Demand side economics is an outgrowth from Keynesian economics, which is contrary to accepted economic
theories, a government ought to cut taxes and increase infrastructure spending with fiscal
deficit during an economic downturn, and focus on increasing tax revenue during
an economic upturn, which may result in an increase in the nominal wages of
those who tend to spend the greatest portion of their income on consumables,
which results in improved business income and grows the economy.
Supply-side
economicsargues that economic
growth can be most effectively created by investing in capital, and by
lowering barriers on the production of goods and services, consumers will then
benefit from a greater supply of goods and services at lower prices;
furthermore, the investment and expansion of businesses will increase the
demand for employees and therefore create jobs. Typical policy recommendations
of supply-side economists are lower marginal tax rates and less government
regulation.
As my view, that Demand side economics is mainly investment in
infrastructure and that Supply-side
economics is mainly to create a good living environment for businesses’
operation.
In comparison, though that investment in
infrastructure may harmful for the long term economic development, but it
really may play a quick role in stimulating economy. And that creates a good
living environment for businesses’ operation will be conducive to long term economic
development, however, it is a hard systematic process that needs a longer time
and comprehensive social reform to achieve its positive role.
In view of that the two big economies – the
United States and China is both reviewing its economic development policies,
which may lead economy from current Demand side economics turning to Supply-side
economics. Especially, that China may put it into practice soon. We can
speculate that the world economy will continue towards recession for a while.
Demand side economics is an outgrowth from Keynesian economics, which is of course itself the economic theories espoused by John Maynard Keynes. Keynesian economics proposed a series of economic ideas that ran contrary to the classic economic formulations, notably the concept of counter-cyclical budget management as a means to mitigate the ebb and flow of economic cycles of glut and recession. For Keynes, aggregate demand from businesses, the government andconsumers is a more important influencing economic activity than free market forces. Keynesian economics disagrees with the classical economics of Adam Smith and others by maintaining that unfettered free markets do not inevitably lead to full employment.
To accomplish this, Keynes proposed that, contrary to accepted economic theories, a government ought to cut taxes and increase infrastructure spending during an economic downturn, and focus on increasing tax revenue during an economic upturn.
Demand side economics comes into play when the increases in infrastructure spending and cuts in taxes results in an increase in the nominal wages of those who tend to spend the greatest portion of their income on consumables. Keynes viewed excessive saving and investment as a potential harm to the economy, since giving additional income to the rich gives them a low marginal incentive to spend, whereas giving additional income to the poor and middle class provides a high marginal incentive for additional spending -- which results in improved business income and grows the economy.
Since Keynes, worldwide governments have felt they have a duty to maintain employment at a high level.[1]
Supply-side economics is better known to some as "Reaganomics," or the "trickle-down" policy espoused by 40th U.S. President Ronald Reagan. He popularized the controversial idea that greater tax cuts for investors and entrepreneurs provide incentives to save and invest, and produce economic benefits that trickle down into the overall economy. In this article, we summarize the basic theory behind supply-side economics.
Like most economic theories, supply-side economics tries to explain both macroeconomic phenomena and - based on these explanations - offer policy prescriptions for stable economic growth. In general, supply-side theory has three pillars: tax policy, regulatory policy and monetary policy.
However, the single idea behind all three pillars is that production (i.e. the "supply" of goods and services) is most important in determining economic growth. The supply-side theory is typically held in stark contrast to Keynesian theory which, among other facets, includes the idea that demand can falter, so if lagging consumer demand drags the economy into recession, the government should intervene with fiscal and monetary stimuli.
This is the single big distinction: a pure Keynesian believes that consumers and their demand for goods and services are key economic drivers, while a supply-sider believes that producers and their willingness to create goods and services set the pace of economic growth.
The Argument That Supply Creates Its Own Demand In economics we review the supply and demand curves. The left-hand chart below illustrates a simplified macroeconomic equilibrium: aggregate demand and aggregate supply intersect to determine overall output and price levels. (In this example, output may be gross domestic product and the price level may be the Consumer Price Index.) The right-hand chart illustrates the supply-side premise: an increase in supply (i.e. production of goods and services) will increase output and lower prices.
Starting Point
Increase in Supply (Production)
Supply-side actually goes further and claims that demand is largely irrelevant. It says that over-production and under-production are not sustainable phenomena. Supply-siders argue that when companies temporarily "over-produce," excess inventory will be created, prices will subsequently fall and consumers will increase their purchases to offset the excess supply.
