Our economies today are structured as demand-side economies. What does it actually mean? Demand-side economics is a macroeconomic theory that argues that economic growth is driven by aggregate demand, which is the total amount of goods and services that people and businesses are willing and able to buy.
According to demand-side economics, the government can stimulate economic growth by increasing demand for goods and services through fiscal policy (such as tax cuts or government spending) or monetary policy (such as lowering interest rates).
The fundamental issue with this macroeconomic theory is that it is doomed to create inflation, no matter what. The key factor of demand-side economics is aggregate demand through consumer spending. People are forced to spend in order for the economy to function. But spending naturally props up the prices of goods and services. Consumer spending is stimulated by government spending and the increase of the money supply by the central bank. These tools of monetary and fiscal policy artificially inflate the value of the national economy, which encourages consumers to spend to stimulate the economy, which in turn, creates inflation.
The conundrum with inflation is that it erodes the purchasing power of the consumer since the prices of goods and services increase faster than the amount of these goods and services available. Thus, it impoverishes the consumer. In other words, demand-side economics impoverishes the consumer because money loses its value, which leads to a decline in living standards, especially for low-income households.
Moreover, inflation can make it difficult for businesses and consumers to make rational economic decisions. For example, if prices are rising rapidly, businesses may be hesitant to invest in new projects, and consumers may be hesitant to make big purchases.
Within demand-side economics, the economy does not grow naturally. It grows according to whatever tools the government and central banks use to prop up the economy instead of letting it grow naturally according to market forces. Hence, demand-side economics is some sort of economic engineering rather than a natural process of economic growth.
It is important for modern economies to embrace supply-side economics in order for consumers to retain a higher purchasing power. Like demand-side economics, supply-side is a macroeconomic theory. But instead of arguing for economic growth through aggregate demand, it argues that economic growth can be most effectively fostered by lowering taxes, decreasing regulation, and allowing free trade.
According to supply-side economics, consumers will benefit from greater supplies of goods and services at lower prices, and employment will increase. Supply-side fiscal policies are designed to increase aggregate supply, as opposed to aggregate demand, thereby expanding output and employment while lowering prices.
The main factor of supply-side economics is that it creates disinflation and deflation. When an economy relies on supply-side economics, it means that there are more goods and services available than there is a demand for them. As a result, the prices of these goods and services are lowered, which makes them more affordable for everyone, especially low-income households. Supply-side economics increase people’s living standards since they can afford more things due to having a higher purchasing power.
Under supply-side economics, the government cuts taxes and deregulates the economy. Supply-side economists argue that high taxes discourage investment and economic growth. They believe that cutting taxes, especially for businesses and high-income earners, will encourage people to work harder, save more, and invest more. This will lead to increased productivity, economic growth, and job creation. And reducing regulations make it easier for business to increase productivity and job creation as well.
The main point about supply-side economics is that governments and central banks play a far less interventionist role in the economy. They are trying not to engineer the economy through artificial mechanisms, but instead, to let the economy grow naturally through market forces. Supply-side economics reflects the real value of an economy.
Will modern economies start using supply-side economics? Probably not because this will make government less useful; thus reducing the size of government. If government’s size is reduced, then many government bureaucrats will be out of work, but on the other hand, the average consumer will be enjoying a much higher standard of living than under demand-side economics.