Supply-side Policy
Government and the Macroeconomy
Supply-side policy is the use of government measures designed to increase the of the economy, so that it can produce more goods and services.
Fiscal policy and monetary policy work on aggregate demand: the total amount of spending in the economy. Supply-side policy works on the other side, on the economy's ability to produce. Instead of changing how much is being spent, it changes how much the economy is capable of making. On a production possibility curve, a successful supply-side policy shifts the whole curve outward, so the economy can produce more of both types of good.
The attraction of supply-side policy is that it can raise output without the usual inflation problem. When a government pushes up demand too hard, prices rise. When it raises productive capacity instead, the economy can produce more at the same or lower cost, so growth comes with stable prices rather than higher ones. That is why supply-side measures are often described as the long-run route to the macroeconomic aims of topic 12.
The trade-off is time. Most supply-side measures take years to bear fruit, because they work by slowly changing the quantity and quality of resources, the skills of workers, and the efficiency of firms.
Common exam question
What supply-side policy aims to do
Question: Choose the definition, aim or most likely result of a supply-side policy from four options (1 mark, multiple choice).
Set in 6 of the 13 multiple-choice papers. The key is always about the economy's ability to produce: higher productive potential, potential GDP or productivity, or the economic growth that follows. The wrong options belong to other policies (more total demand, a change in the interest rate, the money supply or the exchange rate), reverse a supply-side measure (higher direct tax, stronger trade unions, a bigger public sector) or point the wrong way (more inflation, more structural unemployment, a worse current account).
Lower inflation and unemployment can follow from supply-side policy, but they do not define it: when a definition item offered a policy to cut inflation, one to cut unemployment and one to raise productivity, only productivity was right.