Definition
Monetarism and Keynesianism are two contrasting economic theories. Monetarism, advocated by Milton Friedman, argues that government’s best role in economic affairs is to control the money supply for steady economic growth while limiting inflation. Keynesianism, associated with economist John Maynard Keynes, contends that active government intervention in the marketplace and monetary policy is necessary to manage economic recessions and depressions.
Key Takeaways
- Monetarism and Keynesianism represent two different approaches to economic policy. Monetarism focuses on the management of money in the economy and suggests that overall economic health can be best achieved by control of the monetary supply. Keynesianism argues for government intervention in the economy and emphasizes the importance of total spending in the economy, otherwise known as aggregate demand.
- The two theories also differ in their views on government intervention. Monetarists argue that government intervention often leads to market inefficiencies and should be minimal. On the other hand, Keynesians believe that active government intervention in the economy, through public policies and fiscal measures, is necessary to maintain economic stability and prevent recessions.
- Lastly, the theories have different views on the effectiveness of fiscal and monetary policies. Keynesians emphasize the effectiveness of fiscal policies such as taxation and government spending in stabilizing the economy, while Monetarists believe that monetary policies like controlling the money supply and interest rates are more effective.
Importance
Monetarism vs Keynesianism represents two differing economic theories which impact fiscal policy and monetary management on a national and global level.
Monetarism, associated with economist Milton Friedman, emphasizes the role of governments in controlling inflation by regulating the money supply.
It suggests that excessive growth in money supply causes inflation and that macroeconomic stability can be achieved by targeting a steady rate of monetary growth.
On the other hand, Keynesian economics, attributed to economist John Maynard Keynes, argues for active government intervention in the economy, particularly in economic downturns through public spending and tax cuts to stimulate demand, stabilize output and control unemployment.
The importance of these opposing theories lies in their influence on economic thought and policy-making processes, with potential consequences for economic growth, inflation, employment and income distribution in an economy.
Explanation
Monetarism and Keynesianism are two differing economic theories that propose different methodologies for influencing economic performance and stability. Monetarism, typically associated with economist Milton Friedman, emphasizes the role of governments in controlling the amount of money in circulation.
According to monetarist theory, the primary purpose of controlling the money supply is to combat inflation and maintain economic stability. Monetarists believe that the economy is inherently stable and self-regulating, and that the best role for government is to maintain a stable currency.
On the other hand, Keynesian economics, named after economist John Maynard Keynes, emphasizes the use of fiscal policy—including government spending, taxation, and borrowing—to manage the cycles of growth and recession in the economy. The purpose of Keynesian economics is to mitigate the adverse effects of economic recessions, depressions, and booms.
It posits that active government intervention in the marketplace it necessary to manage output and prevent recessions. Keynesians believe that demand is the primary driving force in an economy, rather than supply, and that spending boosts economic growth during downturns.
Examples of Monetarism vs Keynesianism
The Great Depression: Keynesianism would argue that the Great Depression was exacerbated by a lack of intervention to stimulate demand. Keynesians believe that fiscal policy, particularly government spending, can boost total demand in the economy, thereby reducing unemployment and generating growth. In response to the Great Depression, many governments increased spending, in line with Keynesian thought. However, monetarists might argue that the depression was caused by the Federal Reserve’s decision to contract the money supply. Milton Friedman, a leading monetarist, famously argued that if the Federal Reserve had expanded the money supply, the great economic downturn could have been avoided.
The 2008 Financial Crisis: Following the 2008 financial crisis, economies around the world implemented a variety of strategies. The US, under President Obama, employed a combination of monetary and fiscal stimulus, as advised by Keynesian economists. This included the American Recovery and Reinvestment Act which involved significant government spending to stimulate the economy and boost demand. On the other hand, the European Central Bank, majorly focused on controlling inflation (a monetarist goal), was slower to reduce interest rates and enact quantitative easing – a form of monetary policy, which in turn led to a longer and deeper recession in the Eurozone countries in comparison to the U.S.
Current COVID-19 Pandemic: The pandemic situation has seen a large practical implementation of Keynesian theory. Many governments have increased public spending massively to prevent the economy from falling into a recession due to the lockdowns. These stimulating activities include cash handouts, wage guarantees, tax breaks, etc. At the same time, central banks (with their roots in monetarism) have eased monetary policies worldwide, with reductions in interest rates and huge packages of quantitative easing aiming to maintain the money supply and prevent a financial system meltdown. In these situations, it appears that both Keynesian and Monetarist measures are being employed in an economic ’emergency mode’ to prevent the collapse of economies.
FAQ: Monetarism vs Keynesianism
1. What is Monetarism?
Monetarism is an economic theory which argues that the supply of money is the key driver of economic growth and stability. It emphasizes the control of money supply over fiscal policy as the means to control inflation and stabilize the economy.
2. What is Keynesianism?
Keynesianism is an economic theory of total spending in the economy (called aggregate demand) and its effects on output and inflation. It argues that economic stability is achieved by managing demand through fiscal policy, including government spending and tax policies.
3. What are the main differences between Monetarism and Keynesianism?
The main difference between Monetarism and Keynesianism lies in the methods by which economic stability and growth are achieved. Monetarists advocate for control of the money supply through monetary policy, while Keynesians focus on demand management through fiscal policy measures.
4. Who are the most notable economists associated with Monetarism and Keynesianism?
Friedrich Hayek and Milton Friedman are the most notable economists associated with the development of Monetarist theory, while John Maynard Keynes is the economist from whom Keynesian theory takes its name.
5. How do the two theories approach resolving economic recessions?
In a recession, Monetarists would argue for restraint in expansion of the money supply to ward off inflation, whereas Keynesians would propose increased government spending to spur demand and return the economy to its potential output.
Related Entrepreneurship Terms
- Monetary Policy
- Fiscal Policy
- Keynesian Economics
- Inflation
- Gross Domestic Product (GDP)
Sources for More Information
- Investopedia: An in-depth resource with articles across a broad array of financial topics, including Monetarism and Keynesianism.
- The Balance: Offers personal finance resources which also delve into financial theory including the differences between Monetarism and Keynesianism.
- Encyclopedia Britannica: Provides comprehensive and academic articles on numerous subjects, including economic theories such as Monetarism and Keynesianism.
- Foundation for Economic Education (FEE) : Provides resources and articles focusing on economic education and principles, including those related to Monetarism and Keynesianism.
