What are they key elements of Monetarism? Why did monetarist ideas become so influential during the 1970s (discuss with particular reference to the UK economy)?
“Inflation is always and everywhere a monetary phenomenon.” Monetarism is an economic movement and school of thought focussing on the supply of and demand for money as the primary means of regulating economic activity. It rose to popularity in the 1970s along with the neo-liberal movement as a whole, when certain Governments adopted monetarism as their economic ideology around which policy was based; namely the United Kingdom under Thatcher and the ‘Reaganomics’ of the United States under president Ronald Reagan. The person who is most associated with this economic perspective is Milton Friedman, one of the most influential economists of the 20th century, who laid down the foundations and did the most influential work for this field of thinking; working closely with conservative governments that adopted his theories in practice through their economic policies. For this reason he is considered by some to be the ‘intellectual henchman of the right.’
With this label in mind, it seems most appropriate to look at Friedman’s work, being the foremost thinker and articulator of Monetarist thought, to gain a better understanding of this standpoint. Before its rise in popularity, Freidman began laying down the foundations for monetarist thought by revising and developing some previous theories, such as that of Keynes, as a means of creating a different way of viewing the macro-economy. His work on the ‘Permanent Income Hypothesis’ developed ideas on how people formed expectations of the future. Keynes had already thought and developed ideas on this issue in his ‘consumption function’, trying to understand how much of people’s income is saved and how much is consumed, and the balance between saving and investment. Freidman argued that Keynes had taken for granted that, “the current consumption expenditure, is a dependable and stable function of current income,” that is to say that the amount of aggregate consumption depends largely on the amount of aggregate income. Freidman felt that it was not necessarily people’s current incomes that determined their consumption behaviour, but in fact their expectation of future income. If we take expectation to be the factor that determines consumption, the outcome may be significantly different. For instance, if there is a tax cut of 10%, and thus an individual’s annual income rises by that same amount; are they likely to spend it all, or consider this a lucky break and take precaution by saving it? For the Keynesian model to work, it has to be true that if you give people a tax cut or the government increases spending, then consumption increases too. This attacked the notion that the state could rescue the economy in slumps and other recessionary periods by boosting aggregate demand through fiscal policy.
Freidman aimed to solidify his view on the nature of consumption and thus ‘A Theory of the Consumption Function’ is a heavily empirical and statistical work, looking at the total amount of income and the total amount of consumption in the economy each year. He found that as income went up, so did consumption, and on average over time, consumption was approximately 90% of income. He then looked at poor families and rich families in a given year. He observed that poor families tended to spend all of their income, the assumption being that the little money they have did not allow for much saving after necessities were paid for; rich families however, were found to only spend around 50% of their income. Freidman’s reasoning behind this was that poorer families are likely to be aware that they’re having a bad year and thus choose to spend their income as there isn’t enough to save. Those who are doing better off in any given year are likely to be in a position whereby they can plan and save for coming years, when they may be...
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