This essentially amounts to the belief in a vertical (or almost vertical) supply curve, as shown in the left-hand chart below. In the right-hand chart, we illustrate the impact of an increase in demand: prices rise but output doesn't change much.
Vertical Supply CurveAn Increase in Demand → Prices Go Up
Under such a dynamic - where the supply is vertical - the only thing that increases output (and therefore economic growth) is increased production in the supply of goods and services as illustrated below:
Supply-Side Theory
Only an Increase in Supply (Production) Raises Output
Three Pillars The three supply-side pillars follow from this premise. On the question of tax policy, supply-siders argue for lower marginal tax rates. In regard to a lower marginal income tax, supply-siders believe that lower rates will induce workers to prefer work over leisure (at the margin). In regard to lower capital-gains tax rates, they believe that lower rates induce investors to deploy capital productively. At certain rates, a supply-sider would even argue that the government would not lose total tax revenue because lower rates would be more than offset by a higher tax revenue base - due to greater employment and productivity.
On the question of regulatory policy, supply-siders tend to ally with traditional political conservatives - those who would prefer a smaller government and less intervention in the free market. This is logical because supply-siders - although they may acknowledge that government can temporarily help by making purchases - do not think this induced demand can either rescue a recession or have a sustainable impact on growth.
The third pillar, monetary policy, is especially controversial. By monetary policy, we are referring to theFederal Reserve'sability to increase or decrease the quantity of dollars in circulation (i.e. where more dollars mean more purchases by consumers, thus creating liquidity). A Keynesian tends to think that monetary policy is an important tool for tweaking the economy and dealing with business cycles, whereas a supply-sider does not think that monetary policy can create economic value.
While both agree that the government has a printing press, the Keynesian believes this printing press can help solve economic problems. But the supply-sider thinks that the government (or the Fed) is likely to create only problems with its printing press by either (a) creating too much inflationary liquidity with expansionary monetary policy, or (b) not sufficiently "greasing the wheels" of commerce with enough liquidity due to a tight monetary policy. A strict supply-sider is therefore concerned that the Fed may inadvertently stifle growth.
What's Gold Got to Do with It? Since supply-siders view monetary policy not as a tool that can create economic value, but rather a variable to be controlled, they advocate a stable monetary policy or a policy of gentle inflation tied to economic growth - for example, 3-4% growth in the money supply per year. This principle is the key to understanding why supply-siders often advocate a return to thegold standard, which may seem strange at first glance (and most economists probably do view this aspect as dubious). The idea is not that gold is particularly special, but rather that gold is the most obvious candidate as a stable "store of value." Supply-siders argue that if the U.S. were to peg the dollar to gold, the currency would be more stable, and fewer disruptive outcomes would result from currency fluctuations.
As an investment theme, supply-side theorists say that the price of gold - since it is a relatively stable store of value - provides investors with a "leading indicator" or signal for the dollar's direction. Indeed, gold is typically viewed as an inflation hedge. And, although the historical record is hardly perfect, gold has often given early signals about the dollar. In the chart below, we compare the annual inflation rate in the United States (the year-to-year increase in the Consumer Price Index) with the high-low-average price of gold. An interesting example is 1997-98, when gold started to descend ahead of deflationary pressures (lower CPI growth) in 1998.
The Bottom Line Supply-side economics has a colorful history. Some economists view supply-side as a useful theory. Other economists so utterly disagree with the theory that they dismiss it as offering nothing particularly new or controversial as an updated view of classical economics. Based on the three pillars discussed above, you can see how the supply side cannot be separated from the political realms since it implies a reduced role for government and a less-progressive tax policy.
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Nearly five years since the recession ended in June 2009, economic policy discussions continue to focus on dubious short-term countercyclical measures to "stimulate demand." The Economic Report of the President for 2014 wastes an entire chapter rehashing the jobs supposedly "saved or created" by the 2009 fiscal stimulus and Federal Reserve easing. That analysis relies on notoriously inaccurate forecasting models to take credit for the entirely prosaic facts that (1) the last recession eventually ended just as all previous recessions did, and that (2) employment subsequently rose a bit.
This evades the key issue: Did fiscal or monetary stimulus actually "stimulate demand"?
In recent years the U.S. has experimented with demand-side stimulants on an unprecedented scale. Monetary stimulus involves pushing interest rates down to subsidize big borrowers (mainly governments and banks) at the expense of small savers (seniors). That was the reason the Fed shoved the federal-funds rate down to near zero. Even quadrupling the Fed's assets had no clear and significant impact on the sluggish growth of nominal GDP.
