Fiscal & Monetary Policy

Supply-side policy is government measures designed to increase the productive capacity (long-run aggregate supply) of the economy.

Where fiscal and monetary policy shift aggregate demand, supply-side policy shifts aggregate supply. The long-run prize is higher growth without higher inflation: the closest thing macroeconomic policy has to a free lunch.

Supply-side policies fall into two broad families.

Human-capital and infrastructure policies

These investments raise the quality and quantity of the inputs the economy has to work with.

• Education. Better schooling raises the skills of future workers.
• Training and apprenticeships. Workers in employment become more productive.
• Healthcare. A healthier workforce works more hours and more productively.
• Infrastructure investment. Roads, ports, airports, broadband: better infrastructure cuts firms' costs and connects markets.
• R&D and technology support. Subsidies and tax credits for research speed up innovation.

These policies have a long lead time: results may take a decade or more to show up in productivity figures.

Market and institutional reforms

These reforms change the rules of the game so that markets work more efficiently.

• Deregulation. Reducing red tape lowers firms' compliance costs and barriers to entry.
• Privatisation. Transferring state-owned firms to the private sector (in theory) raises efficiency.
• Labour-market reform. Limiting union power, reducing the duration of unemployment benefits, raising the retirement age, easing hire-and-fire rules.
• Trade liberalisation. Cutting tariffs and non-tariff barriers exposes domestic firms to international competition.
• Lower corporation tax. Encourages firms to invest more in physical capital and to stay in the country.
• Subsidies for investment and R&D. Targeted at sectors the government wants to grow.

These tools are sometimes politically contentious. Deregulation can have side-effects (financial-crisis risk, environmental damage); labour-market reform can hurt workers in the short run.

Why supply-side matters

A government that relies only on fiscal/monetary policy faces the growth-inflation conflict (topic 12): pushing AD up makes inflation worse. Supply-side policy shifts the long-run aggregate-supply curve to the right, which raises the economy's capacity so it can produce more without triggering inflation.

That is why supply-side policy is described as the long-run solution to the macro-policy trade-offs.