Economists look at recent economic history somewhat as follows: After a strong quarter-century of economic growth following World War II, the combination of poor fiscal, regulatory, and monetary policy, plus the oil price shock, wound up generating substantial inflation in the 1970s, combined with a major collapse of productivity growth. In the expansion phase of each post-World War II business cycle, the inflation rate got worse, whether measured at the trough, the midpoint, or the peak, peaking at 13 percent in 1980. Thus, the first round of disinflation reduced the 13-percent inflation rate to the 4½ percent range for most of the 1980s.
While a far better performance than in the ‘70s, it was still at a level which had compelled a Republican president, Richard Nixon, to impose wage and price controls on the economy. As the expansion progressed, there were some signs of modestly building inflationary pressures. In any event, the Federal Reserve, having been burned numerous times in the past by waiting too long and then overreacting, thereby contributing to the next downturn, was desirous of getting ahead of the curve and engineering a so-called soft landing. Better yet, hopefully, the inflation rate could be taken down another notch so that the 4½ percent did not become the floor with nowhere to go but up. Therefore, the Fed raised short-term rates 300 basis points, from 7 percent to 10 percent during the period from March 1988 to January of 1989, as President Bush assumed office.
It was thus clear that President Bush was going to experience quite modest economic growth during the early years of his presidency. This was mirrored in the relatively conservative projections built into President Bush’s economic forecasts, which turned out to be the most accurate set of forecasts any president had received in a long time, although we all—especially the president—would have preferred a stronger economy and lousy forecasts.
The Fed, I believe, would have succeeded in engineering a soft landing had it not been for the confluence of events softening the economy in addition to tight monetary policy: the problems in real estate and the financial sector; the collapse of the Soviet Union accelerating the defense draw-down and implying a much larger future defense draw-down; and Saddam Hussein’s invasion of Kuwait, which created a temporary oil shock to the economy. If those things, which the Fed couldn’t have anticipated in March of 1988, had not occurred, the economy almost certainly would have skirted the recession, had a stronger recovery, and President Bush may well have been reelected.
President Bush put forward a variety of innovative proposals which were good public policy but not forcefully conveyed, either individually or in combination, as an effective economic program. He fought for certain types of tax reductions and other policies while Democrats in Congress tried to raise taxes on the rich, and the politics degenerated into a “rich versus poor” fairness debate. My own view is that