Demand Side Economics

Demand-side economics is frequently referred to as “Keynesian economics” after John Maynard Keynes, a British economist who outlined many of the theory’s most important attributes in his General Theory of Employment, Interest, and Money.

According to Keynes’ theories, economic growth is driven by the demand for (rather than the supply of) goods and services. Simply put, producers won’t create more supply unless they believe there’s demand for it.

Demand-side theory directly counters classical and supply-side economics, which hold that demand is driven by available supply. This may seem like a chicken-and-egg distinction, but it has some major ramifications for how you look at the economy and the government’s role in it.

In contrast to supply-siders, Keynesians place less emphasis on overall levels of taxation, and believe much more in the importance of government spending, especially during periods of weak demand.

Here’s how demand-side economics differs from supply-side:

• Demand-side economists argue that instead of focusing on producers, as supply-side economists want to, the focus should be on the people who buy goods and services, who are far more numerous.
• Demand-side economists like Keynes argue that when demand weakens—as it does during a recession—the government has to step in to stimulate growth.
• Governments can do this by spending money to create jobs, which will give people more money to spend.
• This will create deficits in the short-term, Keynesians acknowledge, but as the economy grows and tax revenues increase, the deficits will shrink and government spending can be reduced accordingly.

There are two-prongs to demand-side economic policies: 

• an expansionary monetary policy
• a liberal fiscal policy.

In terms of monetary policy, demand-side economics holds that the interest rate largely determines the liquidity preference, i.e., how incentivized people are to spend or save money. During times of economic slowness, demand-side theory favors expanding the money supply, which drives down interest rates. This is thought to encourage borrowing and investment, the idea being that lower rates make it more appealing for consumers and businesses to buy goods or invest in their businesses—valuable activities that increase demand or create jobs.

When it comes to fiscal policy, demand-side economics favors liberal fiscal policies, especially during economic downturns. These might take the form of tax cuts for consumers, like the Earned Income Tax Credit, or EITC, which was an important part of the Obama administration’s efforts to fight the Great Recession.

Another typical demand-side fiscal policy is to promote government spending on public works or infrastructure projects. The key idea here is that during a recession it’s more important for the government to stimulate economic growth than it is for the government to take in revenue. Infrastructure projects are popular options because they tend to pay for themselves in the long term.  READ MORE...