The document compares monetarism and Keynesian economics, outlining key aspects of each school of thought. Monetarism, mainly advocated by Milton Friedman, emphasizes the control of the money supply as a determinant of economic activity, while Keynesian economics, founded by John Maynard Keynes, focuses on aggregate demand and the necessity of government intervention to achieve economic stability. The document also highlights historical contexts, criticisms, and the evolution of both theories, particularly in response to economic challenges such as stagflation and the 2007–08 financial crisis.

1. 1
Monetarist and Keynesian
School of Thoughts

2. 2
Monetarism
Monetarism school of economic thought
that maintains that the money supply is the
chief determinant on the demand side of
short-run economic activity
American economist Milton Friedman is
generally regarded as monetarism’s
leading exponent.

3. 3
The monetarist approach became
influential during the 1970s and early ’80s.
 The foundation of monetarism is the
Quantity Theory of Money.
 The theory is an accounting identity—that
is, it must be true.
It says that the money supply multiplied by
velocity equals nominal expenditures in
the economy.
As an accounting identity, this equation is
uncontroversial.

4. 4
What is controversial is velocity.
Monetarist theory views velocity as
generally stable, which implies that
nominal income is largely a function of the
money supply.
Variations in nominal income reflect
changes in real economic activity (the
number of goods and services sold) and
inflation (the average price paid for them).

5. 5
The quantity theory is the basis for several
key tenets and prescriptions of
monetarism
• Long-run monetary neutrality: An
increase in the money stock would be
followed by an increase in the general
price level in the long run, with no effects
on real factors such as consumption or
output.

6. 6
Short-run monetary no neutrality: An
increase in the stock of money has
temporary effects on real output (GDP)
and employment in the short run because
wages and prices take time to adjust (they
are sticky, in economic parlance).

7. 7
Constant money growth rule: Friedman,
proposed a fixed monetary rule, which
states that the Fed should be required to
target the growth rate of money to equal
the growth rate of real GDP, leaving the
price level unchanged. If the economy is
expected to grow at 2 percent in a given
year, the Fed should allow the money
supply to increase by 2 percent.
The Fed should be bound to fixed rules in
conducting monetary policy because
discretionary power can destabilize the
economy.

8. 8
Interest rate flexibility: The money
growth rule was intended to allow interest
rates, which affect the cost of credit, to be
flexible to enable borrowers and lenders to
take account of expected inflation as well
as the variations in real interest rates.

9. 9
Many monetarists also believe that
markets are inherently stable in the
absence of major unexpected fluctuations
in the money supply.
They also assert that government
intervention can often destabilize the
economy more than help it.
Monetarists also believe that there is no
long-run trade-off between inflation and
unemployment because the economy
settles at long-run equilibrium at a full
employment level of output

10. 10
Friedman contended that the government
should seek to promote economic stability,
but only by controlling the rate of growth of
the money supply.
It could achieve this by following a simple
rule that stipulates that the money supply
be increased at a constant annual rate tied
to the potential growth of gross domestic
product (GDP) and expressed as a
percentage (e.g., an increase from 3 to 5
percent).

11. 11
Characteristics of Monetarism
1. The theoretical foundation is the Quantity
Theory of Money.
2. The economy is inherently stable.
Markets work well when left to
themselves. Government intervention can
often times destabilize things more than
they help. Laissez faire is often the best
advice.

12. 12
 The Fed should be bound to fixed rules in
conducting monetary policy. They should
not have discretion in conducting policy
because they could make the economy
worse off.
 Fiscal Policy is often bad policy. A small
role for government is good.

13. 13
In the late 1970s and early 1980s, after a
decade of increasing influence,
monetarism’s reputation began to decline
for three main reasons.
One was the growing belief, based on
plausible interpretations of experience that
money demand is in practice highly
“unstable
The second was the rise of RATIONAL
EXPECTATIONS economics
The third was the Federal Reserve’s
famous “monetarist experiment

14. 14
During the 1970s, inflation rose in the
United States, as well as in many other
industrial nations, to levels unprecedented
on a multiyear basis during periods of
relative peace.
This occurred as a consequence of
various “shocks”—oil price increases, the
Vietnam War, and especially the 1971–
1973 demise of the Bretton Woods system
of fixed exchange rates

