The New Supply-Side Economics: Traditionally, macroeconomic policy has been divided into two distinct types. The first type, stabilization policy, attempts to keep output and employment as close to their full employment levels as possible. The idea behind these policies is to minimize, or even eliminate, short-term boom-bust cycles around the natural rates of output and employment caused by fluctuations in aggregate demand.
The second type of policy, growth policy, works on the supply-side and attempts to keep the long-term natural rates of output and employment growing as fast as possible. Thus, if the long-term natural growth rate of output is, say, 2.5 percent, supply-side policy would try to increase this rate, while demand-side stabilization would try to keep us from deviating from it, whatever it might be.
Importantly, these policies were believed to be independent. Monetary and fiscal policy used to stabilize the economy could change how fast the economy returns to the natural rate after a positive or negative shock, but the policy would have no impact at all on the natural rate itself.
But what if this is wrong, as data from the Great Recession suggests? What if demand-side policies impact the natural rate after all? What does this mean for monetary and fiscal policy? It turns out to have important implications. ...