Keynesians v/s Monetarists:
Keynesians were in favour of
demand management policies but were against the use monetary policy as well as
fiscal policy in fighting against inflation. They were of the opinion that fighting
inflation was a costly affair. It was due ti their faith in the shape of
aggregate supply curve. Any effort to lower the inflation would also reduce the
real GNP and thus would be a costly affair.
Milton Friedman emphasised that
the most important determinant of the nominal or current value of GNP is the
money supply. Monetarists believed that an increase in money supply will affect
GNPat current prices slowly over time, with the first effect being felt as an
increase in real GNP, but ultimately will only lead to an increase in the
general price level in the economy. Monetarists believe that the timings cannot
be predicted in advance. In some cases the change in the money supply would
affect the real output quickly and only slowly affect the price level. In other
cases the effect might be slower but predominantly on price level. In the
opinion of the Monetarists economists the main cause of variability in the
economy is the government’s action to stabilise economy (as recommended by
Keynesian economists). The government’s action mess-up things because of
political pressures and because of unpredictability of the link between the money supply and economic variables.
Friedman may be regarded as the
leading prophet in the revival of old quantity theory of money. The theory
states that the fluctuations in the quantity of money affect money income.
Monetarists believe in the stability of the aggregate money demand function
i.e. the relationship between the quantities of money people wish to hold in
cash bear a stable relationship to their money income in aggregate. In the long
run the fluctuations in aggregate money incomes (resulting from aggregate money
supply) will take the form of variations in prices rather than in output and
employment. The monetarists are of the view that the exact location of the AD
Curve as result of initial shock is unpredictable. As the level of Natural
Output is fixed change in money supply has no effect on real output in the long
run but only affects the price level. Because of the unpredictability of the AD
curve and history of the policy making failure, the government was more likely
do harm than good.
Monetarist saw practically no
role for the government policies. They argued that the root cause of poor
performance in past was government’s stabilization policies. Thus, Keynesians
and monetarists disagree both on the determinants of growth and on the role of
government in economic development. Monetarists because of their faith in
unpredictability of aggregate demand believe that government should not
interfere in the economy by using fiscal policy to influence the level of
output and employment. Monetarists also believe that prices and incomes
policies should not be used. They believe that monetary policy will have a
greater impact. A change in money supply would affect both the real output and
the price level. Which of these two variables will change first and in what
quantity is uncertain? Any attempt to affect these variables by the government
was likely to do harm than good. The monetarists argued that there is no
long-run trade-off between inflation and unemployment there may be a transitory
trade-off so that increase in the quantity of money may lead to some rise in
employment and output along with inflation but ultimately the output and
employment will fall back and the overall effect of the increase in money
supply will be on inflation. The monetarists also have a faith in market and
because of this Milton Friedman advocated smaller role for the government in
the management of the macro economy. On the contrary as has already been
mentioned Keynes entirely focused on the management of macro economy especially
the demand side management for achieving higher growth and employment.
Also see supply side economists
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