Flav

Interpreting the Economy and Its Direction

I disagree with the author on several subjects. First, of course that demand shocks are not the sole responsibles for deviations of economic growth with respect to the trend rate, but to postulate that only supply shocks are is incorrect. Both types of disturbances have played (and play) a role in determining movements in output and prices. The 2001-2007 expansion was mainly spured by a growing aggregate demand stemming from a loose monetary policy that meant easy credit for both consumption and investment, and there you have the housing boom and ever rising retail sales (of course, dating back to mid-2007).
In similar fashion, the 90's expansion was primarily prompted by a huge jump in productivity coming from the IT wave, assimilable to a supply shock, that allowed an important reductions in costs and, as the definition of productivity states, greater output with a given amount of inputs. Therefore, given this context, real wages experienced a considerable rise, increasing aggregate demand and then further output growth in order to satsfy this rising demand.
With this example, i want to show that, despite the initial shock might come from one of the two sides, it rapidly translates into the other, having second, third, fourth round of effects and so on. So it is kind of incomplete to asign the responsability of output and prices fluctuations to just one of the sides.
As for the suggestion that the government should take measures destined to stimulate supply, i believe that again you are heading into the wrong direction. Supply shocks are one of the most unpredictable economic events, and when they happen, it is almost imposible to counteract them. The only way their effects on the economy can be appeased is through actions directed to the demand side. An expansion that leads to an overheat of the economy is counteracted by a rise on interest rates or stricter lending, for example (look at what's happening to China).
When you talk about incentives to investment, that's a component of demand, and though it has its influence on supply via capital accumulation, supply disturbances mean a much more severe movements on output and prices, and they're, as i said before, imposible to predict. You can give all the fiscal incentives available to investment, but you may not end up having another procuctivity jump like the 90's IT boom. As Shumpeter remarked, technological shocks more than often comes from the innovative entrpeneur, and although with fiscal incentives you may help rise the odds of that kind of figure to emerge, there's of course no certainty about it