169 Neoclassical Fiscal Policy and Supply-Side Economics (153/108) -- Macroeconomics

169 Neoclassical Fiscal Policy and Supply-Side Economics What you’ll learn to do: compare neoclassical and Keynesian approaches to Fiscal Policy In this section, you’ll learn about how and why there are varying recommendations from economists regarding fiscal policy. As you know, neoclassical economists emphasize less government intervention with the assumption that the economy will return to full employment in the long run. Keynesian economists recommend more intervention, and in this section you’ll learn about some of the specific arguments for both sides. Learning Objectives - Explain supply-side economics, including the role of tax cuts and the Laffer curve - Compare and contrast Keynesian and neoclassical approaches to fiscal policy Much of the previous discussion in this module has taken a Keynesian policy-activist perspective. Recall that the classical, hands-off, approach was initially recommended when the economy collapsed during the Great Depression, but then Keynes came along and recommended that the government step in and intervene in order to make up for a shortfall in private sector spending. One criticism of the Keynesian approach is that the government needs to deficit spend in order to stimulate the economy. Deficit spending requires the government to borrow money, which may lead to higher interest rates, making it harder for private businesses to borrow money. This is known as crowding out, and weakens the effects of fiscal policy. Keynesians would argue that any crowding out is minimal, since the economy is not operating at full capacity; thus resources can be found easily without taking them away from private businesses. Neoclassicals believe in a more passive fiscal policy approach, designed to promote economic growth with stable prices. They believe in low tax rates and limited government spending, which they believe will allow the private sector, and thus the economy as a whole, to flourish. Alan Greenspan, former chair of the Board of Governors of the Federal Reserve is one such neoclassical economist. Many neoclassicals, including Greenspan, are wary of budget deficits, arguing that they provide a drag on economic growth because of crowding out. Try It Watch It: Tax Cuts During the Recession Watch this video to understand how some neoclassically-minded small business owners and economists felt about the possibility of ending the Bush tax cuts in 2010. Note that these tax cuts were eventually extended, although changes were made later in the American Taxpayer Relief Act of 2012. Supply-Side Economics A particular type of Neoclassical economics became popular in the 1980s, after the election of President Ronald Reagan. This was supply-side economics, also known as Reaganomics. Supply-siders believe that economic activity is motivated by after-tax returns to that activity. Thus, people are attracted to jobs that pay well, and businesses are attracted to industries with high profits. Additionally, tax cuts increase economic a