The zombie economics of demand-side fundamentalism


The federal government has spent an enormous amount of money fighting COVID-19.

Uncle Sam ran a deficit of $3.1 trillion in fiscal year 2020. Just recently, President Joe Biden signed the American Recovery Plan Act into law, adding another $1.9 trillion in spending. But apparently, this isn’t enough. Both Federal Reserve Chairman Jerome Powell and Treasury Secretary Janet Yellen say more is needed. Without continued fiscal support, they argue, the economic recovery will flounder.

Nonsense on stilts.

Powell, who has a legal and banking background, probably doesn’t realize how silly his position is. But Yellen, a serious academic economist who used to helm the Federal Reserve herself, should. As much as I dislike the federal bureaucracy, I much prefer technocrat-Yellen to political-Yellen. Unfortunately, given the partisan landscape, we’re probably stuck with the downgrade.

Time for some terminology.

Macroeconomic performance depends on the supply side and the demand side. The former refers to the factors of production (land, labor, capital, etc.) and the technology that puts them to work. The latter refers to overall spending patterns. In the long run, economic well-being depends on productivity, which is a supply-side factor. In the short run, spending disruptions can cause economic dislocations, resulting in less production and more unemployment. But these are temporary problems. It’s been more than a year since the initial COVID-19 shock, more than enough time for the economy to adapt to new spending patterns. Remember, though, you can’t spend money on goods that haven’t been produced. The supply side dictates the relevant resource constraints.

The position espoused by Powell and Yellen can best be characterized as demand-side fundamentalism. This was the reigning paradigm of macroeconomics from the immediate post-War years until the early 1980s. A group of economists, who recognized there are these things called “constraints” and that more spending couldn’t fix supply-side bottlenecks, put demand-side fundamentalism to rest. Unfortunately, it’s risen from the grave. It’s a foul, stinking corpse, and we should get it back in the ground as soon as possible.

The economic recovery depends on the performance of the supply-side. It’s just not plausible the remaining problems are due to deficient demand. Keep in mind: Following a negative spending shock, eventually, wages and prices fall, people change their expectations about the future, and the economy readjusts. Low spending isn’t our problem right now. Low production is. Until that picks back up, all the spending in the world won’t give the economy the boost it needs.

Sometimes this position is caricatured as “supply-side fundamentalism.” Critics liken it to the supply-side economics movement of the Reagan years. But they’re wrong on two counts. First, recognizing that the availability of labor, capital, and technology matter for economic performance is hardly “fundamentalism.” I’m sure Powell and Yellen would pay lip service to this tenet, but their policy recommendations belie their true beliefs. Second, supply-side economics was a policy paradigm, not a school of economic thought. I’m not making a claim about tax rates and tax revenue, for example. I’m simply pointing out that COVID-19 raised the costs of production and thus reduced the maximum sustainable levels of output and employment. We must ease this supply-side constraint to recover.

What policies can help the supply side? Again: the answer isn’t tax cuts.

Instead, federal resources should be marshaled to stamp out what remains of the pandemic. We need money for testing. We need money for tracing. And we absolutely need money for vaccines. More inoculation means faster economic revival.

Is this what we got? Ha! Of course not.

The American Recovery Plan Act was chock full of funding for partisan Democrat priorities that long predated COVID. A measly 9% of the bill was dedicated to curbing the virus. COVID-19 was the pretext for this monstrous abuse of the public trust. The substance was hardball politics, plain and simple.

Demand-side fundamentalism failed us in the 1970s, resulting only in the twin miseries of high unemployment and inflation. I don’t think we have to worry about inflation this time, but the fundamental problem remains the same: spending is the wrong tool for the job. Powell and Yellen found their hammer, but there are few nails about. They’re going to run around whacking things anyway, and we’ll all be the worse off for it.

Alexander William Salter is an associate professor of economics in the Rawls College of Business at Texas Tech University, the comparative economics research fellow at TTU’s Free Market Institute, and a Young Voices senior contributor. Follow him on Twitter @alexwsalter.

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