Keynesian Economics, the Golden Age of Capitalism and the Monetary Policy - Coursework Example

Keynesian Economics, the Golden Age of Capitalism and the Monetary Policy Introduction The differences between Keynesianeconomic policies and the monetary policies have been the center f a huge debate in Macro economics for so many years since the inception of these two schools of thought (Lipsey and Chrystal, 2007). Keynesian economic principles were put forward by John Maynard Keynes, a renowned British economist, while the monetary policies have been spearheaded by Milton Friedman. Friedman, who had first accepted Keynesian’s principles, started to criticize the economic theory pointing out government involvement in the economy. Friedman suggested that governments have a central bank monetary policy whose main aim would be to sustain the equilibrium of demand and supply of money in the economy. As opposed to the Keynesian economics which mainly focused on value stability of a country’s currency and the panic resulting from insufficient supply of money that led to alternate currency and collapse, Friedman and his monetary policy focused on stability of prices as a result of the equilibrium between money supply and the demand of money (Lipsey and Chrystal, 2007). The Keynesian economic principles dominated the macroeconomic world in the 19th century in to the early 20th century, in a period characterized by the rise of capitalism. This period is referred to as the Golden Age of capitalism. The golden age of capitalism, led by The US and other Western economic powers especially after the World War II, (from 1945 to mid 1970s) saw the rise of capitalist nations in to major economic regions of the world. Keynesian Economic Policies A prevailing economic principle in the 1930s and during the Great economic depression was that the economy would recover by itself without any interventions from the government. A British Economist, Keynesian, then suggested that governments should increase their spending and cut taxes so as to revive their economies during the depression (Eatwell and Millgate, 2011). Without government intervention, he argued that the economy would be greatly affected by high unemployment rates and would never recover. In his opinion, increasing government spending during an economic downturn would help to boost demand, as well as setting off the chain of the chain of demand by suppliers and workers whose incomes would have been affected by the increased expenditure by the government. Reducing the tax burden would also enable people to have more disposable income, which would help to boost demand in the economy. He also contended that the most appropriate fiscal policy in periods of high unemployment is to run a deficit budget (Eatwell and Millgate, 2011). Keynesian’s ideas were largely ignored by both the British and the US Governments at the time, until after the World War II (Eatwell and Millgate, 2011). After the war, Keynesians principles of a fiscal policy, government involvement in spending and cutting taxes with the aim of maintaining employment rates became the center of attraction in macroeconomics, both in the debate of national economic policies as well as in research. In the US, the Employment Act (1946) helped the government to start using Keynesian’s economic principles to regulate its economy and improve the employment rate. Application of Keynesian principles saw governments regain economic stability throughout the 1950s and 1960s as they recovered from the economic depression. The Keynesian economic theory was based on the principle of a circular flow of money in the economy (Eatwell and Millgate, 2011). This implies that when one person spends money, kit results in another person earning money. This would then raises the demand of the later, leading him to also spend the money and through buying of goods and services, leading to another person earning the money and so forth. According to Keynes, it is this circular flow of money that enables economies to function well. According to the Keynesian Theory, the aggregate demand created by individuals, households, businesses as well as the government is the most important force that drives the economy and not the principles of free market (Eatwell and Millgate, 2011). This theory asserts that markets do not have clear balancing mechanisms to combat unemployment and drive the economy to full employment. Government intervention in the economy is justified by public policies that lead to full employment and price steadiness in the economy (Eatwell and Millgate, 2011). The End of the Golden Age The golden age in economics refers to the period in history that was mainly characterized by unprecedented national and global economic growth, free trade and capitalism. The concepts of capitalism and free trade were mainly pushed forward by major economic powers at that time like the United States of America, and other Western economic powers and their allies. The golden age came after the economic depression of the 1930s and the World War II and ran from 1945 to the mid 1970s. This period was also characterized by the extensive application of Keynesian economic principles that had helped governments overcome the challenges of the depression. During the years of crisis in the golden age, the economy was characterized with fluctuating exchange rates, protectionism and huge disparities between the highly industrialized nations and the third world countries. The golden age’s unprecedented growth was mainly attributed to the change in economic ideas, from strict application of monetary policies and a free market to adoption of new economic ideas that came with the Keynesian Theory. These Keynesian principles allowed for government involvement in the economy as a short term measure to help governments recover from the recession experienced in the 1930s. The Keynesian principles were very instrumental in ensuring economic recovery and growth of capitalism during this golden era. The golden age also saw the rise of the economies of Asian nations such as Japan and China to be among the biggest economies. Capitalism was seen as the best economic system any country could adopt. The capitalist agenda was advocated for by the US and Britain