The challenge to the Keynesian paradigm, which unfolded largely within the economics profession’s mainstream channels of discussion, came in three distinct waves. The first began with warnings in the late 1960s that the conventional wisdom regarding the mutual exclusivity of stagnation and inflation was simply wrong. The established view held that there existed a trade-off between unemployment and inflation—when the one decreased, the other rose. This relationship appeared to be forcefully demonstrated in the work of a New Zealand economist working at the London School of Economics, A. W. Phillips, who in the late 1950s observed that British statistics indicated that wages and unemployment had varied inversely over a long period. His quantification of this tendency became the well-known Phillips curve, and American scholars soon discerned a similar pattern in the U.S. data. From the Phillips curve, Keynesians drew the implicit lesson that they could use discretionary fiscal and monetary policy to fine-tune the economy along the curve and in that way achieve an acceptable level of unemployment at a moderate level of inflation.

In his 1967 presidential address to the American Economic Association, Milton Friedman devastated the conceptual underpinnings of the Phillips curve and struck the single most telling intellectual blow against the reigning Keynesianism. James Tobin, a prominent Keynesian and the 1981 recipient of the Nobel Prize in economics, described the published version of Friedman’s address as “very likely the most influential article ever published in an economics journal.” Friedman argued that there existed a “natural rate of unemployment,” which is dictated by the particular structural and institutional characteristics of the economy, especially the labor market, at any given point in time; to lower unemployment below the natural rate by trading off a bit of inflation was in the long run impossible. Any such attempt would require increasing rates of inflation and would in the end result in the disastrous condition of stagflation (although Friedman did not use that term), with high inflation and high unemployment coexisting in calamitous tandem. “There is always a temporary trade-off between inflation and unemployment,” Friedman concluded, “[but] there is no permanent trade-off.” The hope of paying for a decrease in unemployment below the economy’s “natural” or structural level with only a modicum of inflation was illusory. In other words, Friedman was calling into question Keynesianism’s most basic policy prescription, the stimulation of demand in order to reduce unemployment. If Friedman was right—and he was— the activist Keynesian paradigm and the U.S. economy were in for serious trouble (as the subsequent experience of the 1970s seemed to prove).

The second wave of the assault on Keynesianism came in the 1970s in the work of the Nobel Prize-winning economist Robert Lucas and his followers of the so-called rational expectations school. Although they elaborated their theories in dauntingly dense and complex formulations, Lucas and his adherents pointed to a deceptively simple conclusion: they argued that predictable government intervention was destined to be futile and ineffectual because economic actors would anticipate it. For example, if government historically responded to recession by boosting demand, firms caught in a downturn would expect the government to do so again and be tempted simply to raise prices in anticipation of government action rather than allowing them to fall or increasing their output. Policy could successfully change behavior only by surprising or fooling economic actors, and, of course, the unpredictableness of a self-conscious policy of surprise carried with it still other dangers of instability. Thus, government activism of any sort was suspect.

Little wonder, then, that the president of the Federal Reserve Bank of Minneapolis, Mark H. Willes, wrote, “Until the early 1970s, the economists who opposed the Keynesians had to be content with pulling a few fish off of their opponents’ hooks. But when what has become known as the theory of rational expectations began to be developed, these economists found that they could simply dynamite all the fish in the lake.” Willes’s comment understated the significance of Friedman’s demolition of the Phillips curve, but captured well the contemporary judgment regarding the radical implications of the rational expectations approach. In his presidential address to the American Economic Association in 1976, Franco Modigliani called the incorporation of the rational expectations hypothesis into Friedman’s critique “the death blow to the already battered Keynesian position.” A third and final, somewhat more oblique attack on Keynesian orthodoxy came in the field that soon came to be called the New Public Finance. Led by such luminaries as Harvard’s Martin Feldstein, this movement argued that existing tax disincentives—the ways in which the tax system discouraged desirable economic behavior—were greater than Keynesians admitted, that they seriously distorted saving and investment decisions, and that the inflation of the 1970s was exacerbating those effects by pushing individual and corporate taxpayers into ever-higher brackets based on inflationary, nominal rather than real, gains. By 1980, the work of the New Public Finance school—Feldstein, his Harvard colleague Lawrence Summers, and Stanford’s Michael Boskin—had, according to Paul Krugman, “convinced many economists that U.S. taxes were in fact a significant obstacle to investment.”

