Demand-pull inflation under Johnson - Economics Video Lecture

Male voice: What I want
to do in this video
is a little bit of 1960's
U.S. economic history
and then just see if our Aggregate Demand
Aggregate Supply model
fits the description
of what actually happened. One could argue
you don't need the ADAS model
to describe what happened,
but we should at least
make sure that it does
describe what happened. If we go to 1960,
this is the very end of the
Eisenhower administration.
Eisenhower was a Republican
in office. The only
reason why I give his party
affiliation is because
if the economy is weak,
and in 1960 the economy
was weak and one can always debate whether
it was due to the government or whether
it was due to just the
natural fluctuations
in the economy, but in
general, when the economy
is weak, it tends to go against the party
that is in power. In 1960, the Republicans
were in power. There was
a recession. One could
argue that was a major
reason why the Democratic
candidate in the 1960
election was able to win,
John F. Kennedy. In
1961, JFK is inaugurated.
He becomes President of the United States.
One of his top goals is
to try to turn around
this economy. He does
it with what can best
be described as Keynesian
policies, and we'll
talk more about that in future videos.
In fact, I should probably devote many
videos to Keynesian policies.
It's the general idea
that the government might
be able to turn around
a recession by sparking demand. The way
that it would spark demand is try to put
more money in people's pockets, or even
in businesses' pockets. It would do that
through some combination of increased
government spending,
maybe somehow giving money
to the poor, some types
of transfer programs,
and tax cuts for people and for businesses
so that they have more money to spend.
These policies get implemented and over
John F. Kennedy's term
you do have GDP begins
to turn back around,
unemployment, I'll just write
employment goes up, and
inflation stays low.
Inflation is low.
These are all of the things
that you want in an economy.
Unfortunately, this is just
kind of a sad human event,
in 1963, John F. Kennedy,
you probably know,
is assassinated. Then his Vice President,
Lyndon Baines Johnson, that
is LBJ right over there,
Lyndon Baines Johnson becomes President.
LBJ becomes President.
A little bit of trivia:
He's tied for the tallest
President in U.S. history,
tied with Abraham Lincoln at 6'4".
He inherits a very, very
good economy; almost,
one could argue, a perfect economy.
If Keynesian policies were
really to be practiced
here to their full idea, in theory, once
the economy started to
get a little bit really
overheated and really
approaching its potential,
in maybe 1964-1965, the
government maybe should have
started to pull back a
little bit on its spending
so that the economy
doesn't get overheated.
But Lyndon Baines Johnson did not do this.
He kept things going,
and in fact he added more
fuel to the fire. One
could argue that some of it
was driven by geopolitics.
A major factor was
right over here, the
Vietnam War, which was
escalated in a major way
under LBJ's administration.
JFK was already dabbling
in Vietnam, but it
became a really major
war for the United States
under Lyndon Baines Johnson.
So some combination of
Vietnam, and he had a huge
number of social programs,
increased government
spending, to try to ease
inequality in the U.S. as well,
so social programs. One could
call it guns and butter.
Social programs to try to ease inequality.
The net effect of this
is government spending
even though the economy
was already red hot,
it was already at its potential, he wanted
to increase government spending even more,
so he kind of took it
beyond its potential.
He made it overheat a
little bit and what happens
in 1966 and onwards is
that you have inflation
starting to grow at a
fairly uncomfortable rate.
Inflation starts to grow dramatically.
Just to get a sense of
it, when I keep saying
that the economy was at
its potential and maybe
he might have taken a
little bit of his pedal
off the gas, or his foot off of the pedal,
I should say, is as we
get into the beginning
of his administration,
1964-1965, unemployment
is in the 4-5% range.
Inflation is in the 1-2% range.
GDP is growing at a very healthy rate.
Despite that, and maybe he could argue
maybe his hand was forced
by geopolitical events
especially on military
funding, the government
continues to even spend more
money, stimulates things
even more because that
money goes to soldiers'
salaries, it goes to
companies that provide,
I guess that make napalm
or make boats or make
whatever else. All of
these government programs
inject even more dollars into the economy,
and so you ended up with
inflation. The economy
was already operating at close to capacity
and it made it go maybe even beyond its
natural capacity. Let's see whether our
ADAS model would make, would
allow for this to happen,
or would describe this,
or would predict this
given what was going on. Let's draw ...
That right over there is my price axis.
This right over here is my real GDP axis.
Let me scroll down a little bit.
This right over here is real GDP.
If we go into the 1964-1965 timeframe,
you could say that the U.S. is performing
at its potential GDP. When I talk about
its potential GDP, I'm
saying that on the long run,
assuming that people aren't overworked,
assuming that factories
are getting their proper
maintenance, they're not being run so hard
that they start cracking at the seams,
this is how much that
the U.S. can produce.
If theory, if everyone worked even harder
and didn't sleep and
were doing things in an
unsustainable way, they might even be able
to produce more. One could view this as
a theoretical maximum. When
we talk about potential
we're not talking about that short term
theoretical maximum, we're talking about
the maximum GDP that
an economy can produce,
I guess you could say, in a healthy way,
or over the long run, assuming that people
aren't overworked and that the factories
aren't overworked in
some way, shape or form.
This could be our situation
maybe in 1964-1965.
Let's draw this right over
here is the level of prices.
We just want to see if, in general, we get
this type of thing
happening from our model.
This is our aggregate
supply in the long run.
Our aggregate supply in
the short run we know
might look something like this.
That's aggregate supply in the short run.
Then from our model we will assume ...
Let me draw that a little
bit neater so it intersects
a little bit better. This right over here
is aggregate ... let
me draw it a little bit
better than that with the slope ...
This is our aggregate
supply in the short run.
Aggregate supply in the short run.
Let's draw our aggregate demand.
I'll do that in this green color.
Aggregate demand might
look something like that.
That is our aggregate demand.
This is 1964-1965. Here
we are, the economy's
humming along at its potential.
Now more gas is thrown on the flame.
Government accelerates
its spending; not just
to turn on the economy;
now because of Vietnam
and all of these social
programs. What's going to happen?
That money's ending up
in company and people's
pockets, they're going to demand more.
It's going to shift the
demand curve to the right.
At any given price, they're
going to demand more.
Aggregate demand is going
to shift to the right.
Maybe it goes, it shifts
to the right, and maybe
it goes someplace right over there.
What is the new short term equilibrium?
Aggregate demand is
intersecting aggregate supply
right over here. Right
over there, and as we see,
the equilibrium level
of prices on this model
now has gone up. Our
productivity, we're now
producing above potential.
We're overheating a little bit.
Actually, if you look at
the data in 1966-1967,
unemployment did become ridiculously low.
It even got in kind of the
three point something percent
for a little while.
Many people would argue
that even now that is
an unnaturally low level
of unemployment; that people and factories
are really operating at, maybe beyond
full capacity, or beyond a
sustainable full capacity.
But, we see from this model what you think
would happen actually does happen.
Prices would go up. Right over there.
Then on the long run, you
really wouldn't be able
to sustain this level of producing above
your potential, and
over the long run things
would settle back right
over here, and all you're
left with, really, is the inflation.