A debate between the relative merits of a demand side and supply side stimulus is an oversimplification of the dynamics of our economy.  Is our economy more demand driven or supply driven? The answer, like so many answers to questions about complicated systems, is “it depends.”

Especially with rapid technological advances new supply creates its own demand.  Apple’s products provides hundreds of thousands of new applications not because consumers asked for them (demand) but because some techno geek thought others would like them (supply).

Marketing research seeking to determine demand is more often wrong than right, occasionally spectacularly wrong such as with New Coke and the merger of AOL with Time Warner.  Most new products fail; most mergers destroy value.  On the other hand we often embrace new technology not because we need it, not even because we want it; we do things today simply because we can.

The demand supply continuum changes from different periods. Stimulating supply creates its own demand.  Henry Ford was noted for raising wages high enough (the famous $10 per day) so that the workers could afford the products they made, and for introducing mass production assembly line techniques (an idea he got from a slaughterhouse) that kept prices low.

Keynesian economists, most represented by Paul Krugman today, emphasize the need for government deficits to replace the spending abandoned by the consumers during economic downturns.  But all spending and all deficits are not alike.

Was the spending before the result of normal consumer demand or the result of an indulgent Fed? If a loose money policy drove prices and spending higher we would be better off letting the excess wind itself down than to replace the stimulus of loose money with the recklessness of fiscal debt. We should embrace the benefits of a recession to wind down market excesses that are part of long term economic growth.  By trying to avoid the pain with loose spending we stand only to inflate the bubble further and risk more pain later. We stand at a loop of bubbles created by deficits perpetuated by deficits to avoid a necessary correction.

It also matters how a stimulus is spent. If it is used to hire teachers, police or census workers then one must consider how they will get paid when the stimulus ends.  If it is given to the ‘social bribery fund’ such as increased welfare or political constituencies, one has to consider how they will respond when the stimulus ends or when the opposition party returns as they always seem to do. But a bridge, a highway, or technological infrastructure can pay benefits long after the stimulus is spent.

That is not to say the we should abandon any flexible efforts on the part of the Fed’s monetary policy or government spending.  But activity that was once deemed a temporary fix to a short term problem has become normal economic policy.  While Keynes thought we had fixed the economic problem (and he was partially right) he did not mean for deficit spending to become permanent economic policy.  Nor did Milton Friedman think that the monetary response to recession should be the rule for normal economic times.  We risk never running out of crisis that need a fix.

How well a stimulus will succeed depends other conditions; what worked before may not work today. Reagan’s deficits combined with sound money and lower taxes created economic growth from a decade of stagnation and inflation. Trying to stimulate an economy with deficits when businesses are inundated with substantially higher taxes, more regulation, uncertain enforcement of contract law, and higher costs is a fool’s errand. Perhaps the stimulus would have had a better effect if business were not being attacked on every front from the same government that is trying to stimulate it. Businesses are reluctant to invest in an economy where the rules change every election cycle.

When bankruptcy and contract law is cast aside by executive fiat we are entering into the realm of third world economies.  Only the most corrupt crony capitalists invest in those countries.

By now we should realize that the academics do not have the answers.  Ideological fixations are impediments to functional solutions. And neither political party has a historical monopoly on sound economic policies.  Coolidge, Kennedy, Reagan and Clinton saw the benefits of sound money and low taxes.  Most  other presidents saw the stagnation and destruction of   a weak dollar or high taxes.

Sound money, low taxes, low regulation (or at least consistent and clear regulations), and free trade are the hallmarks of a successful economy. The difficulty and pain is returning to those ideals when we have strayed so far from them. Being drug free is much easier than transitioning to clean health from addiction.