Fiscal stimulus involves big increases in the national debt, in the hope that taxpayers will not notice that national debt is their debt. Borrowing from Peter to pay Paul is thought to provide a net increase in their combined income or wealth, and therefore faster growth in total spending or "aggregate demand."
To find out if fiscal stimulus worked as advertised, we first need to separate deliberate increases in budget deficits from the portion caused by lost incomes and jobs. Once that separation is taken into account, we see that—according to Congressional Budget Office estimates of cyclically-adjusted budget deficits—the average increases were an unprecedented 5.7% of potential GDP from 2009 to 2012. No fiscal stimulus that large ever happened before in peacetime, and certainly not for four full years.
What happened? After such energetic demand-side stimulus, nominal GDP rose by only 3.8% a year from 2010 to 2013, and by 4% in the first quarter of 2014, compared with average GDP growth of 6.1% from 1983 to 2007. Ironically, the Economic Report of the President predicts faster growth of demand from now on—5% or more—but only after deep cuts in federal spending and euthanasia of quantitative easing. The promised stimulus from the previous fiscal and monetary binge remains undetectable—a big fizzle. Demand grew much faster (at a 6.1% pace) from 1998 to 2000, when the budget was in surplus and the Fed hiked the fed-funds rate to 6.5%.
With either monetary or fiscal stimulus, the intended boost in today's spending comes from borrowing against tomorrow's income. That impulse to shift purchases forward accounts for such ephemeral deficit-increasing schemes as the home-buyer tax credit, the cash-for-clunkers tax credit, the refundable "making work pay" tax credit and temporary payroll tax cuts. As Europe is learning, however, borrowing from the future is no fun when the future arrives.
What was thought to be a short-term stimulus to demand may end up being a long-term drag on supply. Expectations of even higher taxes on additions to future income likely discouraged investments that would have increased future income. There is an expense, and a risk, involved in expanding a small business or improving your education, and the incentive to do either is dampened if the resulting higher income—if any—shoves you into higher tax brackets that federal and state politicians seem so eager to increase again and again. Business investments that pay off only in the long term are particularly sensitive to the prospect of higher tax rates on profits.
Federal Reserve efforts to keep interest rates absurdly low have reduced the incentive to earn and save money for the future while encouraging risky debt and dodgy investments. Flattening the yield curve through Fed purchases of long bonds made it less profitable for banks to lend to small business.
The fact that employment has gradually risen from 140 million to 145.7 million since the recession ended is unremarkable. What is truly remarkable is that at the same time that job opportunities improved, the number of Americans who were neither working nor seeking work soared from 80.9 million to 91.4 million.
One economist who understands the importance of work disincentives is University of Chicago economist Casey Mulligan, author of "The Redistribution Recession" (2012), who first blew the whistle on punitive work disincentives in ObamaCare. Another is Nobel Laureate Ed Prescott, who demonstrated on this page ("Why Do Americans Work More Than Europeans?" Oct. 21, 2004) that the people of France are a third poorer than Americans only because they were deprived of incentives to work—by onerous marginal tax rates on excess effort and generous subsidies to indolence.
The demand-side panacea for weak economic growth has encouraged families and firms to spend a larger fraction of their current income and wealth—by using tax and monetary policy to punish savers and reward debtors. A supply-side solution would incentivize families and firms to produce more income and wealth by minimizing unpredictable regulation and litigation, trade barriers, unreliable money and dispiriting tax rates.
Demand-side economists focus on incentives to borrow and spend. Supply-side economists focus on incentives to work, save, invest and launch new businesses. Demand-side economists focus on the uses of income and debt (consumption). Supply-side economists focus on sources of income and wealth.
From the perspective of demand-side bookkeeping, the fact that consumer spending in 2012 accounted for 68.6% of GDP supposedly means economic growth depends on consumer sentiment. Viewed from the supply side—the sources of GDP—private industry accounted for 86.5% of GDP. If private businesses had not produced $14.1 trillion, consumers could not possibly have consumed $11.1 trillion. Economies do not grow because consumers spend more; consumers can spend more only if economies grow.
The time for demand-side gimmicks has long passed. The remarkably aggressive fiscal and monetary effort to stimulate demand did not stimulate demand. Even if it had worked, we can't pretend to be "fighting recession" forever. Today's economic predicament is not a cyclical crisis but a sustained, subsidized lethargy. Different tasks require different tools. When the number of job seekers falls twice as fast as the increased number of jobs, that is a supply-side problem.
Mr. Reynolds is a senior fellow with the Cato Institute.
Opinions expressed by Forbes Contributors are their own.