as well as major economic powers in Europe. Young nations in Asia, Africa and South America that were gaining independence during this period found it had to compete with the established economies of their colonizers. They had to play to the tune of their colonial masters and adopt the economic systems advocated for by them. This led to a majority of former colonies coming up on economic principles common in the US and Europe at the time. These young nations could not catch up with the economical developments that had taken place in Europe and the new economic system posed a lot of challenges to them. These countries also encountered leadership problems that were capable of steering constant economic growth. This led to huge disparities between the highly industrialized economic powers in the West and these young independent nations. Optimism that existed during the golden age began to shade of in the 1970s with new economic challenges. The oil crisis of 1973 led to increase in global oil prices. This led to a multiple of economic and social issues as first world countries entered in the post industrialization era. The steel crisis in the 1970s led to a decline in demand for steel, there was increased competition to established economies from other nations such as Russia, Mexico among others that established themselves as second world nations. These tough economic problems led to stagnating wage levels and employment rates during the 1970s, and there was need for a new economic policy to restore peoples hope. The Rise of Monetarism and Monetary Economic Principles During the 1970s, economists began to feel the need to go back to the monetary economic principles. This led to a new classical macroeconomics movement that began in the late 1960s, which heavily criticized the Keynesian principles and government intervention in the economy (McEachern, 2008). Milton Friedman was among the economists who criticized the Keynesian economic principles and advocated for a monetary policy. This led to development of monetarism, a school of thought in economics that puts emphasis on the role of the government in regulating the amount of money circulating in the economy. Variation in money supply is seen by monetarists, as having major influences on national economic output in the short run while affecting the price levels in the long run (Bannock and Baxter, 2011). Monetarists oppose existence of a Federal Reserve, but advocate for a central bank policy that aims at maintaining the supply and demand for money at equilibrium (McEachern, 2008). According to the monetary policy, a lot of money supplied to the economy increases inflation. Monetary authorities and institutions in the economy such as the central bank should aim at maintaining the stability of prices in the economy. The monetary policies are mainly based on the hard money economic principles that were very dominant in the 19th century as well as Keynesian ideas on stability of currencies. Most monetary economists sought to bring back pre-Keynesian economic ideas that the economy and markets are inherently stable in cases where there are no major unexpected changes in the supply of money (McEachern, 2008). Government intervention through managing demand by increasing expenditure is not therefore warranted. The main characteristics of the monetary policy include the following; • It is founded on the basic principles of the Quantity Theory of Money. • Monetarists claim that the economy is naturally stable, implying that markets should control themselves because they have mechanisms that enable them to work well. Government intervention in the economy can destabilize the economy. • Governments ought to be bound to fixed rules when enacting monetary policies. Discretion on the government’ part when conducting monetary policies can lead to deterioration of the economy. • Monetarists oppose application of the Fiscal Policy that requires government intervention in the economy through increased expenditure and tax reductions The monetary policy can be illustrated using the diagram below. The graph above exemplifies the connection between the supply of money (MS), demand for money (MD), the quantity of money in the economy and the interest rates. The Equilibrium exists at the point where the level of the supply of money is equal to its demand. Interest rates at this point are relatively stable. Changes in the supply and demand of money in the economy lead to fluctuations in interest rates. Conclusion The arguments of Keynesian economics and those of monetarists have both been the centerpiece of macro economics. These economic theories have shaped government economic policies overtime and are still being used today to steer economic growth. The Keynesian economic theory was most dominant after the World War II and became extensively used in public policy in the golden age. The golden age witnessed unprecedented economic growth at both national and international level. There was stability in the global economy as capitalism emerged as the best economic model and advocated for by major economic powers in Europe and the US. The ideas of a free market were also prevalent during the golden age. This period also witnessed growth of other economies in Asia such as Japan and China to the level of the US and European economic powers at the time. After the golden Age, the new socioeconomic conditions that post industrial countries faced, including the oil crisis of 1973 and the decline in demand for steel demanded for new economic policies. This led to the establishment of the monetary policy, which was based on the principles of a quantity of money in the economy. According to this new economic thinking, the central banks ought to regulate the supply and demand of money in an economy and maintain the equilibrium. References Bannock, G. and Baxter, R. 2011. ‘Monetarism’, The Penguin dictionary of economics 8th edn. Penguin, London. Eatwell, J. and Millgate, M. 2011. The fall and rise of Keynesian Economics, Oxford University Press USA, New York. Lipsey, R.G., and Chrystal, K.A. 2007. Principles of Economics, 11th edition, Oxford University Press, Oxford.. McEachern, W. 2008. Macroeconomics: A Contemporary Introduction, CENGAGE Learning, Belmont. Read More