The recession which occurred in the early 1980's was the most severe and the most significant in terms of economic policy of the post-World War II recessions. There is probably more nonsense on the Internet concerning this recession than for any of the other recessions. There are people who probably consider themselves intellectuals writing about this recession as The Reagan Recession, thus revealing that their partisan politics is a far greater element of their mental makeup than their allegiance to the truth. But back to the recession of 1980-82.

The detailed statistics are important for this recession because it differed from the others in the time pattern. Below is the graph of the levels of quarterly real Gross Domestic Product (GDP) levels, seasonally adjusted and in billions of chained 2000 dollars.

As can be seen in the above graph, the real GDP from 1980 onward was fluctuating up and down and on average not trending in either direction. It is perhaps best to refer to this condition as an economic malaise rather than a recession because the economy was in difficulty more than a year before it was officially an economic recession.

Below the statistics on the unemployment rate will be presented, but the key variable of concern is investment purchases. History demonstrated how important this variable is. The immediate cause of the Great Depression of the 1930's was the catastrophic collapse of investment purchases. There were prior causes, such as the real interest rate stemming from restrictive monetary policy, but it is in investment purchases that these factors have their effect. The graph below shows what was happening to investment purchases in 1979 through 1982.

This was the picture of investment conditions seen by economists and politicians in 1982. It was not a comforting picture. The profile for mid-1981 to 1982 was especially distrubing. It is the classic picture of a catastrophic collapse in progress.

The Statistical Details

Having shown the situation concerning investment it is now appropriate to review the other statistics in detail.

Below are the figures from the Bureau of Economic Analysis of the U.S. Department of Commerce for quarterly real Gross Domestic Product (GDP) levels, seasonally adjusted and in billions of chained 2000 dollars.

What the above GDP statistics show is that prior to 1979 the GDP had been growing by about fifty to a hundred billion dollars per quarter. In 1979 the growth continues but at a slower rate, about thirty billion per quarter. Then after the second quarter of 1980 there is an actual fall in GDP of about five billion and then another fall of nine billion in the next quarter. The economy then recovers in the fourth quarter of 1980 and adds a hundred billion and another hundred billion in the first quarter of 1981. The economy then falls in the second quarter only to rise in the third and fall in the fourth. The erratic pattern continues in 1982 but in 1983 the economy commences to grow again.

Only part of the period would fit the notion of recession as a period of decline in GDP and even less of it would fit the strict definition of a recession as a period in which the GDP declined for two quarters or more. But clearly the whole period of 1980-82 is one of an economic malaise and represents an episode of economic difficulty.

Although recessions are defined in terms of output (GDP) they are felt in terms of the unemployment rate. Here are the unemployment statistics from the Bureau of Labor Statistics of the U.S. Department of Labor.

Several things are clear from the above statistics. First there was a perceptible rise in the unemployment rate in 1980. Second the unemployment rate rose as the period of no growth in output persisted while the labor force grew. Third the peak unemplyment rates persisted after the economy began to grow again in 1983 because of the backlog of unemployed workers that had accumulated during the period of no growth. Fourth, and perhaps most important, after the recovery of growth the unemployment rate stayed at a higher level than it had been at before the recession.

So far there has been no mention of the cause of the recession or malaise or whatever one wants to call it. The cause clearly was Paul Volcker's tight money policy which the Fed carried out to kill the chronic inflation that had developed in the U.S. economy during the 1970's. To show this one needs the statistics on the nominal interest rate, the rate of inflation and the real interest rate. The real interest rate is the key variable because it determines the level of investment. However, the level of investment is an accumulation of work on past inititated investment projects as well as the current ones so the level of investment has a lagged response to the real interest rate.

A subsidiary issue is the impact of the Reagan administration's fiscal policy. Some taxes were cut, government expenditures in some fields were also cut and the net impact has to be evaluated. There were record high levels of deficits, but macroeconomic analysis indicates that governmental actions attempting to stimulate the economy will not be effective unless there are deficits.

There was also a trade deficit that worried politicians. The trade deficit was an effect of the high value of the dollar relative to other currencies and this in turn was the result of the high real interest rates in the U.S. compared to other countries.

(To be continued.)

Investment

The key variable affected by the high real interest rates was the level of investment purchases. The statistics shown below show that investment purchases started to drop in the third quarter of 1979, the quarter in which the policy of more severe constraint on monetary growth was announced, and continued downward to the third quarter of 1980. From then there was a partial recovery until the third quarter of 1981. Thereafter investment purchases turned downward and continuted downward until the fourth quarter of 1982. By that quarter investment purchases were off the previous peak of the second quarter of 1979 by almost $61 billion. Had there been no compensating increases in the other components of aggregate demand the GDP would have been down almost $134 billion. This would have led to an unemployment rate of about 10.4 percent instead of the 8 percent rate that prevailed.

Had there been no compensating increases in the other components of aggregate demand the levels of investment and GDP would have continued downward and there would have been a full blown depression. But there were compensating changes. The most publicized was the Reagan Tax Cut. There were cuts in some fields of Federal government purchases but increases, notably in defense, in others.

The tax cut was justified in terms of Supply-side Economics but equally well could have been justified in terms of demand-side stimulation of the economy. The increase in government purchases along with the tax cut led one economist to characterized the economic policy of the Reagan administration as being "Keynesianism on steroids." Regardless of how the policies were publicized and characterized the end result is that they kept the anti-inflation policy of the Volcker Fed from recreating the conditions of 1929-1930 when the Fed precipitated the Great Depression. For more on the role of Fed policies in creating the Great Depression see Depression Money.

Although the statistics on the recovery of investment purchases were presented above the numbers do not have the impact of a graph in showing how investment purchases recovered after the stimulation of the tax cut and net increases in government purchases.

It is to be noted that the deficits of the Federal Government did not "crowd out" private investment. On the contrary, the expectations of economic recovery and growth induced higher levels of investment purchases. In other words, private borrowing was enticed in. Where did the funds come from for businesses to borrow. They came from the increased savings generated by the recovery of the economy. It is also to be noted that the increased deficits of the Federal government did not lead to increased inflation. On the contrary during the time of the increased deficits the chronic inflation of the 1970's collapsed and did not re-emerge.

(To be continued.)

For material on the other recessions in the U.S. and elsewhere see Recessions.