Covid, Recent Policy, and Supply-side Economics

Let’s suppose you get a flat tire on your new red Schwinn. You take it to the Schwinn store, and the guy starts messing with the chain on your bike. You say, why are you messing with the chain when my tire is flat? He says, I didn’t know how to fix a tire but I have a lot of experience fixing chains.

That’s how to think about monetary and fiscal policies these days. Our policymakers know about one thing and one thing only – demand. Those of you with excess education might remember taking economics and learning that a complete market analysis includes a demand curve and a supply curve. If we demand more weed and less beer, then the price of beer goes down. If the farmer brings a lot of tomatoes to market, then the price of tomatoes goes down. Sometimes the issue in a market is a change in demand. Sometimes the issue is a change in supply. Viola.

But when it comes to macroeconomic policy, we are all Keynesians, which means we think only about demand. Supply is for suckers. Jay Powell at the Fed and all those sharp tacks in Congress know nothing about supply. This makes it easy on them. If the economy slows down, get people to buy more stuff. If the economy speeds up, get people to buy less stuff. Demand, demand, demand. Easy peasy.

What's wrong with a focus on demand? It sounds intuitive. If the economy is weak, then drive interest rates to zero and give everyone a tax cut. Go back a couple of paragraphs. If the problem is your tire, then maybe fixing your chain won’t help much. The remedy ought to reflect the problem. Find a guy who knows how to fix tires! Surely, Larry, you must be smoking funny cigarettes. People today lost their jobs and they are buying less. Isn’t that a demand problem?

Yes and no. Let’s get really abstract now. Suppose X causes a change in Y and then the change in Y causes a change in Z. If you don’t like the change in Z, then what’s the best thing to do? You might say, work on Y. It is the proximate or intuitive problem. But wait, unless you change X, you are still going to get Y and Z. Ugh.

You have to go to the real source or the ultimate cause of the problem. In my example, the real cause of the problem is X. Work on X.

That’s what is happening now. A supply shock caused a change in demand and the change in the demand caused the economy to collapse. Changing demand might seem logical but you are not going to get any real progress until you deal with a critical supply shortage.

What is the supply shortage now? Simple. Covid. Covid is why stores closed. Covid is why factories closed. Covid is why we have historically high unemployment and falling incomes. All that is aggregate supply stuff. Of course, once all that hit, our desire and ability to buy stuff fell dramatically.

But just as Y is not the solution for Z, demand-oriented policies will not solve our weak economy problem. Just as a new chain might make the bicycle run better in some ways, attacking a supply problem with a demand remedy might have some remedial impacts but it won’t solve the problem.

Is this a simple ignorance problem? Do our policymakers not know about supply-side policy? No and no.

This is an ideological problem. Do you old folks recall the 1970s when we discussed supply-side problems? What did we call them ...voodoo, trickle down or Trojan horse.  Wow, if I was a supply-side policy, I wouldn’t want you calling me all those ugly names. But some folks noted correctly that supply-side policy was aimed at restoring supply! Crazy as that might sound, these name-callers noted that the supply-side was largely impacted by SUPPLY. Imagine that. A policy aimed at supply – and suppliers.

Unfortunately, suppliers are business firms. And to our name-calling friends, business firms are selfish rich folks who do not deserve to be assisted. Thus, any remedy aimed at the supply-side of the economy is immediately discounted because it BEGINS by impacting suppliers first. Dead on arrival!

How do we know business firms won’t just give a subsidy or tax benefit to rich stockholders? How do we know they will use the money to restore supply? Fair questions. How do you know that a demand-side tax cut won’t just be hoarded and not spent by households? You don’t know that either. So, what you do is fashion the policy so it is more difficult to not use it for the intended purposes.

But that is not the real problem anyway. The real problem is that some of the name-callers who won’t consider supply-side policy do it because they are driven only by distribution of income issues. To them, supply-side policy looks very nasty. To them, any policy that doesn’t begin with a remedy for distribution of income is not worth discussing.

Am I saying we should not be worried about distribution of income? NO! We should be. We should be spending a lot of our money on solving Covid. Covid is the supply shock. If we solve that problem, then XYZ and most other things will be solved! We know now that lower income people are getting decimated by Covid. With money on Covid, we solve distribution of income AND the economy.

Otherwise, our policies should be aimed at both short- and long-run economic growth. We should forget about demand. If we resolve supply constraints, then the demand constraints will be solved as well. With companies expanding and more people being employed, demand will rise accordingly.

Trickle down, blah blah blah. In 2020, if you want to help people, then work on market opening initiatives that minimize negative health impacts and put some gas into the engine. Let the economy return using sensible policies to control Covid. Try to directly stimulate demand, and you will get very little lasting benefit to the economy.