By the end of the 1970s, the combined weight of these professional challenges had left the Keynesian paradigm in tatters. “By about 1980, it was hard to find an American academic macroeconomist under the age of 40 who professed to be a Keynesian,” lamented Alan Blinder, himself an economist of such inclination at Princeton University. That this “intellectual turnabout” had transpired “in less than a decade” was, in his eyes, “astonishing.”With less sadness, Robert Lucas wrote in 1981 that Keynesianism was “in deep trouble, the deepest kind of trouble in which an applied body of theory can find itself: It appears to be giving wrong answers to the most basic questions of macroeconomic policy.” Pragmatists and policymakers in the middle, who gave allegiance wholly to neither Keynes nor his academic detractors, found themselves adrift on the currents of academic debate and real-world ineffectiveness. As Paul Volcker explained to a journalist, “We’re all Keynesians now—in terms of the way we look at things. National income statistics are a Keynesian view of the world, and the language of economists tends to be Keynesian. But if you mean by Keynesian that we’ve got to pump up the economy, that all these relationships are pretty clear and simple, that this gives us a tool for eternal prosperity if we do it right, that’s all bullshit.”

The weakening of the Keynesian consensus in both macroeconomics (because of intellectual challenges) and policy (because of the practical failure to deal effectively with stagflation) opened the way for the emergence of a new, competing approach to economic problems that would subordinate the Keynesian emphasis on the management of demand to a renewed attention to the problems of supply. The resultant “supply-side economics” was a complex mixture of intellectual insights from within the economic mainstream—often rediscovered ideas from the pre-Keynesian past—and prescriptions from the more highly and overtly politicized worlds of public policy and advocacy journalism.

Whereas the attacks on the existing Keynesian consensus had taken place within the economics discipline’s traditional channels of professionally scrutinized theoretical disputation—in refereed journals and the like— the framing of the supply-side alternative occurred more in the rough-and-tumble of policy debate and was, therefore, a more haphazard and inchoate process. As late as 1981, one supply-sider has noted, “there were no distinctive supply-side texts, no courses, no distinguished scholar, and no school of supply-side economists.” Nevertheless, the formulation of supply-side economics has not lacked for chroniclers, and the recollections of the participants enable us to chart the development of the doctrine with some precision and confidence. Just what constituted the essence of the supply-side approach that took shape as the Keynesian approach went into decline has been a matter of dispute.

The champions of the new school have complained bitterly about being misquoted and mischaracterized. Notwithstanding such controversy, the basic outlines of their position are clear. First, they emphasized that supply matters greatly, an economic truism that had, in fact, been lost sight of since the triumph of Keynes, in the aftermath of which the chief economic problem had seemed to be the maintenance of sufficiently high aggregate demand to keep pace with the economy’s recurrent tendency toward overproduction.

Supply-siders shifted attention back to the problem of productivity and how to raise it. Second, in achieving this rediscovery of the relative significance of supply, the supply-siders also necessarily shifted attention away from macroeconomics, with its concern for aggregate behavior, and back to the behavior of discrete economic actors—individuals and firms.

Third, following the logic of their broad suppositions, the supply-siders believed that the way to achieve prosperity without inflation was to expand supply by increasing the incentives for individuals to work, save, and invest: the surest way to achieve such results was to cut taxes, especially the existing high marginal rates—those tax rates that applied to the last dollar of income and that therefore most discouraged extra effort and enterprise. Such a tax reduction, they claimed, would raise real output—not by increasing demand but by operating on the supply side of the economy. Full-bore supply-siders went so far as to assert that such tax cuts would be so powerful as to actually generate more revenue than would be lost by the cuts themselves.

The theoretical base for these supply-side ideas derived partly from the classical economics of the nineteenth century and partly from more recent developments at the margin of economic discourse in the early 1970s. At one level, the intellectual founders of the supply-side movement considered that they had chiefly “discovered a lost continent of [pre-Keynesian] economics.” The foundation of the supply-side approach derived from the insights of Adam Smith, Jean-Baptiste Say, and Alfred Marshall. The point of good economics and good government, Say had asserted early in the nineteenth century, was to stimulate production, not consumption. Supply-siders asserted that the enduring wisdom of Say’s insight had been obscured by the wrenching experience of the Great Depression and the subsequent sway enjoyed by Keynes’s emphasis on the necessity of maintaining aggregate demand. The “new” supply-side economics, wrote insider Norman Ture, was “merely the application of price theory—widely and tastelessly labeled microeconomics—in analysis of problems concerning economic aggregates—widely and tastelessly labeled as macroeconomics. . . . Its newness is to be found only in its applications to the public economic policy issues of contemporary American society.”

