Reagan systematically slashed and burned government regulations, but individual worker productivity grew no faster in the 80s than it had during the late 70s (about 1 percent for both periods).

As for the claim that Reagan's 1981 tax cuts were responsible for "the greatest peacetime expansion in U.S. history," a few grains of salt are in order here. The timeline better fits the liberal explanation than the conservative one. Volcker expanded the money supply in late 1982, and a few months later the economy took off. However, Reagan's tax cuts were passed in 1981, and were already in effect by 1982 -- but, as we have seen, 1982 was the year of the horrific recession.

Tax cuts were supposed to have spurred economic recovery by liberating the tax dollars of entrepreneurs and allowing them to invest them in greater productivity and jobs. However, such greater investment never occurred. It appears that the rich simply pocketed the savings, because investment fell during the 80s:

Private investment (4)

1970 - 1979   18.6%
1980 - 1992   17.4

So there is no evidence that the conservative revisionism is true.

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1. Inflation: U.S. Bureau of Labor Statistics, CPI-U (1982-84=100), not seasonally adjusted, table CUUR0000SA0. Unemployment: U.S. Bureau of Labor Statistics, Series ID : lfs21000000.

2. Office of Management and Budget, Budget of the United States Government, Fiscal Year 1997, Historical Table 1.2

3. Where We Stand, by Michael Wolff, Peter Rutten, Albert Bayers III, eds., and the World Rank Research Team (New York: Bantam Books, 1992), p. 143.

4. Paul Krugman, Peddling Prosperity, (New York: W.W. Norton & Company, 1994), pp. 126-127.