Keynesian Economics vs. Supply-side Economics

[mandennis]

Newsweek came out with an interesting article pitting Keynesian thought against supplyside economics on which is the best approach to handling the stimulus to address the depression.

Which side are you on?

[steephen]

Based on my eco prof, Keynesian is self adjusting. Thou mahirap intindihin. I'm on the side of Keynesian.

[mandennis]

February 10, 2009, 12:19 pm
The New York Times
Freakonomics
Tax Cuts vs. Government Spending
By Justin Wolfers

As the Senate and the House look to reconcile competing stimulus plans, the big debate is whether to emphasize government spending or tax cuts. A new paper by the New York Fed’s Gauti Eggertsson argues that the risk of deflation should tilt the balance to government spending.

Our current problem is deficient aggregate demand. The government can raise total spending either by buying more stuff, or it can lower taxes and hope that consumers take their tax breaks to the mall. If consumers do indeed spend their full tax cuts (a big if), you might think that either approach stimulates aggregate demand in roughly equal measure.

But that’s not the whole story. Tax cuts stimulate both aggregate demand and aggregate supply. If taxes are temporarily lower, they make working today more attractive than working tomorrow, and thus increase labor supply. This boost to the nation’s productive capacity means that a tax-cut-based stimulus doesn’t do as much to narrow the gap between output and what we can produce.

Under normal circumstances, this doesn’t present a problem, because the Fed can lower interest rates to close this output gap. But right now, the Fed has set interest rates as low as they can go, and so different principles apply. Eggertsson’s concern is that a big output gap will lead inflation to fall, leading real interest rates to rise in the middle of the recession. These higher real interest rates further dampen economic activity, and with the Fed powerless to offset this, there’s the very real risk of a deflationary spiral. And so a tax-cut-based fiscal stimulus might actually backfire. In fact, Eggertsson reckons there’s a chance that tax cuts could even deepen the recession.

Is Eggertson’s conjecture right? Unfortunately the historical record can’t tell us: there’s never been an episode in which we’ve tried reducing taxes when interest rates were this low. When we’re in uncharted waters, we’ve got nothing but economic theory to guide us. And the theory says it’s safer to stick to a spending-based stimulus plan.

[iRebirth]

During a time of uncertainty, supply-side economics becomes ineffectual. So we turn to Keynesian to artificially boost demand.

[mandennis]

The main argument by the GOP against spending is, it will lead to indebtedness. However, take a look at how Reaganomics led to overall US debt over the terms of US presidents since Reagan.

http://zfacts.com/p/318.html