« Links | Main | FRBSF: Do Monetary Aggregates Help Forecast Inflation? »

Saturday, April 14, 2007

Should We Abandon the Phrase “Supply-Side Economics”?

Here's more on supply-side economics. After having stated bluntly that Jude Wanniski is not a good source for anyone interested in understanding the economic reasoning behind supply-side economics, I feel obligated to present rebuttal.

This came by email from Wayne Jett "who was privileged to be a colleague of Jude Wanniski during the last two years of his life." He would like an opportunity to respond generally, and to some of the specific comments made about the role of supply-side economics in policy discussions. Before posting his response, however, I do want to make clear that posting this is by no means an endorsement of the views that are expressed. I strongly disagree with many of the claims and characterizations:

The End of History for Economics?, by Wayne Jett:


This is my first post on Economists' View, which results from my attention being called to recent discussions here on the role of supply side economics in current discourse on public policy. Bruce Bartlett's commentary in the NYT suggests supply side economics "... did its job, creating a new consensus among economists on how to look at the national economy ..." and ought to be "put to rest." Supply side economics, BB says, has become "associated with an obsession for cutting taxes under any and all circumstances ...," so the best thing to do is to "... kill the phrase “supply-side economics” and give it a decent burial."

You and others have commented on the subject and, with your permission, I would like to add a few thoughts from my perspective. This is not the perspective of one who was in the Reagan administration, but one who was privileged to be a colleague of Jude Wanniski during the last two years of his life. In addition, although I have not been a part of your discussions here, I have undertaken in recent years to participate in public analysis of economic issues, particularly monetary policy.

What is supply side economics?

Jude Wanniski believed he coined the phrase while an editor for the Wall Street Journal in 1976 to describe classical economics, both fiscal theory and monetary theory. Jude had studied fiscal theory under the tutelage of Arthur Laffer since 1972 and monetary policy under Robert A. Mundell since 1974. He clearly understood this comprehensive theoretical model to be classical economics, but he chose the new name partly for its descriptiveness and partly to give classical theory a "rebirth" and a new start due to the historical attacks on the classical model by Keynesians.

That said, is it true that we have arrived at a "new consensus between Keynesians and classical economists about how to look at economic issues? Have economists arrived at a sort of "end of history" similar to Francis Fukuyama's analysis that history has proven the best of all forms of government to be republican representation, so no further experimentation is necessary?

I would say that is far from the case. Classical theory is fundamentally at odds with the Keynesian view that a central bank can control domestic interest rates with results that are advantageous either domestically or internationally. Indeed, the classical view is that the attempt to control domestic interest rates, as Keynes advised in 1936 could be done to incentivize domestic production, forfeits the central bank's capability to stabilize the value of its currency.

This makes clear, of course, that the current debate over Fed policy is not merely about whether the Fed should raise or lower its funds rate target. Yes, the media and the Fed dwell on this, and even a number of good economists who identify with supply side theory join in that discussion as if it is the only debate. But it is not.

Since Keynesian theory took the helm of the Fed in 1971 with President Nixon's order closing the gold window to the Europeans, the dollar has lost 95% of its purchasing power relative to gold, which measures the dollar's "spot" value. This is by far the worst performance of an international reserve currency in modern history.

This dismal performance by the U. S. central bank cannot be blamed entirely on John Maynard Keynes. Yes, he recommended something of this nature in his General Theory, when he abandoned his years of teaching classical theory at Cambridge University in favor of creating an abstract theoretical structure capable of advancing the objectives of mercantilism. But Keynes recommended abandonment of free trade and the gold standard on grounds they caused international conflict and war. Surely we don't believe that about free trade, and we shouldn't believe any longer that controlling domestic interest rates is the best means of achieving greater domestic investment and production.

As to fiscal theory, all of us are aware of the rule of diminishing returns as applied to tax rates. Revenues equal zero when the tax rate is zero and when the tax rate is 100%, because production will cease when the tax rate takes all profits. The line graphing total revenues between zero and 100% tax rates shows two tax rates capable of producing the same revenues, one rate lower than the other.

The lower tax rate capable of producing the needed revenue should be chosen for two reasons. First, as with collecting goose down, the government prefers to get the required amount of feathers with the least amount of squawking, and the lower rate will make the taxpayer squawk less. Second, the lower tax rate will permit a higher rate of economic growth, will create more jobs, and the jobs will pay higher wages. Experience following the Kennedy round of tax cuts, the Reagan tax cuts, and the Bush 2003 tax cuts establishes that reduction of marginal tax rates is clearly the superior means to create jobs as compared to manipulation of domestic interest rates. Moreover, when the central bank focuses on controlling interest rates, currency value cannot be stabilized.

Without wishing to appear to speak for Jude, these are the ideas that he wrote and spoke about with rarely matched clarity and insight for about 30 years. While doing so, he compiled a record as a working economist in the financial world that is incomparable in my experience. However, since his record is not the focus of this discussion, I will leave that aside.

Jamie Galbraith joined in the discussion here and mentioned that Jude claimed to have shown that the approval of Smoot-Hawley Tariff Act caused the Great Depression. I know that JG and JW had good relations and discussed each other's views with a sense of collegiality, and I don't wish to disturb that in any respect. I simply wish to make a correction that I am quite certain Jude would make in JG's description. Jude never claimed to have explained the cause of the Great Depression. He did claim, however, and I believe properly so, to have explained persuasively the cause of the Great Crash of 1929. If you have not done so, I urge the reading of his book The Way The World Works, Chapter Seven, where he presents the evidence he discovered and first published in 1978.

Having said all this, have we truly reached such a consensus with which all other economists will rush to agree? I doubt that will be the case. At the same time, I am quite certain classical economic theory is not going away. We are not all Keynesians now, and I don't think all Keynesians are likely to become classical theorists. Classical economists do find themselves in a somewhat similar predicament to what Keynes complained of when he wrote in 1936. He said he had been misled as a young student to believe there was no merit in the views and objectives of mercantilism, so complete was the domination of classical economic thought at the time. Right now, classical theorists are having difficulty getting their views into the mainstream media discourse, so dominant is the Keynesian/mercantilist school.

Should the phrase "supply side economics" be buried? It makes little difference, but my guess is the phrase will survive, if for no other reason than it so promptly gives rise to the pejorative "trickle down" description also used by BB and the NYT. The fact is, supply side theory is the opposite of trickle down objectives. Keynes himself described classical theory in his General Theory as "the theory of the firm," meaning it is the theory of what economic conditions work best for enabling an individual to accumulate working capital, improving his productivity and his standard of living. It is economic theory that looks for the best means by which the lowest income person can climb the economic ladder most efficiently. By comparison, Keynesianism is the theory of the central planner.

Mark, again I hope I did not impose on your site by posting these comments. I did not intend it to be so long, but I hope you will regard it as a fair contribution to the exchanges here. Thank you for allowing me to participate.

    Posted by on Saturday, April 14, 2007 at 12:40 AM in Economics | Permalink  TrackBack (0)  Comments (26)


    TrackBack URL for this entry:

    Listed below are links to weblogs that reference Should We Abandon the Phrase “Supply-Side Economics”?:


    Feed You can follow this conversation by subscribing to the comment feed for this post.