Thursday, October 7, 2010

R.I.P. "Pure" Supply-Side Economics

Just as Keynesian economics was declared dead sometime in the 1970s after its claimed failure to address the inflationary & stagnation effects of the OPEC oil shock, the collapse of the U.S. housing market bubble in 2007 and its subsequent & continuing consequences seems fairly strong evidence that supply-side economics is at least rasping painfully on its deathbed.

Wikipedia has a fairly good and reasonably balanced synopsis.

The most relevant passage therein, for the purposes of this posting anyway, is under the Fiscal Policy section of this Wiki article, which I quote as follows:

"The central issue at stake is the point of diminishing returns on liquidity in the investment sector: Is there a point where additional money is "pushing on a string"? To the supply-side economist, reallocation away from consumption to private investment, and most especially from public investment to private investment, will always yield superior economic results. In standard monetarist and Keynesian theory, however, there will be a point where increases in asset prices will produce no new supply, that is where investment demand will outrun potential investment supply, and produce instead, assets inflation, or in common terms a bubble. The existence of this point, and where it is should it exist, is the essential question of the efficacy of supply-side economics."

Weeding through the boring pedantic jargon, what this means is that asset bubbles - the most spectacular of which we just recently witnessed in the U.S. housing market - are evidence of the failure of supply-side economics. If supply-side economics were as effective & true as its proponents claim, the housing bubble should not have happened. But, it did happen.

Markets fail.  Extremist ideologues and ill-informed, non-critical thinkers seem unable to grasp this fact. Denial is an early stage of the recovery process. Clearly we have a long way still to go before we can, as a nation, move forward.

1 comment:

  1. P.S. -

    Paraphrasing Mark Twain, the rumors of the demise of Keynesian economics have been greatly exaggerated.

    Not only does Keynesian theory explain & predict the recent housing bubble, but it's supposed failures are really only the political failure of its proponents to wholly implement its policy prescriptions... and not fundamental flaws in theory.

    It seems broadly understood that Keynesian economics prescribes public fiscal deficits to offset declines in private consumption during poor economic cycles. But, what seems largely forgotten by the public & politicians at large is that Keynesian theory ALSO prescribes accumulating substantial government surpluses during peak economic times, to be saved as a buffer against future potential downturns.

    Alas, surpluses always seem to be dissipated by weak-willed political leadership in tax cut giveaways to the rich... ostensibly in hopes of fueling growth in the private sector, which supposedly is a more optimal use for those funds (as a practical matter, however, it really amounts to nothing more than pandering for votes to ensure politicians retain their seats of power).

    I wonder what would happen is we ever really gave Keynes' prescriptions a full try?