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Are You Supply Or Demand

A couple of weeks ago the Internet was ablaze with the great debate over whether you heard Yanny or Laurel in this audio clip.

A few years ago people were losing their minds that some people saw a blue and black dress while others saw a white and gold dress.https://www.nytimes.com/interactive/2015/02/28/science/white-or-blue-dress.html

Regardless of what you personally saw or heard, it is perplexing that 2 people can look or listen to the exact same thing and see and hear something completely different.

Economists have their own version of the great dress debate. It’s called; “are you a supply side or demand side economist”? Just like the great dress debate, economists have little tolerance for other economists that see things differently. Our plan is to string together a few write-ups over the summer months that allow you to explore your economic leanings. Lets start with the supply vs. demand debate.

Greatly simplified, demand side economists believe that government spending and growth of the money supply stimulate the demand for goods and services, and this leads to economic expansion. The primary tool demand side economist use is monetary policy. This group is often referred to as Keynesian economists. They believe active monetary policy is necessary to rev up a slow economy and slow down an economy that is running too hot. They believe supply follows demand because demand creates supply.

Also greatly simplified and in direct contrast to demand side economists, supply side economists believe that increased production leads to economic expansion. Since the primary factors of production are capital and labor, supply side economist prefer fiscal policy to monetary policy. They believe tax policy, deregulation, and a legislative environment favorable to business spurs job growth, which creates supply and boosts growth. They believe demand follows supply because supply creates demand.

Forgive us for stating the obvious. Our current President would be considered supply side, our previous President would be considered demand side. Currently economic preference appears to be determined by party affiliation but this hasn’t always the case. While Ronald Reagan is often referred to as the father of supply side economics, it was JFK’s policy of cutting marginal tax rates that influenced Reagan’s thinking. While Bill Clinton didn’t cut marginal tax rates, he did cut middle and lower end tax rates. In contrast, George W. Bush had demand side leanings. He dramatically increased government spending in an effort to spur economic growth.

Our belief is that there are strengths and weaknesses to both economic theories. What frustrates us is how dug in both sides are. Depending on the economic environment and what may be ailing the economy, different measures are needed. It is generally agreed upon that what caused the economy to crash in 2008 was loose monetary policy and easy lending conditions. This led to a glut of debt. We’ve expressed before our skepticism that traditional demand side economics will fix the problems created by the credit crisis of 2008. Our reasoning is straightforward. The economy collapsed because of too much consumer debt, therefore the solution can’t be adding more consumer debt by keeping rates low. We believe the Fed has it all wrong. It’s not the cost of the debt that is the issue. The consumer lacks the capacity to take on more debt, regardless of the cost.

The recent Tax Cuts and Jobs Act (TCJA) is pure supply side economics. Predictably, economists either love it or hate it. Here’s a great way to determine which way you lean. Art Laffer developed a very simple visual representation of tax rates and tax revenue. The Laffer Curve suggests that, as taxes increase from low levels, tax revenue collected by the government also increases. It also shows that tax rates increasing after a certain point (T* on the diagram below) would cause people not to work as hard or not at all, thereby reducing tax revenue. Eventually, if tax rates reached 100 percent, shown as the far right on his curve, all people would choose not to work because everything they earned would go to the government. Government tax revenue would be the same at a 0% tax rate and at a 100% tax rate. Revenue would be zero! Governments would like to be at point T* because it is the point at which the government collects maximum amount of tax revenue while people continue to work hard.

The challenge is determining the optimal tax rate. If you believe the optimal rate is on the right side of the curve, you lean demand side. If you believe the optimal rate is on the left side, you lean supply side. How ironic. The GreenPort Team

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