Alan Reynolds

Phrases intended to describe complex ideas in a word or two, such as Keynesian or monetarist, invariably become misused or hijacked after three decades. But such semantic abuses can't be halted by Bartlett's white flag. Like it or not, the phrase "supply-side economics" will doubtless continue to be used and abused.

Bartlett says, "The context in which the term had meaning no longer exists, and therefore it has become a barrier to communication." That context refers to a debate about the appropriate "policy mix" in a situation of double-digit inflation combined with severe recession, as in 1974-75 or 1980-82. The supply-side innovation, from Nobel Laureate Bob Mundell, was to suggest that (1) monetary policy is the right tool to keep inflation in check, and that (2) the focus of tax policy should be shifted from short-term accounting results (deficits) toward improving longer-term incentives for productive work and investment. The first part of that package is actually monetarist, and neither part ever ceases to be relevant to inflation and economic growth, respectively.

I wrote a paper on "The Fiscal-Monetary Policy Mix" for the Fall 2001 Cato Journal. It began by saying: "In the early postwar years, during the heyday of fiscal fine-tuning ... the predominant view was that the main function of monetary policy was to 'stimulate' debt-financed purchases by keeping interest rates low. Inflation was first considered a useful lubricant to be traded for lower unemployment, and inflation could be reduced only by tolerating high unemployment. In the late '60s and early '70s, when the shrinking dollar proved less popular than expected, inflation was routinely described by a thermal metaphor ('overheating') and regarded as an endemic problem to be endlessly 'fought' by using fiscal policy (a surtax) and incomes policy (wage-price controls), but never monetary policy."

The context of my remarks was the conventional unwisdom that gave us LBJ's surtax in 1968 and Nixon's price controls in 1971. In a blog commenting on Bartlett's piece, New York Times columnist Paul Krugman was irritated by Bartlett's comment that "Keynesians of that era" thought "monetary policy is impotent and inflation is caused by low unemployment." Krugman replied: "I was a grad student at MIT -- the great Keynesian stronghold -- in the 1970s, and this bears no resemblance to what was being taught. In fact, I still have my copy of Dornbusch-Fischer, 'Macroeconomics,' the 1978 edition -- and it doesn't make any of those assertions."

By 1978, however, supply-side ideas were even getting attention in textbooks. In the 1978 edition of Campbell McConnell's best-selling "Economics" text, the "Last Word" on fiscal policy was a paper of mine that is still online at The 1978 Dornbusch-Fischer text found supply-side tax policy "intriguing" and thought we may well need "fiscal policies that operate on aggregate supply."

Bartlett says: "I still think (supply-side economics) was the right cure for the economic problems we were facing in the late 1970s. I also think it embodies some fundamental truths that are applicable at all times. But these fundamental truths, such as the idea that high marginal tax rates are bad for the economy, are now almost universally accepted." That is almost true. Mainstream economics almost universally accepts "optimal tax theory" and the "elasticity of taxable income" -- elegant elaborations of original supply-side themes. If incentives didn't matter, then we might as well discard the word "economics," not just supply-side (incentive-based) microeconomics.

Greg Mankiw is a "new Keynesian" scholar who thinks tax incentives matter a lot. Ed Prescott is a "real business cycle" scholar who thinks tax incentives matter even more. But Mankiw, Prescott, Martin Feldstein and others still quarrel with their retrograde peers. Being "almost universally accepted" is almost good enough, but not quite. When tax policy in most countries is as close to optimal as Hong Kong's, I will gladly stop mentioning supply-side economics.

Alan Reynolds

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