The Supply-Side Solution

falling by an equivalent amount, consistent with equilibrium, the depression ensued. A similar situation developed in Great Britain when the Bank of England intentionally deflated the economy in order to restore the pre-World War I exchange rate between the dollar and the pound at $4 .87. Keynes crit icized the British government's monetary policy for causing real wage rates and the real burden of debt to rise, thereby creating vast unemployment. Since workers steadfastly refused to lower their nominal (money) wage rates to a level consistent with the decline in the money stock, Keynes advocated inflation, which would cause real wages to decline (in terms of what they would purchase) while nominal wage rates remained unchanged. Or, as Keynes wrote in The General Theory: "Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labor whenever there is a rise in the price of wage -goods. It is sometimes said that it would be illogical for labor to resist a reduction of money-wages but not to resist a reduction of real wages . . .. But, whether logical or illogical, experience shows that this is how labor in fact behaves."! In short, Keynes' view is perfectly consistent with the classical view given the conditions that existed; that is, a deflationary depression when wage rates are rigid. Keynes did not deny that wage rate reductions were a cure for unemployment. In The General Theory he said, "In general, an increase in employment can only occur to the accompaniment of a decline in the rate of real wages. Thus I am not d isputing this vital fact which the classical economists have (rightly) asserted as indefeasible."4 What Keynes also said is that the inflationary cure for unemployment is far less painful (particularly in the political sense) than the orthodox cure . "A change in the quantity of money," said Keynes, "is already within the power of most governments by open-market policy or analogous measures. Having regard to human nature and our institutions, it can only be a fool ish person who would prefer a flexible wage policy to a flexible money policy, unless he can point to advantages irom the former which are not obtainable from the latter. Moreover, other things being equal, a method which is comparatively easy to apply should be deemed preferable to a method which is probably so difficult as to be impracticable."! The effect was a merger of monetary policy and employment policy, such that one could not be considered independent of the other. This relationship was formalized in the "Phillips Curve," which shows an inverse relationship between inflation and unemployment; that is, the higher one is, the lower the other will be, and vice versa . Sir John Hicks, one of Keynes' principal followers, has noted that this situation has had a profound effect on the conduct of monetary policy . Inste ad of concerning themselves solely with ensuring the value of the currency, monetary authorities have become the main controllers of macroeconomic policy. 6 This perversion of the historic role of monetary policy came under strong attack from monetary economists. They argued that there was no long-run money illusion, that workers could not be fooled into accepting lower real income , up to state-set maximums, the increase in tax rates in recent years has reduced the gap between average net wages and average (tax-free) unemployment compensation . The result is that most workers replace at least 60 percent of their net wages. In a GAO sample, one-quarter of the workers replaced over 75 percent of their previous net wages, and a few (7 percent) replaced over 100 percent." Under the circumstances, who wouldn't take the opportunity to put off taking another job for a few months-especially when one's spouse may be working, when one may be getting dividends or pension benefits, or when so many opportunities exist to do work aro und the house that would otherwise have to be paid for or to do a little work for unreported cash. Similarly, there is a tradeoff between saving and consumption that is also affected by the tax rate . Consider an economy in which there are no taxes. Front Matter....Pages i-xiii Introduction....Pages 1-5 We are All Supply-Siders Now!....Pages 6-25 The Economic Effects of Tax Changes: A Neoclassical Analysis....Pages 26-61 The Bankruptcy of Keynesian Econometric Models....Pages 62-72 The Breakdown of the Keynesian Model....Pages 73-85 Taxation, Saving, and the Rate of Interest....Pages 86-109 Supply-Side Tax Policy: Reviewing the Evidence....Pages 110-119 Government Exactions and Revenue Deficiencies....Pages 120-139 Can Tax Revenues Go Up When Tax Rates Go Down?....Pages 140-157 Swedish Tax Rates, Labor Supply, and Tax Revenues....Pages 158-174 Theoretical Analysis and Empirical Measurements Of the Effects of the Philadelphia Income Tax....Pages 175-192 A Time for Supply Economics....Pages 193-206 Some Issues in “Supply-Side” Economics....Pages 207-223 Labor Supply....Pages 224-256 Supply-Side Economics: A General Perspective....Pages 257-264 Taxes and the Supply of National Output....Pages 265-268 Supply-Side Economics: What Chance for Success?....Pages 269-285 Back Matter....Pages 286-290 Edited By Bruce Bartlett And Timothy P. Roth. Bibliography: P. 286-289.