The latest, grim data confirm that the post-recession U.S. economic recovery of 2009-2011 has been one of the weakest on record. Real GDP growth since the recession that ended in mid-2009 has been a meager 5%, compared to average growth of 9% at this same point following nine previous recessions since WWII.
In these prior recoveries private sector employment had grown by an average of 5.7%, but this time it’s up by only 0.9%, and while past recoveries saw the jobless rate decline by an average of 1.5% points, this time it has declined by only a third as much. Perhaps worse still, whereas in prior U.S. recoveries the duration of joblessness rose by an average of 1.5 weeks, this time it’s up by 15.5 weeks – to an all-time high of 39 weeks.
Many apologists for the Obama Administration and the Bernanke Fed claim that the recent recovery has been weak because the prior downturn was so steep. “The ditch was deeper than we first thought,” Obama himself likes to say, and that’s why it’s taking longer to climb out. But history reveals the opposite pattern: Robust recoveries tend to follow the deepest recessions, while weak recoveries follow shallow recessions.
The undeniable anemia of the current U.S. recovery, coming as it does on the heels of what’s now called “the great recession” of 2007-2009, implies that Obama-Bernanke have done all the wrong things – not “too little” of the right things. Yet many economists insist on still more deficit-spending and/or money-printing.
Now consider that this pathetic recovery was “achieved” by a ridiculous increase of 54% in the U.S. public debt (from $9.3 trillion as the recession began in late-2007, to $14.3 trillion today) and of 211% in the Fed’s monetary base (from $825 billion to $2.5 trillion), which serves as latent rocket fuel for rising inflation rates. These numbers would be horrific enough were they merely the inadvertent fallout of otherwise reasonable and well-meaning public policies; but in truth the results are the inevitable result of two highly-acclaimed, widely applauded but deadly policy approaches: Keynesianism and Monetarism.
Both schools, while posing as academic rivals, in fact have far more in common than they admit. Both obsess about mere spending and consumption — the economy’s “demand-side” — to the neglect and harm of its all-important supply-side. What always drives a robust economy is not “consumers” per se but savers, investors, innovators and producers.
Whereas Keynesians claim a free economy is at risk of “over-producing” and under-consuming, Monetarists claim it is at risk of “deflation” due to insufficient money supplies. The Keynesians are always eager to boost what they call “insufficient aggregate demand,” typically by means of government deficit-spending, a policy they tout as “stimulus.”
Likewise, the Monetarists are ever-eager to counter imagined threats to demand allegedly posed by insufficient money-creation, and if necessary they’d resort to helicopters to dispense the needed money from above, a policy they call “quantitative easing.” Yet these demand-side schemes – Keynesian deficit-spending and Monetarist money-printing alike — only erode entrepreneurial and productive prowess. For example, today’s dangerously long duration of unemployment (39 weeks) reflects repeated extensions of jobless benefits, which Keynesians demand as a way to stoke more consumption, not extra jobs or output.
In truth, and contra-Keynesianism, mere consumption is the effect of production, not its cause; to consume is equivalent to using up or destroying wealth, not creating it anew. Likewise, and contra-Monetarism, the mere creation of fiat paper money (or bank reserves) by a monopoly central bank isn’t the same as creating real wealth; indeed, more often than not the effect — inflation — only undermines the wealth-production process, by distorting price signals, while simultaneously robbing unsuspecting money-holders of purchasing power.
Sadly, U.S. policymakers seem to be aping the crazy policies adopted by their Japanese counterparts starting two decades ago: gargantuan deficit-spending and money-printing. Keynesian and Monetarist policies can easily cross borders, much like viruses. Japan’s economy has stagnated during this time, not “in spite of” its demand-side schemes but because of them. Its government debt is now 200% of GDP, double what it was in 1996, and at the same time the Bank of Japan boosted the money supply by 158%. What good did any of this do? Japan’s NIKKEI today is half what it was in 1996, while its industrial output is higher by only 1%.
In this century so far America also has suffered a “lost decade” of sorts, due to the anti-prosperity schemes of both Keynesians and Monetarists; they’ve depressed the economic growth rate and saddled both current and future generations with massive and unparalleled deficit-spending and debt monetization. Together with a burgeoning mass of regulations, demand-side policies suffocate private-sector incentives to save, produce, invest and hire. Thus capitalists are on strike — and rightly so, since they face political assaults from both sides.
