The Reagan decade of the 1980s was a period in which only a handful of supplyside economists had conifdence. Most everyone else predicted it would be a decade of unprecedented calamities. As the decade recedes into history, it leaves behind an impeccable record of success.
Even including the 508-point plunge in the October 1987 stock market, Standard & Poor's 500 stocks produced an average annual return of 17.4 percent during the 1980s - more than double the earnings of the 1960s and 1970s.Moreover, the collapse of inflation produced the greatest fortunes made in the bond market in our history. During 1982 investors in U.S. Treasury bonds, the safest financial instrument in the world, made 40 percent on their money.
At the beginning of the decade, the inflation rate, as measured by the consumer price index, was approaching 15 percent. Many predicted that Reagan's tax cuts would send infalation and interest rates higher. These wrong predictions caused many investors to shun stocks and bonds and to invest in gold and silver.
However, inflation collapsed - just like supply-side economists had predicted - and stocks and bonds soared in value while gold and silver prices fell through the floor.
Many people bet against Reagan because his own top officials were betting against him in public. Remember budget director David Stockman's prediction that the U.S. economy would be wrecked by budget deficits? Or the prediction by Martin Feldstein, the chairman of Reagan's Council of Economic Advisers, that the economic recovery in 1983 would be weak and faltering?
As each prediction proved false, new ones arose to take their places. Pundits predicted that the strong dollar would deindustrialize America. When oil exports soared, the same pundits predicted that the weak dollar would let foreigners take over our economy.
Reagan's supply-side policies cured stagflation, the malaise that had halted the American economy in its tracks during the 1970s. Reagan's new economic policy launched the economy on its longest sustained expansion in our history, without any rise in the rate of inflation. In 1981 practically every economist in the country believed such a result to be strictly impossible.
Why did $50 billion deficits wreck the Carter economy and $200 billion deficits leave the Reagan economy unaffected? The answer is simple. Prior to 1981, deficits were used as pump-priming devices, and the Federal Reserve printed money to finance them, thus adding demand pressures to the economy.
Under Reagan the Federal Reserve wasn't allowed to print money. The Treasury had to finance the deficit by selling bonds to the public, which takes money out of the private sector just as effectively as a tax increase does. Thus, the Reagan deficits were not pump-primers.
Moreover, Reagan's deficits were the result of his decision to give up the inflation tax that had kept previous deficits under control by forcing taxpayers into higher tax brackets.
One thing is certain: when policymakers next make a mess of the economy, they will blame it on Reagan's policy of a decade ago that launched our longest expansion.