Economists were vexed during the 1970s, as unemployment and inflation rose together to stifle economic growth and all forms of investment. The Keynesian Phillips-curve paradigm, whereby employment and inflation are supposed to move in opposite directions, completely broke down. The Ivy League formula of increasing the money supply to spur growth, and high taxes to hold back inflation, had failed utterly.
Between the late 1960s and 1980, the U.S. inflation rate rose from 2 percent to 14 percent, while the unemployment rate gradually drifted higher, from 4 percent to almost 10 percent. It was a period of decline for the country. Americans were demoralized.
As stagflation became more deeply embedded in the U.S. economy, Soviet adventurism in Central and South America, Asia, and elsewhere around the world became more pronounced. The Soviets saw the U.S. cut and run from Vietnam. Our Cold War adversary saw nothing but weakness emanating from the U.S.
Ronald Reagan changed all that. From the moment of his swearing-in in Jan¬ uary 1981, with his extraordinarily strong character and deep and abiding faith in God, Reagan acted relentlessly to revive the nation.
More than any modern president, Reagan understood the link between economic growth at home and American strength overseas. It was the Gipper’s most brilliant insight. He acted swiftly to show our enemies that we would produce the necessary economic resources to do whatever it would take, for however long was necessary, to triumph over the Communist menace.
Immediately upon assuming office, he reversed the economic policy of the decline years. He brought down marginal tax rates, restoring the incentives necessary for economic growth. He gave Federal Reserve chairman Paul Volcker the strong ground to stand on, allowing him to harden the value of the dollar and slay inflation.
At bottom, what became known as Reaganomics was a new pro-growth policy mix of tax incentives at the margin and stable money. But there was more. The Californian launched a massive military buildup totaling about $1.5 trillion. He deregulated oil prices, proving the conventional wisdom wrong as energy became much cheaper. He launched U.S.-Canadian free trade. He was unyielding in his opposition to the air-traffic controllers’ strike, firing thousands of these government workers and ending the anti-growth union stranglehold on private industry. He created individual retirement accounts and 401(k)s, giving birth to the investor class. He also slashed social spending by reducing domestic program levels (excluding Social Security and health care) by nearly $50 billion in 1981. That amount would come to about $90 billion today.
By 1986, Reagan’s tax-reform plan left two marginal rates of 28 percent and 15 percent, a long stone’s throw from the 70 percent top rate he had inherited. His plan also cut about 2,000 pages from the tax code.
Ideas matter. Results quickly followed for Reagan. Between 1982 and 1989, the economy grew, adjusting for inflation, by 35 percent: more than 4.5 percent per year. As growth was restored, tax revenues came flowing in. Income-tax revenues grew by 50 percent during this period even as tax rates dropped. By 1986, the inflation rate had fallen to 1 percent. By the end of his term, unemployment had dropped to 5.5 percent. Interest rates had plunged. The stock market had soared.
From July 1982 through the end of 1988, the S&P 500 averaged a near 21 percent annual gain. Brand-new industries arose in computing, software, communications, and the Internet — original endeavors that completely streamlined and transformed the American economy for the decades to come. In effect, Reaganomics launched a 20-year boom, the longest prosperity period in the 20th century.
Reagan critics to this day continue to harp on deficits and debt, rather than the growth miracle produced by Reaganomics. But they are factually wrong. Reagan inherited a budget gap of roughly 2.5 percent of the economy. By the end of his two terms, he left it exactly where he found it. In between, he restored our economic health and revitalized our standing around the world.
By the time of his summit meetings with Soviet chairman Gorbachev, Reagan was able to say calmly and diplomatically that the U.S. could produce the goods and the Soviets could not. In the next few years, the Berlin Wall came down and the Soviet Union collapsed.
Reagan’s visionary linkage of domestic economic recovery, military preparedness, and worldwide peace had worked with a stunning swiftness that literally no one but the former Hollywood actor had ever visualized.
The greatness of Ronald Reagan was his optimistic vision. His unequivocal belief in freedom and democracy, in America as a city on the hill, never faltered. His free-market prescription for economic growth relied on the creativity of ordinary people working in free enterprise rather than under government planning. He believed in entrepreneurship, not welfarism. He understood how to use military power. And his optimistic faith in America gave a moribund country a new life.
Reagan saved America. His passing is a sad occasion. But as his soul gazes down from the heavens, he will see that his ideas will live forever.
— Larry Kudlow, NRO’s Economics Editor, is CEO of Kudlow & Co. and host with Jim Cramer of CNBC’sKudlow & Cramer.