The evidence against Keynesians and Monetarists is undeniable (by most), so they’ve tried to deflect attention from their failures, either by claiming they’re trying to fix all the “problems” left over from the Reagan-inspired supply-side policies of the 1980s and 1990s (which is today’s Big Lie), or by claiming their demand-side schemes haven’t yet been enacted with sufficient intensity. Supposedly more of the same poison is required, perhaps a “QE-3″ or “QE-4,” say the Monetarists, or maybe more deficit-spending, say Keynesians like professor Caroline Heldman of Occidental College (Obama’s alma mater), who on June 3rd conceded to the Fox Business Network that capitalists today are on strike and reticent to invest, but whose only “solution” was to impose on these same capitalists still more deficit-spending and punitive taxation:
“There isn’t any evidence that there’s insufficient capital in private hands. We know that private firms have actually stockpiled more money than they ever have historically. What’s happening is that Washington didn’t spend enough with the economic stimulus plan. It should have been about twice the size, and we didn’t put it into shovel-ready jobs, either. So it’s not an issue of government spending too much but not spending enough, and not spending it on the right things. . . . Also, the vast majority of our problem with the structural budget deficits aside from the unfunded wars is the loss of tax revenue because of the economic crisis, and also because we’re just not taxing wealthy people their fair share. We stopped doing that about ten years ago.”
Heldman’s advice echoes the vile and deadly practice of blood-letting, wherein medieval quacks and witch-doctors insisted on taking more blood if the patient got weaker. Her approach also fits Einstein’s definition of “insanity” as “doing the same thing over and over again and expecting different results.” If true, Keynesians and Monetarists need to be institutionalized, not in academia or Washington, but in psychiatric wards.
Only recently have astute Americans begun to realize that the real choice isn’t between Democrats and Republicans, or even “liberals” and “conservatives,” but between genuine defenders of reason, liberty, and the law and proponents of sheer stupidity and tyranny. Perhaps a younger generation of policymakers might also come to realize how little real difference exists between the demand-side schemes of Keynesians and Monetarists – and how they can learn by revisiting honestly the methods and successes of supply-siders.
J.D. Foster, Ph.D.Norman B. Ture Senior Fellow in the Economics of Fiscal Policy Thomas A. Roe Institute for Economic Policy Studies
Testimony before The Subcommittee on Regulatory Affairs, Stimulus Oversight, and Government Spending Of The House Committee on Oversight and Government Reform United StatesHouse of Representatives February 16, 2011
My name is J.D. Foster. I am the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy at The Heritage Foundation. The views I express in this testimony are my own, and should not be construed as representing any official position of The Heritage Foundation.
At best, stimulus efforts based on government spending and tax cuts with little or no incentive effects have done no harm. At best. It is quite possible most of these efforts over the past couple of years have slowed the recovery while adding hundreds of billions of dollars to the national debt.
The record is all the more unfortunate because it is possible for a President and Congress to work together to stimulate the economy to faster growth during and after a recession. They can do so by improving incentives to produce and to work: for example, by reducing regulations and tax distortions. They can do so by reducing the uncertainties surrounding future policy. They can do so by expanding foreign markets for domestic goods and services. Recent efforts to stimulate the economy have been unsuccessful because they did little or none of these things. Regulations have increased. Uncertainty has increased. Tax distortions have been left in place or even increased in some areas. And efforts toward free trade have been anemic, at best.
Stimulus can work, but it has not worked because the Administration took another approach, emphasizing tax relief with little or no incentive effects combined with massive increases in spending. The President inherited a ballooning budget deficit and opted to grow it further. At best, this would be expected to be ineffectual. At best, because the resulting increased deficits infused economic decision-making with even more uncertainty about the consequences of massive deficit spending and how and when government will act to restore fiscal sanity.
Fortunately, the economy is showing clear signs of sustained recovery; uneven recovery to be sure, stronger in some areas than others both geographically and by industry, but recovery nonetheless. Despite the tremendous blows from the financial crisis and all that it entailed, the underlying strengths of our free market system once again are at work, giving expression to the vitality, energy, and innovation of the American people. Make no mistake: Our economy is recovering despite—not because of—the actions taken in Washington to grow it.
Signs of Taking the Wrong Road
The heart of the Administration’s approach to stimulus is the equivalent of fiscal alchemy. Alchemy, “the art of transmuting metals,” refers specifically to turning base metals like lead into gold. Fiscal alchemy is the attempt to turn government deficit spending—whenever, wherever, and on whatever—into jobs. Regarding near-term stimulus, it is not a matter of how wisely or foolishly the money is spent. It is not a matter of how quickly or slowly the money is spent. It is not a matter of whether some is saved or not—any more than the phase of the moon or adding a bit more wolfsbane or a stronger electric current enhances the prospects for lead to become the substance of an alchemist’s dreams.
