The 1980s American Economy

Supply-Side Economics and a Growing Budget Deficit

1980s ATM
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In the early 1980s, the American economy was suffering through a deep recession. Business bankruptcies rose sharply compared to previous years. Farmers also suffered due to a decline in agricultural exports, falling crop prices, and rising interest rates. But by 1983, the economy had rebounded and enjoyed a sustained period of growth as the annual inflation rate stayed below 5 percent for the remainder of the 1980s and part of the 1990s.

Why did the American economy experience such a turnaround in the 1980s? What factors were at play? In their book “Outline of the U.S. Economy,” Christopher Conte and Albert R. Karr point toward the lasting impacts of the 1970s, Reaganism, and the Federal Reserve as explanations. 

Impact of the 1970s

In terms of American economics, the 1970s was a disaster. The 1970s recession marked the end of the post-World War II economic boom. Instead, the United States experienced a lasting period of stagflation, a combination of high unemployment and inflation.

American voters held Washington, D.C., politicians responsible for the economic state of the country. Upset with federal policies, voters ousted Jimmy Carter in 1980 and voted in former Hollywood actor and California Governor Ronald Reagan as president, a position he held from 1981 to 1989.

Reagan's Economic Policy

The economic disorder of the 1970s lingered into the beginning of the 1980s. But Reagan’s economic program soon began to have an effect. Reagan operated on the basis of supply-side economics—the theory that advocates lower tax rates so that people can keep more of their income. Proponents argue that supply-side economics results in more savings, investment, production, and ultimately, greater economic growth.

Reagan’s tax cuts mainly benefited the wealthy, but through a chain-reaction effect, they also helped lower-income earners as higher levels of investment eventually led to new job openings and higher wages.

The Size of the Government

Cutting taxes was only one part of Reagan’s national agenda of slashing government spending. Reagan believed that the federal government had become too large and interfering. During his presidency, he cut social programs and worked to reduce or completely eliminate government regulations that affected the consumer, workplace, and environment.

What he did spend on was military defense. In the wake of the disastrous Vietnam War, Reagan successfully pushed for big budget increases for defense spending by arguing that the U.S. had neglected its military. 

Growing Federal Deficit

In the end, the reduction in taxes combined with increased military spending outweighed the spending reductions on domestic social programs. This resulted in a federal budget deficit that went above and beyond the deficit levels of the early 1980s. From $74 billion in 1980, the federal budget deficit ballooned to $221 billion in 1986. It fell back to $150 billion in 1987 but then started growing again.

Federal Reserve

With such levels of deficit spending, the Federal Reserve remained vigilant about controlling price increases and raising interest rates any time they seemed a threat. Under the leadership of Paul Volcker, and later his successor Alan Greenspan, the Federal Reserve effectively guided America’s economy and eclipsed Congress and the president.

Although some economists were nervous that heavy government spending and borrowing would lead to steep inflation, the Federal Reserve succeeded in its role as an economic traffic cop during the 1980s.