"Life Cycle" Hypothesis of Saving: Aggregate ... - Arabictrader.com

322 Miscellanea
for the whole of the 70s and early 80s. You can explain a lot by the effect of disruption
of oil. The very high price of oil affected not only the ability to produce
but also the cost of production, and in addition these prices gave rise to inflation,
very high inflation. This in turn led the government to take measures to reduce
inflation, which led to diminished activity and decreased employment. When you
have inflation you get into a momentum, a situation in which the inflationary condition
feeds itself. Higher prices lead to higher wages, which in turn lead to still
higher prices and higher wages, and the system is fed into itself. To stop this trend
you must prevent the growing as fast as inflation. When this happens, the
economy becomes short of money and interest. You get unemployment, which in
turn reduces inflation, and eventually you kill it, which in the case of the U.S.
was pretty severe. This was stabilized in 1979–80, a period in which monetarists
played a critical role.
What was done in the U.S. was essentially to maintain the money supply, fixed
on the grounds of monetarism. Then after inflation was broken, and the monetarists
wanted to continue with the same policy, we turned around and permitted
rapid rise. Mr. Volker was never a monetarist, but used monetarism as an excuse
to promote his policies. So, clearly, through the 70s one reason for the decline
was the drop in productivity, which accounted for the continued problem in
the 80s.
A hypothesis worth considering has to do with the change of exchange regimes,
from fixed to floating. The abandonment of fixed exchanges found many people
willing to go along with the change, with the expectation that they would get a
system which would work much better. At no cost you get many benefits in particular
that each country would have more freedom to do what it wanted. What
people did not understand was that fixed exchanges imposed a certain discipline
as to what kind of policy you can have. When you have various exchanges you
do not have to agree, but then there is nothing to keep the exchange fixed. There
is nothing to prevent the exchanges from moving even more widely.
So in principle we have moved into a period of high variation in exchange
rates. Of course this period owes a great deal, I am afraid, to the deeds and misdeeds
of Mr. Reagan, who singlehandedly decided that he would cut taxes and
spend more on armaments simply because it was a “good thing to do.” People
do not like to pay taxes so why not cut taxes, and this of course created a gigantic
deficit, of which you are aware, of up to 4 to 5 percent of income. It created
instability. When you do this, then of course the amount of domestic ceiling available
for capital formation is reduced because it is absorbed by the government
deficit, so you have less ceiling. Interest rates rise, and you attract foreign capital.
Foreign capital is attracted by way of the movement of the exchange rates. Essentially
it is evaluation: it takes a higher exchange rate to import the capital needed