Question

Describe supply-side economic ( austerity, neoliberal ) policy and how it is supposed to simulate economic growth . Include crowding-out in your answer.

(at least 150 words).

Answer 1

Classical economists believe in market correction of an economy and f there is no external involvement then market creates greater welfare. Keynes believes during recession as wages are sticky and prices are difficult to come down it is essential that govt. pushes economy through mulitiplier effects and then only it can come back to potential output or else it will stuck in low GDP and high average price levels.

During an deflationary level, govt. can adopt expansionary fiscal policy(lowering tax rates and increasing govt. spending) and central bank can have expansionary monetary policy ( lowering interest rates and increasing money supply ).

However, both these policies have policy conflicts. Example to raise economic output expansionary policies may lead to inflation and cause vicious cycle in an economy.

It should be noted that Supply side policies are the most essential to ensure overall long term economic growth.

These policies are of two types- Market based and interventionist based.

In market based- labour market reforms, encouraging competition and creating a business friendly environment is involved. In Interventionist based policy focus is on creating human and physical capital. If this capital is supporting the policies implemented by govt and central bank then policy conflicts can be lowered and long run solid development can be achieved. However, it should be noted that supply side policies are long term ,need time and investments.

Hence if policymakers want to maintain short term employment at highest level and does not want to stress govt. budget then capacity building through supply side policy along with proper combination of monetary and fiscal policies is needed so that economy is kept busy without inflationary impacts.

Hence in my opinion Keynes theory is more appropriate.

Nice example is US during recession. Keynesian perspective of huge govt. investments have corrected the economy. All policies explained above can take GDP to new levels.

Economists agree on factors enlisted in supply side policies explained above.