The zombie economics of demand-side fundamentalism

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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.

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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.

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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.


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