Macro Problem 3

By: Donna Moulton, Daniela Dessi, Karissa Cook, Jeanine Minnocci, Joseph

Mangione, Alexander Di Paola

Scenario: 4 For the years: 1972-1975

Economic Indicators: GDP

Unemployment

CPI

Industrial output

Trade

The Economy is dead in the water. Unemployment is well

above 7% and industrial output has been down in 6 of the 7 months. Inflation is high and

shows no signs of abating anytime soon. Meanwhile, there’s enormous political

pressure from all regions and groups in the country, as well as from foreign central banks and

government. The plea: Do Something!

Background Happening around the world:

Britain takes over direct rule of Northern Ireland in bid for peace

President Nixon orders "Christmas bombing" of North Vietnam (December)

United States events: US Supreme Court rules that death penalty is unconstitutional

Thriving economic growth post WWII starting in 1947

1973 the stock market crashed. Source: http://www.infoplease.com/year/1972.html

U.S. abandoned the gold standard

Newly industrialized countries caused competition in the metal industry

EconomicsUS GDP (1998 dollars): $1,237.30 billionFederal spending: $230.68 billion

Federal debt: $435.9 billion

Median Household Income

(current dollars): $9,697

Consumer Price Index: 41.8

Unemployment: 5.9%

Cost of a first-class stamp: $0.08

Recession in the 1970’s differed from previous recessions → this recession was a stagflation, where high unemployment coincided with high inflation. (https://en.wikipedia.org/wiki/1973%E2%80%9375_recession)

GDP:

http://useconomy.about.com/od/GDP-by-Year/a/US-GDP-History.htm

Unemployment Rate: 1972- 1975

https://www.google.com/search?q=2008+economic+data&sourceid=ie7&rls=com.microsoft:en-US:IE-Address&ie=&oe=&gws_rd=ssl#q=1973+unemployment+rate

http://useconomy.about.com/od/GDP-by-Year/a/US-GDP-History.htm

1973: GDP $25,415 Organization of Petroleum Exporting Countries (OPEC) oil embargo.● Tripling inflation to 8.7%. Fed doubled rate to 11%. U.S. withdrew from Vietnam.

Nixon resigned over Watergate.● Unemployment was close to 5% throughout 1973 and started to rise in 1974 until it

reached 7.2% in the 4th Quarter of that year, reaching a high of 9% in May 1975.

Unemployment:

CPI:

http://www.usinflationcalculator.com/inflation/consumer-price-index-and-annual-percent-changes-from-1913-to-2008/

CPI:

http://www.usinflationcalculator.com/inflation/consumer-price-index-and-annual-percent-changes-from-1913-to-2008/

https://research.stlouisfed.org/fred2/series/CPIAUCSL

Cost of Living 1973 Compared to TodayConsumer Price Index:

1973: 42.6 - 44.42012: 227.7

http://sphs73reunion.org/webpages/zremeconomy.html

Industrial Output:

https://research.stlouisfed.org/fred2/series/INDPRO

Industrial Output:The Industrial Production Index (INDPRO) is an economic indicator that measures real output for all facilities located in the United States manufacturing, mining, and electric, and gas utilities

1972 1973January 41.66 45.71July 43.45 46.87November 44.89 47.7

Trade:

Other Economic Factors:

Recession

Inflation

The Stock Market

Income Growth

Recession:The post war boom that started in 1947 had slowed to a crashing halt in 1973.The annual GDP ratio dropped from a pre 1973 value of 3.6% per year to 2.8% after 1973. Productivity growth dropped from 2.5% to 1.5%. GDP growth rate dropped from 7.2% to -2.1% in 1973. Real GDP level fell 3.2%.

Inflation: The inflation rate ranged from 2.94% to 3.61% in 1972. In January of 1973 the inflation rate was 3.61 but increased dramatically throughout the year, to 6.8% in the Third Quarter, and to a high of 8.71% in November. The inflation rate continued to increase in 1974 to a high of 12.3%.

