Demand side economics
Demand side economics is an outgrowth from Keynesian economics, which is of course itself the economic theories espoused by John Maynard Keynes. Keynesian economics proposed a series of economic ideas that ran contrary to the classic economic formulations, notably the concept of counter-cyclical budget management as a means to mitigate the ebb and flow of economic cycles of glut and recession. For Keynes, aggregate demand from businesses, the government and consumers is a more important influencing economic activity than free market forces. Keynesian economics disagrees with the classical economics of Adam Smith and others by maintaining that unfettered free markets do not inevitably lead to full employment.
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To accomplish this, Keynes proposed that, contrary to accepted economic theories, a government ought to cut taxes and increase infrastructure spending during an economic downturn, and focus on increasing tax revenue during an economic upturn.
Demand side economics comes into play when the increases in infrastructure spending and cuts in taxes results in an increase in the nominal wages of those who tend to spend the greatest portion of their income on consumables. Keynes viewed excessive saving and investment as a potential harm to the economy, since giving additional income to the rich gives them a low marginal incentive to spend, whereas giving additional income to the poor and middle class provides a high marginal incentive for additional spending -- which results in improved business income and grows the economy.
Since Keynes, worldwide governments have felt they have a duty to maintain employment at a high level.[1]
Criticism
Demand side economics is sometimes called "inflation economics," demand side growth is accompanied by an increase in prices which offsets that growth. For example, the 2008 stimulus enacted by George W. Bush happened at the same time as an increase in the price of oil to $140/barrel,[2] though this was also heavily influenced by issues in international trade. The problem is described by classical economists where an increase in demand shifts its curve to the right (econ speak for "this leads to higher prices"). Generally speaking, the resulting inflation is caused not by the increase in spending, but rather the monetary policies of increasing the supply of money in order to keep interest rates low. Low interests rates help avoid the "crowding out" effect that can happen when governments increase spending when an economy is relatively healthy: ie the government absorbs the excess capital present instead of the private sector, which yields zero gain in terms of increasing output (or the GDP) of the economy. The increased supply of money cancels out this effect, but at the cost of rising prices (how high the prices rise, relative to increases in income, are difficult to decipher). Of course, the majority of economists will tell you that controlled inflation is pretty much needed for economic growth and generally speaking this problem only is less prevailent when the economy is in a recession (or when the stimulus is most needed), so this criticism is one largely ignored by the mainstream (called "Orthodox") of the science, other than the New Deal, this sort of government policy has never been implemented consistently enough to produce sustained economic growth.
The recession of 1938 is the an example of how reversing Keynesian policies quickly threw the US economy back into chaos. FDR wisely reinstated demand side practices to continue the upward trajectory in economic growth as involvement in WWII approached.
See also
References
- What is demand side economics?
- Oil Rises After Bush Stimulus Plan, Seattle Times