Reviews | The liberal case of supply-side reform

Why policymakers should increase supply to fight inflation.

The city of Iowa needs a new strategy to combat the recent inflationary spurt hitting the US economy.

Policymakers should focus on supply-side reforms, such as abolishing exclusionary zoning laws and crafting tax regimes that attract more businesses to the community.

To put it simply, policymakers in liberal cities need to start promoting policies that give people more stuff if inflation is to be brought down nationwide.

We are currently in what economists call demand-driven inflation. At the macro level, this type of inflation occurs when cash-flooded people and businesses spend money in the economy at a more frequent rate.

As a result, suppliers cannot meet consumer demand and therefore raise prices to ensure that they do not run out of produced goods.

The traditional way to fight demand-driven inflation is to curb demand for goods through the country’s central bank, the Federal Reserve. This involves the use of restrictive monetary policy tools.

When implementing tight monetary policy, the Federal Reserve raises the federal funds rate, or the interest rate at which commercial banks can earn on their excess reserves, the money they lend to consumers in the economy.

So when the federal funds rate rises, commercial banks are more likely to hold onto their excess reserves instead of lending them to consumers. Since consumers do not have access to this cash, they are reluctant to spend money, which dampens inflation.

However, if the Federal Reserve raises the federal funds rate too steeply, there is a risk that a recession could occur. Consumers would not be able to spend money in the economy, leading to businesses losing profits and people losing their jobs.

This scenario played out in the late 1970s and early 1980s when, to fight inflation, the Federal Reserve inadvertently caused a recession. The reality of the situation was that the Federal Reserve was playing a guessing game when it came to fighting inflation.

Another, albeit more deliberate, approach to fighting inflation involves local policymakers concocting policies that would encourage businesses to increase the supply of goods and services in the economy. This would lead companies to increase production and meet consumer demand.

Although supply-side policies take longer to affect the economy than demand-side fiscal and monetary policies, they are also less likely to have unintended consequences.

To illustrate supply-side politics in action, if the Iowa City Council were to vote to liberalize exclusionary zoning policies in the city, it would increase the supply of homes and lower their prices, making homes more affordable for everyone.

Likewise, in order to reduce the cost of dining out, Iowa City should introduce policies that encourage new restaurants. This would increase restaurant competition, lower meal prices and combat inflationary pressures on the economy.

For the record, demand-side policies to curb macroeconomic issues such as inflation are absolutely necessary. That said, these policies should be carried out alongside supply-side reforms that increase the quantities of goods and services in an economy.

In the long run, if supply-side reforms are undertaken, the economy will be more stable and resilient to inflationary crises and thus further improve the quality of life for average Iowans.


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