Monetarist and Keynesian Economics
Economists on the Role of the State in the Economy
Modern American politics is fraught with issues which split neatly along party lines. Economic policy is among the most obvious examples, with Republicans historically favoring Monetarism, and Democrats favoring Keynesian economic theory. Monetarists argue for minimal state intervention in the economy, emphasizing long-run health and stability of the economy, and fearing the potential negative effects of market distortions. Keynesians on the other hand advocate relatively frequent interventions to aid the short-run stability of the economy, because the long-run health of the economy is ultimately unknowable and, as Keynes argued, “In the long run, we are all dead.” Not only do monetarists and Keynesians differ in how frequently the government should adjust the economy, but they also hold different views on what methods the government should use, with monetarists advocating for the use of monetary policy and Keynesians fiscal policy.
Keynesian Economics
In 1936 John Maynard Keynes published The General Theory of Employment, Interest, and Money, and revolutionized economic thought. In his General Theory Keynes advocated for the use of Fiscal Policy to regulate unemployment, limit inflation, and stabilize economies during economic downturns. Fiscal policy is the use of “taxation, or government spending to regulate the economy.” Keynesians argue that because prices, particularly wages, are sticky and do not respond quickly to market pressure, that in an economic downturn the government must spend money and invest in the economy to prevent a rise in unemployment or a drop in wages, which Keynes believed would decrease “income, consumption, and aggregate demand,” causing the economy to shrink. Keynes General Theory is among the most influential economic theories of all time and was the predominant economic thought during much of the 20th century, though it did start to fall out of favor in the 1970s and 80s. Despite its decrease in popularity, Keynes’ work is still influential today, with a resurgence of Keynesian thought and policy beginning in the 2000s, particularly with the stimulus packages in response to both the 2008 Financial Crisis and the Covid-19 pandemic.
Monetarist Economics
Monetarism is an economic theory built on the Quantity Theory of Money that emphasizes “long run monetary neutrality, short run monetary non-neutrality, the distinction between real and nominal interest rates, and the use of monetary aggregates in policy analysis.” Monetarists advocate for the use of monetary policy to ensure the long run stability and growth of the economy. Monetary policy is the manipulation of interest rates and reserve requirements and the use open market operations to shift the supply of money and credit available in the economy. While monetarism has its roots in the 16th century, it wasn’t until the 1970s, with the work of Milton Freidman, that it began to challenge the predominant economic theories and establish itself as the new mainstream economic thought. Freidman’s A Theory of the Consumption Function, was instrumental in causing this shift. In its Freidman argued that people’s consumption was based on their expected annual income, not their nominal income, and because of this “people’s behaviors would not adjust in response to fiscal policy measures, as they would perceive such policies as temporary.”