Supply-Side Economics

SUPPLY-SIDE ECONOMICS is the body of thought that is concerned with government policy in relation to aggregate supply. It is an approach that stemmed from the reactions of policymakers, economists, and 20thcentury conservatives to the Keynesian revolution, which dominated economic thought from 1936 to the 1970s, when developed nations began experiencing low or negative economic growth.

Supply-side economics emerged from this state of affairs in the 1970s and 1980s. Governments, according to these supply-siders, had focused too much of their attention on aggregate demand to undue neglect of aggregate supply. With economies sliding into recession and seemingly stagnant secular economic growth, economists, politicians, and others were ripe for a change. No one embodied the sentiments, at least in the political realm, of supply-side economics—and ushering in their policies—more than Ronald Reagan.

The foundations of the supply-side revolution have roots in classical economics with the belief that the free market works in not only correcting economic downturns, but also in maximizing output. While its foundations lie in classical economic theory, the supply-side revolution is a direct by-product of the Keynesian revolution and its economics. It is a redirection of economic policy away from demand management—actually its re-jection—toward policies that focus on supply-side factors with a belief in the welfare-maximizing effects of a free-market system.

Supply-side economics is as much about monetary policy, as it is about fiscal policy with the classical principle that a monetary policy favoring price stability and low inflation is important in providing the positive conditions for planning in credit markets, labor markets, and wherever else monetary contracts are important.

To understand the supply-side revolution, it is necessary to examine the state of affairs that existed beforehand, both in theory and in policy. The term supply-side economics was created by Jude Wanniski in 1975 to give currency to a growing tide of discontent and its alternatives to the demand-side economics produced by the predominant Keynesian economics of the day. The events leading up to this time are crucial in understanding the opportunity of reinventing classical economics. The oil crises that shocked the U.S. economy, as well as others, led to recession and high inflation in 1974 and into 1975. The mounting importance of government presence in the economy through welfare, entitlements, and other redistributions of income financed through higher taxes indicated a creeping socialist state and its accompanying malaise. This, along with the growing influence of monetarism, led to the foundation of supply-side economics. It was this environment that produced supply-side economics.

In the Keynesian world that dominated economics in the 1960s, aggregate demand management was advocated and was believed in principle. But the shifting Phillips Curve convinced economists and others that the tradeoff with inflation, caused by increases in aggregate demand, was short-lived and did not exist in the long run. This shifted the emphasis toward the natural rate of unemployment and full-employment output. The question became, if we cannot influence output through demand management, how can we influence employment and output through supply factors?