NationStates Jolt Archive

I’m trying to wrap my brain around the real difference between Keynesian or demand-side economics, and supply-side economics.

From my understanding, the Keynesian school of thought is that government can stimulate the economy on a macro-level, through a variety of means, including manipulation of monetary standards and deficit spending to create employment, and therefore the demand needed to stimulate the economy.

Isn’t supply side practically the same thing? Supply-side economists, from what I can tell, argue that focusing on the supply side of the equation, will automatically create the demand that will stimulate the economy. Their method however, was to manipulate the tax system. However, supply side economics still ended up in budget deficit, so you more or less ended up with government funded economic recovery - Keynesian economics.

I’m missing something here right? Is this nothing more than an economic chicken vs. egg? I take a look at the Reagan period, and see that the US national debt tripled during his tenure, and they call it ‘supply-side’. I look at Ontario’s NDP reign under Bob Rae, and he triples the province’s debt, and they call it ‘Keynesian’.

I’m curious.

Keynesian economics is based upon the principle that demand creates its own supply, whereas supply-side economics hinges on the principle that supply creates its own demand. The former manipulates aggregate demand to boost GDP, while the latter manipulates aggregate supply to boost GDP.

Even though both use fiscal policy to manipulate the economy, Keynesian economics uses increases in government spending to boost the economy (since government spending is calculated as part of aggregate demand, or real GDP) whereas supply-side economics uses tax cuts to stimulate the economy. The idea is that by returning money to taxpayers it will cause consumers and investors to spend more, boosting real GDP.

The deficits produced under Keynesian policies are intentional and are meant to stimulate the economy by expanding the money supply, whereas the deficits in supply-side economics are not really part of the policy and are supposed to be eliminated by the boost in economic growth that tax cuts are supposed to produce. The scope of these tax cuts is based upon their interpretation of the current tax rate's position on the Laffer curve.

I figured you might stumble on this one sooner or later... the crickets were deafening. :p

Well, that's what I mean... other than the method of boosting employment, they both essentially are trying the same thing - create employment to drive the economy. The deficits during the Reagan era may not have been intentional, per se, but they were there.

Perhaps one could argue that supply-side didn't actually take place. Would such an economic boost have happened if the government had to reign in spending to control the budget deficit?

I figured you might stumble on this one sooner or later... the crickets were deafening. :p

I was still asleep...I went to bed at 7 AM. Ironically enough, I was actually working on my take-home Econ 201 midterm.

Well, that's what I mean... other than the method of boosting employment, they both essentially are trying the same thing - create employment to drive the economy. The deficits during the Reagan era may not have been intentional, per se, but they were there.

Yes, that's true. The main difference in this case is more of the philosophy behind the two methods; their goals are the same, but they use different methods to achieve it.

Perhaps one could argue that supply-side didn't actually take place. Would such an economic boost have happened if the government had to reign in spending to control the budget deficit?

Actually, it might not have. During the early 80's, the government used an extremely tight fiscal policy, and when that was combined with the overly strong dollar it made it difficult for the US economy to get the kind of liquidity and overseas demand it needed to recover from the 1970's stagflation and the 1982 recession. We needed to pump that deficit spending in to the economy in order to return in to a more normal state of affairs; unfortunately, that came at the cost of some of the largest deficits in history.

And an interesting possibility is that the budget surpluses of the late 90's actually made the 2001 recession worse than it might have been otherwise by removing money from the economy at the same time that investment spending was plunging from the dot-com collapse. When combined with overtightening by the Federal Reserve, it made the monetary environment too tight and there wasn't any liquidity cushion to soften the blow.

Yes, that's true. The main difference in this case is more of the philosophy behind the two methods; their goals are the same, but they use different methods to achieve it.

Well, when I started looking up supply-side (on wiki), I read into the whole 'supply creates demand equal to the value of the created product' line of thinking. Which makes sense. But I had to scratch my head because I thought that was always a Keynesian concept.

Or are Keynesian concepts more along the lines of monetarism, and controlling fiscal policy? I always took creation of government jobs to be a Keynesian concept, but perhaps it isn't?


Actually, it might not have. During the early 80's, the government used an extremely tight fiscal policy, and when that was combined with the overly strong dollar it made it difficult for the US economy to get the kind of liquidity and overseas demand it needed to recover from the 1970's stagflation and the 1982 recession. We needed to pump that deficit spending in to the economy in order to return in to a more normal state of affairs; unfortunately, that came at the cost of some of the largest deficits in history.

