Trickle Down Economics Why does supply side economics

Trickle- Down Economics Why does supply side economics fail to work?

Key Terms • Fiscal policy: taxing/spending actions completed by the federal government • Monetary policy: management of interest rates and money supply in circulation by the federal reserve

Prior to the Great Depression Promoted economic theories from Adam Smith, Wealth of Nations - laissez-faire doctrine - Invisible hand - Self-interest in free markets would produce the best outputs Resulted in a highly unstable economy marked by booms and busts throughout

Adam Smith wrote Wealth of Nations from his mom’s house! • Mom’s Invisible Hand “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner…but from their regard to their own interest. ” Smith’s dinner came from the benevolence of his mother!

Post Great Depression • Promoted theories from John Maynard Keynes, The General Theory of Employment, Interest, and Money • Father of demand-side economics - Aggregate demand was incredibly unstable (decisions were guided by base “animal spirits”) - Stimulating aggregate demand was absolutely necessary through gov’t intervention

How can demand be stimulated? Government needs to increase spending (became known as deficit spending!) - Private spending is unstable! - Government spending jolts the economy! - Full employment could return! Argued that once private investment returned to normal the gov’t stimulus could be abandoned.

The Golden Age of Keynesian Economics

Stagflation Inflation rates began to rise due to shortages in production in the early 1970 s (remember oil/grain!) Nixon made price increases illegal! Why does this create a shortage in supply?

Because the problem of stagflation was primarily on the supply-side, not the demandside, Keynesian demand-management solutions were not effective – increasing demand would solve unemployment but not inflation!

Reagan Promoted supply-side economics - Cutting taxes would stimulate the economy - Increase the incentive to supply labor - Expand the real GDP (gross domestic product) - Reduce the price level

What is GDP? GDP (Gross Domestic Product) measures the health of the overall economy - Measure in two ways - Income approach: what everyone earned in a year - Expenditure approach: what everyone spent in a year

Did Reagan’s approach work? • Longest peacetime expansion on record - Output grew - Unemployment declined - Inflation declined The growth in federal spending exceeded the growth in federal tax revenues

Summary: Would Reaganomics work today? • Tax rate was extremely high in the 1980 s (top bracket 80 s vs. today) - Similar tax cuts today would bankrupt the gov’t • Increased the payroll tax to pay for Social Security - People like to take home as much money as they can!