Sunday, January 3, 2010

Forrester on Reagan Proposals

Evaluation of the Reagan Economic Proposals by Jay W. Forrester and Nathaniel J. Mass

July 23, 1981

Summary of a presentation made to Sponsors of the System Dynamics National Model on May 5, 1981

I found Nathaniel Mass's obituary. Apparently after being Associate Professor at MIT he just worked at a bunch of consulting companies.

Anyway, I wanted to write about a few notable points from the paper.

Forrester argues that American businesses are not doing as well globally or even domestically not because of government regulation or labor, but because of "managerial ineffectiveness" and "fundamental long-term economic changes." By managerial ineffectiveness, he is referring to the fact that inefficient practices are being passed on to the consumer as higher prices. "Prices could be raised to cover rising costs because the increasing money supply created a public ability to pay higher prices." I wonder how relevant this criticism is today. Regarding "long-term economic changes," Forrester cites his paper "Productivity as Affected by Long-Term Economic Changes," 1979.

He also says that contrary to popular belief, tight money supply has little effect on business cycles and real economic activity. "Business cycles can combine with an underlying steady inflaction caused by the creation of excess money to induce the Federal Reserve to tighten money just ahead of a recession that was already imminent." "Our computer simulations of economic behavior indicate that the mild recessions following World War II were not a result of government policy but instead were a consequence of the capital-construction boom at that time for rebuilding the capital plant that had become obsolete during the depression of the 1930's and World War II." I wonder if there is more analysis somewhere about why the Great Depression happened.

Forrester says that "the Johnson administration has correctly come to be blamed for starting the trend toward high inflation." Although, he notes that "the process of inflationary deficits coupled with money creation to cover the deficit" has been perpetuated by every administration since. Apparently, the ave annual deficit during the Johnson administration was $8.6 billion. During Nixon's first time, it was $16, during his second term, it was $43.5, and during the Carter administration, it was $47.3 billion. We all know what happened from there.

Forrester approves of reducing government spending, a 'supply-side' policy, although he doesn't think the Reagan administration is putting enough emphasis on it. Indeed, while Reagan reduced spending on social programs, I believe that he increased defense spending so much that the deficit ballooned. "As people are released from government employment and from support through transfer payments, more human resources become available for private-sector production. Only through such transfer to making goods, growing food, and building housing can the standard of living of the country be raised."

The concept of the velocity of money is also notable. I'm not too clear on what it is, but it seems like the idea of increasing leverage of banking institutions. "As velocity increases and becomes more volatile, the Federal Reserve loses more and more of its control over the effectiveness of money. Because of the multiple forces now converging to increase velocity, a direct legal control of velocity may soon be needed. Such a control would take the form of setting a minimum permissible bank balance in terms of a specified number of days worth of average transactions."

I wonder if Forrester and System Dynamics began to fall out of favor with their assessment of the Reagan policies since Reagan became immensely popular. However, their prediction that Reagan's policies would increase the deficit certainly happened, although I'm not sure if their prediction about rising inflation happened. Perhaps that prediction just materialized with the crash in 2008.

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