A Demand Side Revolution?

Mar. 23, 2012 5:36 PM ET167 Comments

First, we had the supply-side revolution. Basically, this was a movement started with one very reputable economist (Robert Mundell) and a few others, like Jude Wanninski and Arthur Laffer (for a short history, see Bruce Barlett). The basic idea is simple: Tax cuts pay for themselves.

According to Wanninski, each of the main US political parties needed to be a sort of Santa Claus. The Democrats were the spending Santa, but the Republicans should become the tax-cut Santa. The idea was taken up by the influential Irving Kristol and, after spending the 1970s in the political wilderness, it became policy under Ronald Reagan.

Not everybody was immediately taken in. Vice president George Bush famously described it as "voodoo economics," and when he became president he (despite a fair bit of "lip reading"), he raised taxes. But one can say that the idea has renewed currency in the Republican party today (despite the fact that the evidence on its effectiveness isn't terribly encouraging, tax cuts rarely pay for themselves).

However, now the economic forces are such that ideas have been formed pointing to a "demand side" economics going beyond mainstream Keynesianism. The latter (in its policy form) is simply the idea that economic policy should be counter-cyclical, that is, try to stabilize the business cycle. Running budget deficits and lower interest rates when there is a crisis, doing the opposite when there is an economic boom.

But the type of the recession has rendered one type of policy reaction rather impotent (the interest rate reductions) and the other part (increasing public spending) on steroids. To such an extent, in fact, that reputable economist like Larry Summers and Brad DeLong have published a paper in which they argue that under certain economic conditions (which they believe have been met today), increasing public spending can pay for itself.

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