The basic theory of demand-side stimulus is beguilingly simple. The theory observes that the economy is under performing and total demand is too low, and thus total supply needed to meet that demand is too low. It would appear obvious enough, then, that a solution is to increase demand by deficit spending and rising supply will naturally follow. The net of government spending over tax revenues adds to total demand. Increase the deficit and you increase demand, supply naturally follows, and voila: the economy is stronger and employment is up. One wonders then why government should not simply increase spending much, much more and create instant full employment.
Why, indeed. The answer, as is now obvious, is that this policy does not work for the simple reason that government must somehow fund this additional spending, and it does so by borrowing. Suppose you take a dollar from your right pocket and transfer it to your left pocket. Do you have a new dollar to spend? Of course not.
Or suppose you pour a bucket of water into a bathtub. You would expect the level of the water to rise. But where did the water in the bucket come from? It came from dipping it into the bathtub. You may make a splash, but when the water settles, in terms of the water level nothing will have changed.
An increase in government borrowing to finance an increase in deficit spending produces one of two ensuing events, either of which (or in combination) leaves total demand unchanged. First, the increase in government borrowing can mean a reduction in the amount of saving available for private consumption and private investment. Government demand goes up, private demand goes down, total demand is unchanged.
Alternatively, the increase in government borrowing may be financed not by reducing private borrowing but by an increase in net inflows of foreign saving—either a reduction in the gross outflows of U.S. saving or an increase in the gross inflows of foreign-sourced saving. Total demand remains unaffected, however, because the balance of payments still balances, and so the increase in net inflows of saving is matched by an increase in the net inflows of goods and services—the increase in the trade deficit offsets the increase in deficit spending.
Underlying this simple confusion surrounding demand-side stimulus is that the theory ignores the existence of a well-developed financial system, the job of which fundamentally is to direct private saving into private consumption, private investment, or government deficit spending. Even in the past few years, when the financial system has worked poorly in the sense that institutions have failed, markets struggled, and the direction of investment dollars has been less than stellar, the markets still managed to take every dollar of saving and direct it toward a borrower willing to take it and use it. Demand-side theory presumes the existence of financial markets, as government must rely on those markets to issue debt to finance deficit spending, but then ignores that absent the additional government borrowing, markets would have directed the saving to other purposes, which would have added to total demand in the same amount.
These economic relationships are analogous to the law of conservation of energy, which says that energy can be neither created nor destroyed in a closed system, but can only be transformed from one state to another. If we exclude the possibility of cross-border capital flows, then the closed system is the domestic economy and the energy conserved is the amount of saving available. If we allow for the possibility of cross-border capital flows, then the closed system is the global economy and the energy conserved is the amount of domestic saving augmented or diminished by the second closed system of the balance of payments.
You Could Be a Demand-Sider If…
There are some tell-tale signs that one has intentionally or inadvertently fallen prey to demand-side stimulus alchemy. One such sign arises when one engages in discussions about multipliers. The multiplier principle is simple enough—if government deficit spending rises by a dollar, does total demand rise by more than a dollar? Make no mistake. One must first accept the possibility that government deficit spending can boost total demand before one embarks on an empirical investigation of multipliers. First, one must believe that lead can be turned into gold to investigate the advantages of incantations over potions.
Another tell-tale sign is references to whether amounts are saved or spent. For example, one argument in favor of direct spending over broad-based tax relief is that every dollar of spending is spent, whereas some portions of a tax cut are saved, and the higher the income of the tax cut recipient, the more from a tax cut is likely to be saved. A related example is the argument that the additional cash income from extending the Unemployment Insurance program for the long-term unemployed is highly likely to be spent virtually in toto, suggesting that such a policy is particularly efficacious stimulus.
Whether the monies resulting from deficit spending are saved or spent matters not a whit to the immediate level of economic activity. If these monies are spent, then private demand must fall by the amount borrowed. If the monies are saved, then government debt is higher and private saving is higher, yet total demand is again unmoved.
One of the original motivations for the demand-side theory of fiscal stimulus was the observation that private saving might be parked in unproductive locations. We hear echoes of this today when, for example, the President refers to the need for private companies to employ their enormous cash hoards to increase investment and employment.
