Supply Side and Disinflation
"Supply Side" ideas first became prominent in the late 1970's, when inflation rates close to 10% were common. While not remarkable on a world scale, this was quite high by the standards of US history, and the problem of stabilizing the price level -- of disinflation -- was a central concern. Here is the problem of disinflation as the Supply Siders saw it:
Figure 7: A Supply Side Disinflation
In the Figure, we see aggregate demand increasing from the darker green AD1 to the lighter green AD2. Supply Siders would see this, increasing aggregate demand, as the main source of the "inflationary spiral." With Aggregate Supply stationary at LAS1 -- output at Y1 -- the price level would rise from p1 to p2. To prevent this inflation by demand side policies would mean preventing the shift of aggregate demand toward the right. This would mean policies with very unpleasant results: restriction of the money supply and high interest rates, resulting in low investment; cuts in government spending and/or tax increases. While Supply Siders have always favored cuts in overall government spending, they regard tax increases and high interest rates as bad things.
The "Supply Side" proposal then took a reverse approach. Suppose that, by cutting taxes, we could stimulate economic growth to shift the LAS curve to LAS2, with output of Y2. Aggregate Demand could then continue to increase, but with a new equilibrium at output Y2, the price level would remain stable at p1.
Of course, there are some criticisms of the Supply Side idea --- .
Criticisms
Copyright