Stock Market:Starting in February 1973 the value of the S&P 500 declined by over half and the Dow declined by 45% over 21 months.The average trailing PE ratio slumped from 17-18 to 7-11 and stayed at that level for a decade.The stock market was so affected that it took until August 1983 to return to the same levels of January 1973.

Income Growth:A slowdown in income growth started in 1973.

Between 1947 and 1973 family income increased over 100%, increasing at an average annual rate of 3.19%.

Between 1973 and 2004 family income only rose 22%.

Between 1973 and 2006 family income for the bottom 90% increased at an average annual rate of .5%.

Between 1973 and 1987 the income of families headed by someone less than 30 years of age fell 30%.

Economic Situation:http://www.mofa.go.jp/policy/other/bluebook/1972/1972-1-11.htm

The U.S. economy in 1972 experienced prosperity that consisted of stable prices, a high real growth rate (6.4 per cent) and a fall in unemployment (5.1 per cent at the end of 1972).

After achieving short term success in fixing prices under Phase 2, in which wages and prices were legally controlled, the U.S. Government shifted from legal controls over wages and prices to voluntary controls (the so-called Phase 3) in January 1973.

Prices, which had shown signs of an increasing trend focused around wholesale prices since the end of 1972, sharply increased their upward pressure on the occasion of the shift.

The economy continued to grow in the fourth quarter of 1972 through the first quarter of 1973, marking a real annual growth rate of 8 per cent in the first quarter of 1973.

The growth rate greatly exceeded the initial Government estimate of 6.75 per cent made at the start of 1973, and the U.S. economy recently began to show signs of overheating accompanied by inflation.

Fiscal policy solution:Expansionary policy- a policy that allows to increase the money supply and or prevent inflation. An example of this is fiscal policy, which comes in versions of tax cuts, rebates, and increased government spending.

Issues:

The dollar. The price of gold had been fixed at $35 an ounce since the Roosevelt administration. But the growing U.S. balance-of-payments deficit meant that foreign governments were accumulating large amounts of dollars -- in aggregate volume far exceeding the U.S. government's stock of gold.

In retrospect, some would call the Nixon presidency the "last liberal administration." This was not only because of the imposition of economic controls. It also carried out a great expansion of regulation into new areas, launching affirmative action and establishing the Environmental Protection Agency, the Occupational Safety and Health Administration, and the Equal Employment Opportunity Commission. "Probably more new regulation was imposed on the economy during the Nixon administration than in any other presidency since the New Deal," Herbert Stein ruefully observed.

http://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_nixongold.html

Monetary policy solution

Expansionary Monetary Policy

Lower interest rates/Increasing the money supply to boost economic activity.

Reduce incentive to save, therefore, consumer spending will increase

Lower reserve requirement

Buy securities

Main objective of this policy is to increase aggregate demand and economic growth in the economy

In order to increase overall investment within the economy, interest rates on bonds will be decreased

Conclusion: Best Solution

An Expansionary Fiscal Policy should be used.A macroeconomic policy that tries to expand the money supply to stimulate

economic growth or prevent inflation.

Increase aggregate expenditures and aggregate demand through an increase in government spending (both government purchases and transfer payments) or a decrease in taxes.

Creating jobs which will alleviate unemployment.

Actual Outcome:Recession ended in March 1975 & the unemployment rate did not peak until several months afterwards.

In May 1975, the rate reached its height 9 percent.

Economic recovery from the 1973 -1975 recession had many of the characteristics of a typical U-type recovery.

GNP reached and then exceeded its pre-recession level by the first quarter of 1976. Industrial production had also recovered to its pre-

recession levels by the end of 1976.

The major influence of the 1974 recession was stagflation, that is inflation during a period of recession. The Federal Reserve, as a

result, adjusted its mandate in believing that the inflation-unemployment tradeoff was much higher than previously thought, and

established a six percent target as full employment. Thus, unemployment, which had reached a peak of 9% in May 1975 did not dip

below 6% until June 1978.