For example, during the Great Depression many citizens took to stashing their saving around the house as faith in the security of private financial institutions crumbled. They would bury it in a coffee can in the back yard, or perhaps sew twenty-dollar bills into the lining of a suit. Clearly, in these cases, the saving has been withdrawn from the financial system and so total demand as commonly measured fell. However, this cautious financial behavior lends no support for increased deficit spending. There is nothing about a government going deeper into debt that is going to instill such confidence in a coffee can-based saver as to entice that person to disinter his or her cash just to make it available to the government.
Unless the saving has been withdrawn entirely and held in cash, it remains part of the financial system, and banks and other financial institutions are lending those monies to someone else to use. Companies today with large cash hoards are choosing not to invest these monies themselves in expanded productive capacity; however they are not locking them in the Chief Financial Officer’s office safe, either. These corporate savings are deposited with and deployed by the financial system.
Why Are Demand-Siders Not Quaking?
The Congressional Budget Office recently released its analysis of the near- and intermediate-term budget picture showing a budget deficit for 2011 of almost $1.5 trillion or 9.8 percent of our economy.[1] However, under the CBO forecast based on current law, the deficit drops dramatically to 7 percent of our economy by 2012 and it drops a similar amount as a share of the economy by 2013. The Administration’s Mid-Session Review released last July showed a similar pattern.[2] (This testimony was written prior to the release of the President’s Fiscal Year 2012 Budget, which presumably will show the same general pattern.
In light of these forecasts, if the Administration and other demand-side stimulus proponents believed their own theory they would today be concerned to the point of apoplexy. Rather than forecasting reasonably good growth for 2011 and 2012, they would be forecasting a growth recession at best, and more likely a return to recessionary conditions.
The measure of the amount of demand-side stimulus is whether the deficit is rising or falling relative to the size of the economy. From 2008 to 2009, the ratio of the deficit to Gross Domestic Product (GDP) rose from 3.2 percent to 9.9 percent. This 6.7 percent massive dose of fiscal stimulus represented the largest deficit burst since 1942. It was half again as large as the next biggest dose in the post-war era—a 4.4 percentage point burst in 1949. If demand-side stimulus worked, the economy’s growth today should be China-esque.
On the flip side, a 5.5 percentage point drop in the deficit-to-GDP ratio from 9.8 percent in 2011 to 4.3 percent in 2013, as CBO forecasts, should raise loud alarms amongst demand-side supporters. If demand-side deficit-soaring stimulus works to boost the economy, then a rapidly shrinking deficit should undercut the economy. Yet, no such concern is in evidence. Instead, the Administration forecasts a steady improvement in output and employment. The Administration apparently no longer believes in demand-side stimulus.
To be clear, a rapid decline in the budget deficit through a combination of strong spending restraint and revenue recovery through economic growth is exactly what the nation needs today. The point, in the current context, is merely that demand-side supporters apparently expect as little downward effect from the rapid drop in the deficit’s share of our economy as we saw stimulative pressures when the deficit began its historic ascent.
The Fall, Rise, and Fall of Demand-Side Stimulus
It was not that long ago that demand-side stimulus was generally understood to be ineffective. After a couple decades of unsuccessful attempts at fiscal fine-tuning in the 1950s through the 1970s, not just in the United States but around the world, a reluctant consensus for abandoning these policies developed. For some reason, this consensus fell apart during the recession President George W. Bush inherited from President Clinton. While Bush emphasized the importance of rate reductions, it also became acceptable again to talk about “putting money in people’s pockets so they could spend.” Demand-side stimulus was back, and as ineffective as ever as we learned in 2001 and 2002.
The demand-siders remained ascendant as President Obama took office and as yet another recession unfolded. Facing a choice of cutting tax rates à la first President Reagan in 1981 and then Bush in 2001 and 2003, or returning to the deficit spending policies of the early post-war period, Obama and his congressional allies naturally chose not to emulate their ideological opponents. They chose to increase mightily an already rapidly growing spending bulge and budget deficit. If ever this policy was going to work, this was it. It failed.
That demand-side stimulus has again failed is increasingly obvious even to those who advanced the policy, some reluctantly, some with gusto. It is safe to predict that many of those who remained silent in opposition will soon come out and say they opposed this policy all along. It is even safe to predict that some of the loudest proponents will recant in some future year, likely asserting in all seriousness and hoping no one will check, that they knew all along that the President’s demand-side stimulus policy was doomed. It matters far less that these voices will still have currency in certain quarters than that, for awhile at least, demand-side stimulus policies will again be tabled as effective only in growing the national debt.
Stimulus That Would Have Helped
There is much the last Congress could have done to stimulate the economy. A simple example is that Congress might have acted quickly, rather than waiting until the last minute, to extend the Bush tax cuts through 2012. The uncertainty surrounding tax policy slowed the recovery.
