Mark Thoma summarizes the follow-up to Bruce Bartlett’s continued insistence that those of us who learned economics during the 1970’s understood only vulgar Keynesianism. Bruce seems to think we believed only fiscal policy mattered, which of course is such absurd. He also seems to think graduate students were not aware of either the Real Business Cycle theory of the new classical challenge to the Phillips curve. It is true that Finn Kyland and Edward Prescott published their Time to Build and Aggregate Fluctuations in 1982, but the challenge from the new classical school as to whether aggregate demand policies could lead to anything other than a very transitional blip away from full employment had economists wondering if there was some other reason why real GDP deviated from some trend line for sustained periods of time.
Then again – most of us recognized back then that fiscal stimulus with tight money would crowd-out investment and/or net exports. And there are a few of us who think President Kennedy got it right when he talked about the aggregate demand effects of fiscal policy.
Lawrence White suggests that not every class in economics was at the same level of quality as those attended by graduate students at MIT. On the other hand, Tim Worstall reminds us that economists have been talking about all sorts of means of increasing efficiency for many years:
Supply side reform to me means just that, reform of the supply side. Nationalizing or privatizing the railroads is supply side reform, deregulating the airlines is supply side reform, adding or subtracting to farm subsidies is supply side reform, as was welfare reform (as Richard Layard went on about for years, it was to bring the long term unemployed back into the reserve army of the unemployed and thus influence or shift the Phillips Curve). To claim, whether in support or in opposition, that it’s all about marginal tax rates is to me to miss the entire point. There are parts of the economy, at times, which need to reform so as to free them (and equally, in other places and times, restrain them, like the break up of AT&T) and thus reform the supply side. That, to me at least, is the point about such supply side economics and to lose that insight in a squabble over marginal tax rates is a pity, at the very least.
Thanks Tim for elevating the debate!
Update: Lawrence Lux makes a couple of more contributions to this debate including this on real business cycles:
My problem resides with the exact definition of Supply shocks. Both Bruce and Mark imply that while Supply shocks are natural, they should somehow be reduced by Public policy. Supply shocks are a natural condition, the result of process of business development; a process of investment followed by a recoupment of financial reserves (a Period of Marketing distribution to make initiated Production profitable). Artificial supplement of these financial reserves through favorable tax rates dissipates Business energy from optimum organization of Production and Marketing to maximize Profitability, and directs Business interest into new Production modes before the ‘bugs’ of the older Production have been worked out. You can definitely place me outside the Supply-Side spectrum.
He is exactly right. Every time I hear some politician saying we should give tax breaks to stimulate small business investment, my mind starts pondering the general equilibrium effects of how the implied increase in interest rates (yes, I’m doing Solow style classical economics here) will crowd-out investment for larger businesses. Now if the marginal productivity of capital for small business is not greater than the marginal productivity for larger business, this kind of reallocation of capital strikes me as promoting inefficiency.