Supply-side theory, the economist Arthur Laffer agreed, was “little more than a new label for standard neoclassical economics.” Laffer, who taught at the University of Southern California and had worked at OMB in the Nixon years, and Robert Mundell of Columbia University provided what little updating accompanied the modern formulation of supply-side theory in the 1970s. Both were academic outsiders. After having made significant contributions in the field of international economics early in his career, Mundell served as an eccentric, long-haired economic guru to the Right, organizing conferences at his own Italian villa, increasingly removed from the professional mainstream even as his influence among policy entrepreneurs grew; Laffer remained similarly aloof from the conventional world of academe, but became widely known by virtue of authoring the central heuristic device of the supply-side crusade, the so-called Laffer curve, which illustrated the truism that tax rates set too high were as ineffective at raising revenue as tax rates set too low. Laffer was, Martin Anderson, President Ronald Reagan’s chief domestic and economic policy adviser, subsequently wrote, “the first person who took the simple idea of supply-side tax effects that has been around since the dawn of economics and painted a picture of it.” It was indicative of the professional remove of the supply-side theoreticians that insiders would subsequently celebrate the fact that Laffer first drew the curve that bore his name on a paper cocktail napkin during a legendary meeting with a White House staffer from the Ford administration at the Two Continents Restaurant across the street from the Treasury Department in Washington. The chief attraction of the Laffer curve was its suggestion that a reduction of tax rates could conceivably pay for itself by generating more revenue, a generally dubious proposition that would ultimately make the device as controversial and professionally suspect as it was politically seductive—no small feat for a truism.

In the mid-1970s, Mundell and Laffer spread their ideas by means of an ongoing, informal supply-side economics seminar-cum-dinner that convened at Michael I, a Wall Street area restaurant within yards of the American Stock Exchange in Manhattan. The other participants in the Michael I discussions included Jude Wanniski, an editorialist for the Wall Street Journal, who would serve as the emergent movement’s energetic and hyperbolic publicist, and Robert Bartley, that newspaper’s editor in chief. These two powerful business journalists quickly made the Journal’s op-ed page into, as Bartley put it, “a daily bulletin board” for supply-side ideas. Wanniski helped spread the supply-side message to Irving Kristol, a founding father of the neo-conservative movement then starting to blossom; soon the readers of Kristol’s increasingly influential journal of opinion, The Public Interest, were exposed to approving discussions of supply-side doctrine. Wanniski penned the burgeoning movement’s most complete manifesto in 1978, a book that he, with characteristic zeal, entitled The Way the World Works. The basic economic prescription formulated at Michael I and subsequently publicized in these neo-conservative forums was tight money to curb inflation and supply-side (i.e., incentive-creating) tax cuts for economic growth.

Meanwhile, the same supply-side approach to fiscal policy emerged independently in a very practical way on Capitol Hill, where the staff economists Paul Craig Roberts and Bruce R. Bartlett worked with Representative Jack Kemp (and, later, other Republicans) to develop the supply-side ideas that eventuated in Kemp-Roth. Kemp proved to be the linchpin that joined the several wings of the supply-side crusade together. In 1975, Bartley met Kemp in Washington and upon his return to New York, told his Wall Street Journal colleague Wanniski, “You’d better get by and meet this guy Kemp; he’s quite a piece of horseflesh.” Wanniski sought out the young congressman and in short order introduced him to Laffer and Kristol. By mid-1976, the Wall Street Journal had begun to champion Kemp as the chief political spokesman for the new intellectual movement. As Kemp emerged as America’s first supply-side politician and the movement’s political drum major, both the New York theoreticians and publicists and the Washington political economists rallied around him, thereby giving the appearance of unity to a movement that had in reality appeared in different guises and in different places virtually simultaneously.

By April 1976, the new movement had cohered sufficiently to gain its own appellation. In a paper delivered to a meeting of economists, Herbert Stein sketched a taxonomy of economic orientations that included a group he identified as “supply-side fiscalists.” Contrary to the myth that soon grew up among supply-siders, a myth nurtured by the tendency of some movement faithful to accentuate their challenge to establishment economics, Stein did not intend the label to be pejorative (although he would quickly become a spirited critic of supply-side doctrine). Audacious pamphleteer that he was, Wanniski seized upon the label but dropped the term “fiscalist” as too limiting. Supply-side economics now had a name.