The Congress could have resisted the temptation to tinker. For example, it could have resisted the temptation of the first-time homebuyer’s credit, which on balance slowed the recovery in the housing sector by first confusing and then slowing the price discovery process. To be sure, home sales at first increased, and then collapsed, and in the meanwhile housing markets had a powerful new source of market noise to filter out as they searched for proper price levels.
The Congress and the President could have halted the storm of new regulations and threatened regulations, beginning but not limited to Obamacare. According to estimates by my colleague James Gattuso, the cost of the federal regulatory burden now tops $1 trillion—before Obamacare.[3]
Above all, Congress could have focused its fiscal policies on the sources of recovery and growth, rather than give in to the perennial delight of increasing spending on politically favored causes. One example among many is that the Congress could have cut the corporate income tax rate from 35 percent to 25 percent for a decade for about the same deficit impact as all the so-called fiscal stimulus. President Obama acknowledged in his State of the Union address that the corporate tax rate is too high. Had he acknowledged this two years ago and pressed for a reduction at that time, many more fellow citizens would today have gainful employment.
Because the budget deficit today is so enormous, the nation’s policy options aside from halting or reversing the regulatory onslaught are severely limited, confined essentially to expanding free trade and cutting spending deeply to restore fiscal balance. Near-term efforts to cut non-security discretionary spending are essential, but must be seen as but the first step in a steady march against government spending, including reforming the major entitlement programs to stabilize these programs and to stabilize government spending. The best Congress and the President can do now in terms of fiscal policy is to get the nation’s fiscal house in order by cutting spending, repeatedly.
The impact of supply-side economics on Toronto’s rising house prices
DAVID AMBORSKI AND FRANK CLAYTON
ontributed to The Globe and Mail
Published
Last updated
David Amborski is director and Frank Clayton is senior research fellow at Ryerson University’s Centre for Urban Research and Land Development. Dr. Clayton is author of the recent report titled Why There Is a Shortage of New Ground-Related Housing in the GTA.
The housing market in the Greater Toronto Area is hotter than at any time since the late 1980s. Prices of existing and new ground-related homes (single detached and semi-detached houses and townhouses) are rising rapidly.
There has been widespread media coverage of the demand factors, low interest rates and rapid population growth that have contributed to the rising price of housing. According to a recent poll conducted by Angus Reid, the public as a whole seems to understand and support the role that demand plays in high regional housing prices.
Alas, home prices are not determined by demand alone. Supply is a big part of the equation.
Normally, in the private economy, when demand for a product or service picks up, prices begin to rise and suppliers respond by increasing supply, which in turn, moderates the initial price increase. While homebuilders are like other suppliers in their desire to increase the production of homes, they are unable to do so as there is a severe shortage of sites in the GTA for new single and semi-detached houses and townhouses.
Unlike the other requirements for homebuilding – labour, materials and capital – the supply of serviced land rests on the shoulders of municipal governments.
Land-use planning policies enforced by the province of Ontario favour the intensification of sites in built-up urban areas, especially mixed-use developments near existing transit nodes. As a result, in the past decade, more than 143,000 units, mostly condominiums for owner or renter occupancy, have been started in the GTA. This ample supply of sites has moderated price increases for these types of residential units.
Circumstances have been quite different for single and semi-detached houses and townhouses, which are mainly found in the “905” suburban area code.
Beginning in 1989, the province required municipalities to maintain at least three years’ supply of serviced or readily serviceable land for a range of housing types.
The current provincial government has stopped monitoring and enforcing this serviced-lot supply requirement and the policy is being disregarded or incorrectly interpreted by most GTA municipalities.
The previous ample supply of sites for houses has long been exhausted and is not being replenished in anywhere near the numbers required to meet current, let alone future, demand.
As a result, starts of single and semi-detached houses and townhouses in the GTA have fallen by half, dropping from about 30,000 units in 2001-2003 to about 15,000 units in 2013-2014. This is despite very strong demand for this type of housing.
The province, through its imposition of its Growth Plan for the Greater Golden Horseshoe and the Greenbelt and the creation of the Metrolinx regional transit authority, is effectively the regional planning body for the GTA. As such, the province should immediately begin monitoring and enforcing its own requirement that the 905 municipalities maintain at least a three-year supply of serviced and readily serviceable land to meet the current and expected future demand for ground-related housing.
Without a proactive provincial government, there is no hope for relief from high prices for ground-related housing in the GTA.