And an interesting possibility is that the budget surpluses of the late 90's actually made the 2001 recession worse than it might have been otherwise by removing money from the economy at the same time that investment spending was plunging from the dot-com collapse. When combined with overtightening by the Federal Reserve, it made the monetary environment too tight and there wasn't any liquidity cushion to soften the blow.

Depending on what those budget surplusses are spent on, wouldn't that money stay in the economy anyway? Or were they spending it on foreign debt?

Well, when I started looking up supply-side (on wiki), I read into the whole 'supply creates demand equal to the value of the created product' line of thinking. Which makes sense. But I had to scratch my head because I thought that was always a Keynesian concept.

No, the Keynesian concept is the exact opposite; it believes that demand creates its own supply, and the goal is to manage that demand through government policies to keep the economy running at potential GDP.

Or are Keynesian concepts more along the lines of monetarism, and controlling fiscal policy? I always took creation of government jobs to be a Keynesian concept, but perhaps it isn't?

No, actually the underlying theory of supply-side economics tends to be more on the fiscally conservative side, since they ideally want to reduce the size of government as well as cut taxes.

Depending on what those budget surplusses are spent on, wouldn't that money stay in the economy anyway? Or were they spending it on foreign debt?

That was the thing. Those surpluses were being held by the government to try and fund entitlements like Social Security and Medicare; that money wasn't really going back in to the economy at all.

All right, thank-you!

So, I'm coming away from this with the basic understanding that the main difference between the two school of thoughts is that supply-siders believe that freeing up capital by reducing taxation will increase investment, and thus the creation of product that will drive a new demand - and stimulate the economy. The budget deficits are coincidental, and not necessarily a feature of supply side.

Tried and true Keynesian concepts would have left the US economy in a stagnant position - theoretically.

But I can't help but think that all that really happened is the US economy just borrowed its economic strength from the future. There's no escaping that large debt hanging over America's collective head.

All right, thank-you!

So, I'm coming away from this with the basic understanding that the main difference between the two school of thoughts is that supply-siders believe that freeing up capital by reducing taxation will increase investment, and thus the creation of product that will drive a new demand - and stimulate the economy. The budget deficits are coincidental, and not necessarily a feature of supply side.

Exactly.

Now, some supply-siders will also take cues from Keynesian theory and encourage those deficits to attempt to further boost the economy, but basic supply-side theory does not really use deficits as part of its policy tools.

Tried and true Keynesian concepts would have left the US economy in a stagnant position - theoretically.

Well, if we look at the 1930's it's pretty clear that pure Keynesian economics don't really do too much to boost the economy. Those policies did help curb the worst poverty of the Depression, but they didn't actually help it grow out of it.

But I can't help but think that all that really happened is the US economy just borrowed its economic strength from the future. There's no escaping that large debt hanging over America's collective head.

That's the thing. Fiscal policy is supposed to be cyclical; during recessions, deficits stimulate the economy and during expansions it is supposed to produce surpluses that can be used to keep the debt in check and save up for future economic slowdowns. However, that's gone haywire and we're running deficits regardless of economic conditions. And, of course, running deficits during expansions, like we currently are, can actually harm the economy far more than they help.

So, a tool that is normally meant to be used during recessions is now occurring all the time, reducing its effectiveness and forcing us to borrow against the future to fund it.

That's the thing. Fiscal policy is supposed to be cyclical; during recessions, deficits stimulate the economy and during expansions it is supposed to produce surpluses that can be used to keep the debt in check and save up for future economic slowdowns. However, that's gone haywire and we're running deficits regardless of economic conditions. And, of course, running deficits during expansions, like we currently are, can actually harm the economy far more than they help.

So, a tool that is normally meant to be used during recessions is now occurring all the time, reducing its effectiveness and forcing us to borrow against the future to fund it.

Well, what do you figure is the solution to this issue? I tend to argue along the lines of democratic reform. North America's democratic tendencies lend towards short-lived governments that tend to accomplish changes in short bursts... sometimes this is a good thing, however, I like the Swiss model of semi-permanent governments that change only slightly in make-up after every election cycle. This, in my mind, lends itself towards as sense of continuity, and you are less likely to have governments that spend to meet election goals.