That the movement deserved to be singled out as a new, valid, or useful contribution to the centuries-old effort to understand and better order the economic affairs of humankind was challenged from the start. To some critics, the supply-side vision was simply a repackaging of common knowledge; to others, it was a pseudoscience whose relationship to “real” economics was similar to the relationship of astrology to astronomy. Herbert Stein argued that the supply-side dogma was old hat, both theoretically and practically. That supply constituted an important element in economic analysis was, he wrote, something commonly known since the first parrot had gotten a Ph.D. in economics for learning to say “supply and demand.” He considered the Laffer curve argument a “shoddy” echo of the argument mounted by business conservatives in the early postwar years that tax cuts could work miracles—increase production, cure inflation, prevent a recession, raise revenue, and perhaps cure the common cold. “They were Lafferites before there was a Laffer curve,” he told an audience of professional economists, “and possibly before there was a Laffer.” In the hands of such business leaders, Stein recalled archly, supply-side propositions had been little more than “a way of arguing that what is good for us is good for you.”…

When asked whether the incentive effects of reductions in marginal tax rates might not be necessarily slow to appear, Laffer answered, “How long does it take you to reach over and pick up a fifty dollar bill in a crowd?” “That’s how quick it is,” Wanniski agreed, “if the incentive is there, the production is there.” However, to dismiss moderate supply-siders as religious cultists or to focus on “punk supply-sidism” obscures the crucial fact that the supply-siders were not wholly isolated in their essential analysis and policy recommendations.

As the 1970s wound down, the U.S. economy was in free fall, beset by a dramatic drop-off in the rate of productivity growth and a highly unstable rate of inflation. The dominant postwar policy paradigm, Keynesianism, was in tatters, under assault for both its intellectual inadequacy and its practical ineffectiveness. In this setting, the supply-siders’ emphasis on the microeconomic foundations of economic activity and their prescription of tight monetary policy to combat inflation and incentive-directed tax cuts to stimulate economic growth found more than a little resonance. Whereas supply-siders themselves have exaggerated their isolation by romanticizing their role as a tiny band of brothers struggling bravely against a wrongheaded establishment, liberals have exaggerated that isolation out of sheer disdain for the supply-side approach. In truth, by the end of the 1970s supply-side ideas had a significant place in serious discussions of the U.S. political economy…

Although the community of academic economists accorded supply-side analysis a distinctly mixed reception, Harvard’s Martin Feldstein made the National Bureau of Economic Research (NBER) an outpost of supply-side emphasis, if not doctrine, when he became the organization’s president in the mid-1970s. Feldstein’s own research was wide-ranging; when he won the American Economic Association’s prestigious John Bates Clark medal in 1977, the citation lauded his contributions in thirteen different subject areas; but unifying most of his scholarship was a deep interest in the elasticity, or incentives, effects of government policies. And incentive effects lay at the heart of supply-side economics. When the NBER held a two-day conference in January 1980 to review the postwar experience of the U.S. economy, Feldstein reported approvingly that “there are at present some signs of growing public and governmental interest in increasing the rate of capital formation.” “The Keynesian fear of saving that has dominated thinking . . . for more than thirty years is finally giving way,” he told his audience, “to a concern about the low rates of productivity increase and of investment. . . . If the public begins to see more clearly the links between current policies and future consequences, there will be less reason to fear the unexpected consequences of myopic decisions.”…

Thus, by 1980 supply-side economics was both less and more than met the eye. While the claims of its champions were overwrought, so too were the denunciations of its detractors. It remained more a policy vision than a scientific analysis, but it seemed to fill a real void that was theoretical as well as practical. Much of the supply-side approach was already familiar to economists, and the parts that seemed freshest were, in fact, the doctrine’s most dubious aspects. Supply-side thinking remained outside the mainstream, but its policy particulars and its conceptual underpinnings enjoyed notable support.

In retrospect, the emergence of the supply-side doctrine was highly significant. First, it offered policymakers a fundamental change in perspective, a new way in which to envision the nation’s economic problems and their solutions. Second, it enabled the Republican Party to rebound from the disaster of Watergate; in Jude Wanniske’s joyous phrase, the GOP was “reborn as a party of economic growth.” Daniel Patrick Moynihan, now a Democratic senator from New York, had just this development in mind when he observed uneasily in July 1980, “Of a sudden, the GOP has become a party of ideas.” Finally, it gave to conservatives a powerful rationale for the policy agenda that would help them win the White House and undertake yet another ideological crusade in conjunction with (and under the cover of ) a drive for economic growth, a crusade that this time sought to undo the modern American welfare state that had been born of the New Deal and so greatly augmented by the growth liberals’ crusade of the 1960s.