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Supply-side policies - introduction

S:\triplea_resources\DP_topic_packs\economics\student_topic_packs\media_macroeconomics\images\gears_accelerator_2.jpgIn this section you studt the following topics in detail:

  • The role of supply-side policies
  • Interventionist supply-side policies
  • Market based supply-side policies
  • Evaluation of supply-side policies

A Short history of supply-side policy

From 1945 until the mid-1970s, Keynesian fiscal policy (Demand Management) was the major instrument of government economic policy in most countries around the world.

The Phillips curve represented the observed inverse relationship between the rate of unemployment and the rate of inflation in an economy. In other words, the lower the level of unemployment in an economy, the higher the rate of inflation (and vice-versa). This observed relationship had underpinned many governments' macroeconomic policies since the 1950s.

However, while this trade off appeared to exist in the short-run, the relationship broke down in the long-run. In the early 1970s, 'stagflation', occurred in many countries, which was the simultaneous increase in inflation and unemployment; a situation that Keynesian economists believed was not possible.

As a result, the use of monetary policy to achieve macroeconomic goals (prioritising inflation) became widespread, and has dominated government policies in major economies since the 1970s. The 'radical right', or monetarists, in the USA particularly (although similar moves were happening in Europe), suggested that concentration on the demand-side of the economy was untenable and that governments should focus instead on supply-side policies to create greater flexibility in the economy to react to changes in aggregate demand. Monetarist policies came to dominate government economic approaches to controlling inflation coupled with a free-market approach for unemployment in most developed economies: with a growing importance placed on the use of interest rates to fine tune economic development.

The debate moved away from Keynesian policies to arguments over the nature of supply-side policies and whether these should be more or less interventionist in nature as both liberals and conservatives embraced policy measures focusing on increasing aggregate supply.

However, it should be noted that many governments reacted to the financial crisis of 2007 - 2010, by using traditional Keynesian approaches to stimulate aggregate demand, in face of opposition from Monetarists who saw these policies as inevitably inflationary in the longer-term. eg Obama stimulus package starting 2008

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Read the following articles and reflect on the reaction of governments around the world to the financial crisis of 2007-2010, and why did so many governments revert to policies that appear to be Keynesian in nature?