Supply-side economics is a theory that maintains that increasing the supply of goods and services is the engine of economic growth. Additionally, it advocates tax cuts as a way to encourage job creation, business expansion, and entrepreneurial activity.
Supply-side economics is sometimes known as Reaganomics for its association with President Ronald Reagan. He and his Republican contemporaries popularized the controversial idea that tax cuts for wealthy investors and businesses give them incentives to save and invest, producing economic benefits that trickle down into the overall economy.
Reagan often quoted the aphorism “a rising tide lifts all boats” to explain his take on the theory.1
Like most economic theories, supply-side economics tries to explain both macroeconomic phenomena and—based on these explanations—offer policy prescriptions for stable economic growth.
In general, the supply-side theory has three pillars: tax policy, regulatory policy, and monetary policy. However, the single idea behind all three pillars is that production (i.e., the “supply” of goods and services) is more important than other variables in determining economic growth.
The supply-side theory is typically held in stark contrast to the Keynesian theory, which, among other facets, includes the idea that demand can falter. So, if lagging consumer demand drags the economy into recession, the government should intervene with fiscal and monetary stimuli.
This is the single big distinction: a pure Keynesian believes that consumers and their demand for goods and services are key economic drivers. In contrast, a supply-sider believes that producers and their willingness to create goods and services set the pace of economic growth.
The three supply-side pillars emerge from these premises—Income tax policy, regulatory policy, and monetary policy.
Supply-siders argue for lower marginal tax rates, particularly marginal income tax. Supply-siders believe that lower rates will induce workers to prefer work over leisure (at the margin). Regarding lower capital-gains tax rates, supply-siders believe lower rates cause investors to deploy capital productively. A supply-sider would even argue that the government would not lose total tax revenue at certain rates because lower rates would be more than offset by a higher tax revenue base—due to greater employment and productivity.
Supply-siders tend to ally with traditional political conservatives—those who would prefer a smaller government and less intervention in the free market.
This is logical because supply-siders—although they may acknowledge that the government can temporarily help by making purchases—do not think this induced demand can either rescue a recession or have a sustainable impact on growth.
The third pillar, monetary policy, is especially controversial. Monetary policy is the Federal Reserve’s ability to increase or decrease the quantity of dollars in circulation and adjust interest rates. Both are used in attempts to control growth and inflation.
A Keynesian tends to think that monetary policy is an essential tool for tweaking the economy and dealing with business cycles. In contrast, a supply-sider does not believe that monetary policy can create economic value.
While both sides agree that the government has a printing press, the Keynesians believe this printing press helps solve economic problems. But the supply-sider thinks that the government (or the Fed) is likely to create problems with its printing press by creating too much inflationary liquidity with expansionary monetary policy and not sufficiently “greasing the wheels” of commerce with enough liquidity due to a tight monetary policy.
A strict supply-sider is thus concerned that the Fed may inadvertently stifle growth.
It is called supply-side economics because the theory believes that production (the “supply” of goods and services) is the most important macroeconomic component in achieving economic growth.
What Is the Opposite of Supply-Side Economics?
The opposite of supply-side economics is Keynesian economics, which believes that the demand for goods (spending) is the key driver for economic growth.
What Is Reaganomics?
Reaganomics is a term for President Ronald Reagan’s economic policies that focused on tax cuts for the wealthy, believing they would lead to savings and higher investments, producing economic benefits that would trickle down to the entire economy. Reaganomics also focused on increased military spending and the deregulation of domestic markets.
Is Keynesian Economics Supply-Side or Demand-Side?
Keynesian economics is demand-side economics, which believes that demand in the economy is the key driver of growth. The increase or decrease in demand for goods and services impacts how much supply producers bring into the economy. Keynesian economists believe that if consumer demand is decreasing, then the government is responsible for increasing spending and intervening with fiscal and monetary stimuli.
How Are Supply-Side and Demand-Side Economics Different?
Supply-side economics believes that producers and their willingness to create goods and services set the pace of economic growth. In contrast, demand-side economists believe consumers and their demand for goods and services are the key economic drivers.
Supply-side economics has a colorful history. Some economists view the supply-side as a useful theory. Other economists so utterly disagree with the theory that they dismiss it as offering nothing more than an updated view of classical economics.