15. 15
This demise left central bankers with a
major new responsibility; namely, to
provide a nominal anchor for national fiat
currencies to replace the GOLD STANDARD.
on October 6, 1979 the Fed would try to hit
specified monthly targets for the growth
rate of M1, with operating procedures that
emphasized control over narrow and
controllable monetary aggregate,
nonborrowed reserves

16. 16
the events that occurred from October
1979 to September 1982 are widely
viewed as the crucial beginning of a
necessary and successful attack on
inflation
Short-term interest rates jumped
dramatically in late 1979 under the
tightened conditions, and 1980 witnessed
a major fall in output in one quarter
followed by a major jump in the next, due
primarily to the imposition, and then
removal, of credit controls.

17. 17
1981 and into the middle of 1982, a
sustained period of monetary stringency
brought about the deepest recession since
the GREAT DEPRESSION of the 1930s and
began to bring inflation down, more rapidly
than many economists anticipated, toward
acceptable values

18. 18
Keynesian Economics
Keynesian economics was developed by
the British economist John Maynard
Keynes during the 1930s in an attempt to
understand the Great Depression.
 Keynes advocated increased government
expenditures and lower taxes to stimulate
demand and pull the global economy out
of the Depression.

19. 19
Subsequently, the term “Keynesian
economics” was used to refer to the
concept that optimal economic
performance could be achieved by
influencing aggregate demand through
activist stabilization and economic
intervention policies by the government.
Keynesian economics is considered to be
a “demand-side” theory that focuses on
changes in the economy over the short
run.

20. 20
The main plank of Keynes’s theory, which
has come to bear his name, is the
assertion that aggregate demand the most
important driving force in an economy.
Keynes further asserted that free markets
have no self-balancing mechanisms that
lead to full employment.
Keynesian economists justify government
intervention through public policies that
aim to achieve full employment and price
stability.

21. 21
There are three principal tenets in the
Keynesian description of how the
economy works:
Aggregate demand is influenced by many
economic decisions—public and private.
Private sector decisions can sometimes
lead to adverse macroeconomic
outcomes, such as reduction in consumer
spending during a recession.

22. 22
Prices, and especially wages, respond
slowly to changes in supply and demand,
resulting in periodic shortages and
surpluses, especially of labor.
Changes in aggregate demand, whether
anticipated or unanticipated, have their
greatest short-run effect on real output and
employment, not on prices.

23. 23
Keynesianism evolves
Particularly noteworthy were his
arguments with the Austrian School of
Economics, whose adherents believed
that recessions and booms are a part of
the natural order and that government
intervention only worsens the recovery
process.

24. 24
Keynesian economics dominated
economic theory and policy after World
War II until the 1970s, when many
advanced economies suffered both
inflation and slow growth, a condition
dubbed “stagflation.”
Monetarist economists doubted the ability
of governments to regulate the business
cycle with fiscal policy and argued that
judicious use of monetary policy

25. 25
Members of the monetarist school also
maintained that money can have an effect
on output in the short run but believed that
in the long run
Keynesian economists largely adopted
these critiques, adding to the original
theory a better integration of the short and
the long run and an understanding of the
long-run neutrality of money

26. 26
Both Keynesians and monetarists came
under scrutiny with the rise of the new
classical school during the mid-1970s
A new generation of Keynesians that
arose in the 1970s and 1980s argued that
even though individuals can anticipate
correctly, aggregate markets may not clear
instantaneously; therefore, fiscal policy
can still be effective in the short run.

27. 27
 “If you were going to turn to only one economist
to understand the problems facing the economy,
there is little doubt that the economist would be
John Maynard Keynes. Although Keynes died
more than a half-century ago, his diagnosis of
recessions and depressions remains the
foundation of modern macroeconomics. Keynes
wrote, ‘Practical men, who believe they to be
quite exempt from any intellectual influence, are
usually the slave of some defunct economist.’ In
2008, no defunct economist is more prominent
than Keynes himself.”- , Harvard professor N.
Gregory Mankiw

28. 28
The global financial crisis of 2007–08
caused resurgence in Keynesian thought.
But the 2007–08 crisis also showed that
Keynesian theory had to better include the
role of the financial system. Keynesian
economists are rectifying that omission by
integrating the real and financial sectors of
the economy