(Bloomberg) — Forty years ago, President Ronald Reagan and Federal Reserve Chairman Paul Volcker oversaw a root-and-branch restructuring of the U.S. economy.
Today, Joe Biden and Jerome Powell are trying to do the same thing — only in reverse.
In the Reagan-Volcker regime change, power in the economy shifted from the government to the market and from labor to the owners of capital. The emphasis was on efficiency, not equality, and on promoting supply, not demand.
Monetary policy was put in charge of managing the economy and reining in inflation, while fiscal spending took a back seat. And the new priorities became entrenched –- at least until now.
“The parameters of the economic system and of public policy went through profound changes at that time,” said Paul McCulley, the former Pacific Investment Management Co. executive who now teaches at Georgetown University. “We’re fundamentally going through exactly the same thing now.”
As the U.S. emerges from the pandemic, Biden is reasserting the role of government spending and taxation in the economy — first with the $1.9 trillion relief bill approved in March, and now with proposals to spend more than $4 trillion on public investments and programs aimed at lower and middle-income families, like child care and paid leave. He outlined the latest plan in an address to Congress late Wednesday.To help pay for them, the president has set his sights on the owners of capital. He’s calling for higher taxes on capital gains, corporations and the wealthy. Biden has also championed labor unions, openly backing the failed effort to organize workers at Amazon’s warehouse in Bessemer, Alabama.
“Biden is more pro-union, more pro-redistribution, more pro-social welfare state, more pro-government spending in an uninhibited way than arguably anybody we’ve had since LBJ,” said Peterson Institute for International Economics President Adam Posen. He was referring to former President Lyndon Baines Johnson, whose Great Society programs in the 1960s expanded health care and lowered poverty.
The Fed under Powell has undergone a regime change as well. Gone is the focus on capping inflation, the cornerstone of the Volcker Fed. Now the emphasis is on avoiding the deflation that has bedeviled Japan for decades.
Rather than trying to offset the ultra-expansionary thrust of Biden’s policies, the Fed is amplifying them, as Powell again made clear to reporters on Wednesday. It’s keeping interest rates near zero — and as the government’s budget deficit widened, the Fed bought up trillions of dollars of the resulting debt.
Powell, whose term as Fed chair is up for renewal next year, is also all-in on Biden’s bid to lift labor’s share of the economic pie and spread the benefits of a hot jobs market to Black Americans and other groups that have historically been left behind.
There are dangers in the paradigm shift that Biden and Powell are engineering. The economy could overheat and bring an unwelcome resurgence in inflation.
“The risks of inflation are really picking up and the Fed is acting in a very benign manner,” said economic historian Michael Bordo, a professor at Rutgers University. He sees a danger that the Fed “gets co-opted so much” into backing the administration’s agenda that it loses the inflation-fighting credibility won by Volcker.
‘The New View’
It’s perhaps no surprise that Biden and Powell are staking out radically different policies than Reagan and Volcker did. The forces driving the economy have changed significantly.
Back then, double-digit inflation was enemy number one. Volcker led the drive to bring it down, jacking up interest rates and plunging the economy into a deep recession.
Reagan played a part as well, taking on the unions — whose automatic cost-of-living pay increases contributed to the wage-price spiral –- by firing striking air traffic controllers in 1981 after they illegally walked off the job.
The president also championed what’s known as supply-side economics. He cut taxes on capital and household income, especially for the wealthy, and loosened regulations in a bid to boost economic efficiency.
“Reaganomics was based on this idea that there is a scarcity of supply of capital, goods and labor,” said Megan Greene, a senior fellow at Harvard Kennedy School. “The new view is that there is an oversupply of all of those things.”
That oversupply has suppressed inflation and interest rates, held back economic growth and contributed to widening inequality. And it’s put a premium on government action to ensure that the economy doesn’t suffer from a chronic shortage of demand.
Since the Fed has cut interest rates close to zero, the onus falls on fiscal policy. Fortunately, those same low rates means the government doesn’t have to pay nearly as much to run up big debts — a point made repeatedly by Biden’s Treasury Secretary Janet Yellen.
‘Seize-Back of Power’
The two paradigm shifts are alike in one sense: They’re both a backlash against what came before. In Reagan’s case, it was the increased sway of the government in the economy, which was seen as stifling enterprise and business dynamism.
Biden’s presidency comes after an epoch of increasingly unfettered capitalism that failed to deliver benefits for many Americans -– a perception reinforced by the outsized impact of Covid-19 on those less well off.
The changes wrought by Reagan and Volcker lasted for decades, a longevity that may be tough to match. With Biden’s Democrats only holding small majorities in Congress, political analysts say it’s almost inevitable that the president will have to pare back some of his more ambitious plans.
Still, McCulley sees political and economic forces in train that will push the country down a similar path whatever happens to individual pieces of Biden’s agenda.
“Income and wealth inequality was very much on the radar well before the pandemic, and was pointing to a seize-back of power by democracy from unbridled capitalism,” he said.
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