Download Monetarist View

Monetarism / Keynes
Monetarist View
Keynesian View
Inflation – caused by excessive
growth in the money supply.
Monetary policy must therefore act
to restrict the growth of the money
supply. Fiscal policy must work to
produce a low Public Sector
Borrowing Requirement so that the
government does not have to print
the money it needs to cover
spending.
Inflation – is caused by cost-push
factors, can be controlled by prices
and incomes policies. If inflation is
demand-pull in nature then the
government will have to accept
higher unemployment if it wishes to
lower inflation by reducing public
spending and/or increasing taxes.
Unemployment – is caused by a lack
of competitiveness in the economy
as a whole, and by failures in the
market for labour in particular.
Monetarists argue, therefore, that tax
rates should be reduced in order to
increase incentives to work. Workers
should accept lower wage rates to
prevent themselves being priced out
of jobs. Generous welfare payments
to the unemployed should be cut to
encourage people to take jobs.
Trade unions should lose their power
to fix wages which are too high.
Unemployment - caused mainly by a
lack of demand in the economy.
Governments need to increase
demand by increasing the Budget
Deficit, the Public Sector Borrowing
Requirement. However, many
Keynesians believe that much of the
unemployment in Britain in the
1980s/1990s was structural. Here they
would agree with monetarists that
supply-side measures such as extra
investment are essential.
Growth – will be increased if the UK
becomes more competitive. Cutting
tax rates, privatisation, reducing
union power, cutting welfare benefits,
helping small businesses – all these
measures will help growth.
Growth – can be stimulated by
keeping a high level of demand in
the economy. This will encourage
firms to invest, because firms know
they will be able to sell their products.
The Current Account – will look after
itself as long as the government does
not attempt to fix an artificial rate of
the pound.
The Current Account – can be kept in
balance through use of import
controls or by devaluing the pound.
Keynesians disagree amongst
themselves as to how effective each
policy could be, or whether such
policies would be effective at all.
Overall – monetarists believe that the
government’s role is to control the
money supply and to help freemarket forces work. The government
has only a limited role and cannot
directly control either unemployment
or the growth rate.
Overall – Keynesians argue that the
government can have a powerful
effect on the economy and believe
that free-market forces can reduce
the economy to ruins if left to
themselves. Accordingly,
governments have to correct freemarket forces to ensure that the
economy is running at full
employment.
Monetarism / Keynes
Fiscal Policy
By adopting various policy measures governments can affect the economy.
The main weapon is fiscal policy – a government policy with regard to
government spending, taxation and borrowing.
Fiscal policy can affect the economy in a number of ways. First it may affect
the level of demand in the economy. If a government spends more and/or
raises les money in taxation there will have to be an increase in the amount
that the government borrows – the Public Sector Borrowing Requirement
(PSBR) or PSBR will go up.
An increase in PSBR will mean that the private sector will have more money to
spend. This will come about either because the private sector is paying less in
taxes than before or it will have money as a result of extra government
spending. For example, if the government has spent more on roads, then the
private sector will end up with that extra money in the form of wages, orders
for raw materials etc.
Economists disagree, however, about the exact link between PSBR and
aggregate demand.
Keynesian economists argue that an extra £1 of government borrowing will
increase national income by more than £1. This is known as the Multiplier
Effect. The argument is that if the government increases, say, spending in
hospitals by £1, then it will lead to an increase in income. But whoever
receives that £1 (workers, firms etc) will spend it, creating further income in the
economy. The money will keep travelling round the economy, each time,
creating extra income as it goes.
Monetarists, however, argue that there is no multiplier effect. In fact £1 of
extra borrowing by the government will mean that the private sector will not
be able to borrow that £1 extra public spending crowds out private spending,
so that an increase in the PSBR has no overall effect on aggregate demand in
the economy.
Second, fiscal policy can affect the distribution of income and wealth in the
economy. By making the rich pay more taxes than the poor, and by
increasing spending on programmes that benefit the poor rather than the
rich, the government can make the distribution of income and wealth more
equitable. Making the poor pay more in taxes and reducing spending
programmes designed to help the poor will increase the income and wealth
inequalities in the economy.
Thirdly, fiscal policy can affect the decisions of industrial consumers, workers
and firms.

Of a government gives cash grants or reduces taxes to firms making
investment, then total investment in the economy should rise

Workers may work harder, if incentives to work are increased. This can
be done by reducing the marginal rate of income tax (the rate of tax
on the last pound earned by the worker). Or it can be done by
reducing unemployment benefits so that the difference between
income in work and out of work is increased
Monetarism / Keynes

Entrepreneurs can be encouraged to start up in business and expand
through a whole variety of measures – e.g. reduced marginal tax rates
on income and profits, investment grants and tax privileges on
borrowed funds

Firms can be encouraged to take on more workers through reducing
taxes on the emp0loyment of workers – the main tax in the UK being
employers’ national insurance contributions
Key Terms:
Fiscal Policy – government policy with regard to public expenditure, taxation
and borrowing.
Public Sector Borrowing Requirement – the difference between the total
government revenue and total government spending.
Multiplier Effect – the theory that extra spending will lead to further increases
in spending in the rest of the economy.
Crowding Out – the theory that extra government spending leads to less
spending by the private sector.