The Economic Report of the President for 1975 states:

“We therefore confront three problems:

Immediate problem of recession and unemployment,

Continuing problem of inflation

Problem of reducing America's vulnerability to oil embargoes”

The economy needs an immediate one-year tax cut of $16 billion... We chose the method that would provide immediate stimulus to the economy without permanently exacerbating our budget problem.

12 percent rebate of 1974 taxes, up to a maximum of $1000. The rebate will be paid in two large lump sum payments totaling $12 billion, the first beginning in May and the second by September.

$4 billion investment tax credit which would encourage businessmen to make new commitments and expenditures now on projects that can be put in place this year or by the end of next year.…

it will increase the size of the budget deficit. This is all the more reason to intensify our efforts to restrain the growth of Federal spending. I have asked Congress to institute actions which will pare $17 billion from the fiscal 1976 budget. we foresee a deficit of more than $50 billion for the fiscal year beginning July 1.”

The energy program will entail costs. The import fee and tax combination will raise approximately $30 billion from energy consumers.

● A fair and equitable program of permanent tax reductions to compensate consumers for these higher costs. These will include income tax reductions of $16 billion for individuals, along with direct rebates of $2 billion to low-income citizens who pay little or no taxes, corporate tax reductions of $6 billion, a $2-billion increase in revenue sharing payments to State and local governments, and a $3-billion increase in Federal expenditures.

The tax cuts and energy tax increase tabulates as follows:

1. A tax cut was effective at stimulating the economy2. The level of investment purchases was increased despite the increased

government borrowing to finance the tax cut.

Actual Outcome:

Actual Outcome:A careful consideration of the tax cut combined with the energy tax increase reveals that no net tax cut is involved and therefore there would not be any stimulus to the economy. Furthermore the impact of the rest of the package would have been a decrease in aggregate demand of $2 billion. Thus this package would have had no stimulus for the economy; if anything it would have slightly depressed the economy slightly.

Congress rejected the proposed package and enacted its own tax cut. This included a one-time rebate to taxpayers of 10 percent of their 1974 personal income tax, up to a maximum of $200. There was also permanent tax reduction that affected the tax-withholding through the rest of the year. The tax cut bill included negative income tax for low income taxpayers. This was called an earned income tax credit. There was also an increase in the business investment tax credits. To accompany the economic stimulus of the tax cuts there was an increase in state and local governments to be used to create public service jobs.

Sources: http://www.dallasfed.org/

http://www.investopedia.com/articles/economics/09/1970s-great-inflation.asp

http://sphs73reunion.org/webpages/zremeconomy.html (graphs)

https://research.stlouisfed.org/fred2/series/UNRATE FRED UNEMPLOYMENT

http://www.applet-magic.com/rec1974.htm

https://research.stlouisfed.org/fred2/categories/3

https://www.google.com/url?sa=t&source=web&rct=j&url=https://fraser.stlouisfed.org/docs/publications/SCB/pages/1970-1974/8713_1970-1974.pdf&q=economy%20in%201972&ved=0ahUKEwjXuZql84zMAhVCKh4KHWJ5ATMQFggbMAA&usg=AFQjCNFElM0FBRHGsvzZAFkUJMTmiJGlDQ&sig2=lRqxtQfJYDwOyLLsgpZoUA

http://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_nixongold.html

http://www.infoplease.com/year/1972.html

https://en.wikipedia.org/wiki/1973%E2%80%9375_recession)

http://useconomy.about.com/od/GDP-by-Year/a/US-GDP-History.htm

http://www.usinflationcalculator.com/inflation/consumer-price-index-and-annual-percent-changes-from-1913-to-2008/

http://www.mofa.go.jp/policy/other/bluebook/1972/1972-1-15.htm

Sources (Continued)https://www.census.gov/foreign-trade/statistics/graphs/gands.html

https://research.stlouisfed.org/fred2/series/TWEXBMTH

http://www.tradingeconomics.com/united-states/gdp-growth-annual/forecast