The Battle Over the Economy: A Review of Popular Schools of Economic Thought (Part 2)

In my last article, I talked about the contradictory nature of the economic theories representing various schools of thought, and the fact that some of the most useful theories, those of the Supply-side school, are receiving the least amount of attention.

Many of the theorists, most notably the Keynesians, are still hung up on the Philips Curve, which claims employment and inflation are positively correlated. Many of these economists, including Alan Greenspan, believe that the Philips Curve suggests inflation is coming, and thus the economy should be managed to prevent this.

Supply-Side economists, meanwhile, reject the Philips Curve, and consider currency policy the driver of inflation. Rather than measuring currency quantity like Austrians and Monetarists, they attempt to measure currency "quality" against gold (or a basket of precious metals), a steady store of value, and assert that "inflation" will remain low as long as the dollar remains strong relative to gold.

Supply-side economists suggest that Austrians and Monetarists are wrong to view money supply expansion as always inflationary. Most Supply-siders think inflation is government-created money supply in excess of the amount demanded by an economy's producers. This is simultaneously reflected in a currency's change in value relative to gold.

Supply-siders also state that lower taxes (esp. capital gains) and the strong dollar relative to gold have together resulted in low-inflation growth. Most also believe that the stock market's appreciation and historically-high valuation is justified by economic growth and a declining interest-rate and equity-risk premium.

I believe the Supply-side school, when integrated with a wider understanding of rational economics, (e.g. elements of the Austrian and Rational Expectations schools) best explains inflation and economic growth. Supply-side forecasts have tended to be more accurate than those of others schools over the years, and that alone should give them a more prominent position among those seeking near-term economic answers.

In my view, the Austrian school, at least in its current mainstream manifestation, is perpetually negative, forecasting since the '80s near-term ruin that has never materialized. Nonetheless, while it may appear that their recent "Armageddon" perspective is a lot of hot air, their insights into the destructiveness and instability of government interventionism must not be ignored. And the works of the school's founder, Carl Menger, are perhaps the most under-appreciated texts in economics.

The Monetarist school appears to be gradually fading in importance, and while it does have some important adherents among some central bankers, its single-factor money supply model has generally had poor predictive power.

Keynesianism continues to maintain its hold on mainstream economics, though its practitioners appear to be disintegrating its theoretical framework, and have remained relatively quiet during positive economic periods. The large numbers of Keynesian policymakers should be closely monitored, because their tendency is to seek increased government spending, devaluation, and "stimulative" inflation.

Lastly, I believe that the New Era school has made the mistake of reversing cause-and-effect. Technological progress is one effect of economic stability, as more capital can be made available for investment in productivity- enhancing tools. Past periods of technological progress collapsed when bad economic policies attacked producers. I consider New Era types to be primarily stock-market tooters, asserting current market valuations and inflation rates that are compatible with numerous future economic policies. In actuality, only rational policies will fulfill current market expectations.

So let's hear it for the Supply-siders, many of whom have consistently managed to identify the real forces affecting the economy, and deserve a lot more respect than they are currently getting.

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.