Question

What are the effects of the rise in government spending on output and prices in the US economy in the short run in the 1960's

Answer 1

As president, John F. Kennedy sought to accelerate economic growth by increasing government spending and cutting taxes, and he pressed for medical help for the elderly, aid for inner cities, and increased funds for education. Kennedy also stepped up American space exploration. In early 1963 inflation was stable, corporate profits were at a record high, and the stock market had rebounded, but unemployment was still too high at 5.7 percent.

His successor, Lyndon Johnson sought to build a "Great Society" by spreading benefits of America's successful economy to more citizens. Federal spending increased dramatically, as the government launched such new programs as Medicare (health care for the elderly), Food Stamps (food assistance for the poor), and numerous education initiatives (assistance to students as well as grants to schools and colleges).

Military spending also increased as American's presence in Vietnam grew. What had started as a small military action under Kennedy mushroomed into a major military initiative during Johnson's presidency. Ironically, spending on both wars -- the war on poverty and the fighting war in Vietnam -- contributed to prosperity in the short term. But by the end of the 1960s, the government's failure to raise taxes to pay for these efforts led to accelerating inflation, which eroded this prosperity.

President Johnson inherited a strong economy from president Kennedy. The growth during his presidency between 1964 and 1965 gave him an annual dividend of $4-5 billion in extra revenues to spend. For the first two years of Johnson’s presidency the inflation rate was just under 2 percent. In 1965 inflation began to pick up slightly, but the GNP (gross national product) grew by $9 billion and unemployment stood at 1.4 percent. The economy was looking better during the winter of 1966: real growth was 9 percent, and with unemployment at 3.8 percent the economy was robust.