Summary
- More and more attention is being given to the possibility that our macroeconomic problems may be coming from the supply side of the equation, not the demand side.
- Government programs tend to prefer the demand side programs because they can be executed faster, work faster, and favor the working population.
- Supply side programs take longer to produce, take longer to fully provide results, and favor business interests.
- Obviously, demand side programs are favored by people that have to get re-elected to maintain their jobs.
- Consequently, we cannot be too hopeful that the U.S. economy will get what it really needs, very soon.
More and more analysts are realizing that a large number of the problems in the United States economy are coming from the supply side.
I have written quite a few posts on this subject.
This morning, Mohammed El-Erian added his name to the list as he writes about the problems coming from the supply side of the economy in the Financial Times.
He writes
"There is now growing recognition that there is a limit to goods disinflation and that price increases in the services sector may prove quite stubborn."
Mr. El-Erian believes that there is:
"a stronger policy architecture and a constructive evolution in the policy debate away from the Fed being “the only game in town”, chasing an increasingly elusive and outdated inflation target."
Most importantly, Mr. El-Erian thinks that
"the fundamental medium-term characterization of the US economy has shifted from one of deficient aggregate demand to one of deficient aggregate supply."
This is a different world because of the pandemic. Because of the pandemic, a lot more is going on in the world than would have taken place in the pre-pandemic world.
But, there is more.
Mr. El-Erian lists some of the other factors that are making important contributions to the current situation.
"Some of the driving forces include the overdue green transition in energy and elsewhere, changing globalization, a multiyear quest to enhance supply chain resilience, and a labor market that struggles to fill a record excess of job openings."
The Federal Reserve has created its own detractors for the way it has conducted monetary policy over the past two to three years.
One thing the Fed has done, according to Mr. El-Erian, is to undermine its credibility regarding its inflation target. For one, Mr. El-Erian believes that the target is too low for the world that now exists. He furthermore believes that Federal Reserve actions are not really taken seriously by the financial community because of the way the Fed has acted over the past three or four years.
A second thing that must be done is to include other policymaking agencies elsewhere in the U.S. government to develop a coordinated approach to dealing with the supply-side needs of the economy.
But, there are issues here.
For one, policies to combat supply-side problems in the economy take time to implement and also take time to more fully work their way through the economy.
Politicians that have to get re-elected don't like this fact. Already, the 2024 elections are dominating the news-ways, and supply-side solutions are not being promoted, let alone being constructed.
Second, supply-side policies appear to favor the business side of the economy and not the "common people." Consequently, politicians, in order to get re-elected will tend to lean toward economic policies that favor "the people."
So, there exist two pretty strong reasons why supply-side economic policies are not the most popular approach for politicians that are in need of re-election.
Demand-side economic policies are much more attractive in the sense that they appear to impact the economy sooner rather than later.
I, in whatever way, give you or someone else more money that they can go right out and spend. Demand rises, people are hired, and everyone is better off.
At least that is the way the narrative works.
One problem with that is that, as I have recently written , the spending from the demand side of economic policies doesn't always get into the right channels. More and more data research from the past thirty years shows that more and more of the flow from demand side programs has gone into the financial circuit of the economy and not into capital expenditures that might improve output possibilities.
In other words, the "multiplier" of economic activity on the demand-side seems to be below one, and in some cases has apparently turned out to be substantially below one.
The second point is also highly important. Supply-side economic programs seem to favor businesses, especially bigger businesses. Politicians playing for the "more popular" side of the voting population seem to be reluctant to push toward this end of the voting spectrum.
Supply-side economic programs have always had trouble finding their way through the Congress. This is not a new issue.
Furthermore, so much of what is taught in economics favors demand-side problems. For one, the mathematics of the demand-side approach is much simpler than those that are used on the supply side.
Finally, one thing that continually surprises me is the focus that economists give to the Phillips Curve when discussing macroeconomic policies.
The Phillips Curve is a statistical relationship. It shows the "supposed" inverse relationship between the unemployment rate and the rate of inflation. The conclusion drawn from this relationship is that if the government can push up inflation slightly, the unemployment rate will modestly decline.
So, our policies should be aimed at pushing inflation a little bit above zero, say two percent, so that we can achieve a little less unemployment.
A relatively modest rate of inflation can be politically acceptable when it results in an unemployment rate of, say, 3.8 percent.
There are many problems with this discussion, but policymakers, since the 1960s, have accepted that there is a steady statistical relationship between the two and this relationship can be used to maintain a lower rate of unemployment than might be the case otherwise.
Just one comment on this. To me, this policy approach has contributed to what I have called "credit inflation," an approach to federal government policymaking that has helped to get us into the situation we now find ourselves.
Much of my writing in this blog over the past 15 years focused on "credit inflation" and what it does to the economy. I will continue to write more about this in future blogs.
But, the politicians love the Phillips Curve. If they can "buy" a little more unemployment with just a small increase in inflation, then "go for it!"
Get re-elected.
And, very little attention is paid to the supply side of the economy.
This, to me, is exactly what Mr. El-Erian is saying.
For further details see:
It's The Supply Side