"Keynesian policies are incompatible with price stability" "Monetarist's policies are incompatible with full employment". Discuss the validity of these two statements.

o Spending, consumption, investment, or government expenditures cause output to fluctuate.

* The natural rate of employment is not necessary the "ideal"

o In the past Keynesian policies have advocated using price stabilization as means of affecting the business cycle

o Market Information can be imperfect - time lags between policy and implementation restrict the success of fine-tuning

o Majority of labour in fixed-priced contracts not inflation adjusted

* In general Keynesians believe in combating unemployment rather than conquering inflation.

o Macroeconomic fluctuations reduce economic well being, government knowledgeable to intervene in free market, unemployment is more important than inflation

o Rises in prices are manageable if wages rise proportionately

o Higher inflation could be a reasonable trade off against more money in people's pockets [which wasn't there before], at least until some injection of wealth had taken place through new employment opportunities

* Consider the period between mid seventies to the mid eighties, a period of major structural changes some due to technological advances. Did this leave a surplus of unskilled labour and massive structural unemployment in industrialised economies? Stable prices can lead to investment by firms but investment can be in other fixed factors of production, which may later reduce the demand for labour creating mass unemployment in the short-run, while the workforce re-skills itself?

* To adopt a policy of price stability assumes that money is neutral. Changes in money will only have an effect on the price level while no effect on the real economy. The inherent value of a good is separate from its price, the relative price. This value is held without money. e.g. two oranges=three bananas=two oranges? But what happens when two bananas=three oranges. Is this inflation?

* An increase in the quantity of money has an inverse relationship to the purchasing power of money. The more money in the economy the less it buys! Therefore changes in relative prices are separate from the price level, but inflation still causes problems because in market economy the relative price cannot be set without the relative price of money [PPM] [1]. Any attempt will lead to inefficient allocation of resources. Too many bananas not enough oranges.

* Monetarist might argue that a control on the price level would allow a transparent fluctuation of relative prices or the "worth or value" of bananas and oranges, thereby ensuring that there are sufficient goods and services available in the economy.

* When new money is introduced into the economy the first people to receive this injection benefit more than people who receive it later in the circular flow of money as they will possess the money while the price level gradually changes. The money has lost some of its purchasing power.

* Therefore adopting monetary policy in increasing money supply will lead to a redistribution of wealth from later recipients to the initial recipients, thereby altering the supply and demand for goods and services.

* Now that two bananas are now equal to three oranges, is this due to their demand and supply or because of the demand and supply of the purchasing power to obtain these goods?

* In conclusion to alter the price level is to tamper with relative prices leading to an inefficient allocation of resources. This type of policy destabilizes businesses and weakens the generation of wealth".[Shostak 2003]

* The fact that general prices were more or less stable during the 1920's told most economists that there was no inflationary threat, and therefore the events of the great depression caught them completely unaware."[6]

"Monetarist's policies are incompatible with full employment". How?

* Free markets are efficient and market forces will eliminate unemployment to the natural rate

o Wages and prices are flexible

o Output only determines AD in the very short-run

o AD merely fuels inflation for a temporary boosts to output and employment, but higher inflation damages business confidence and worsen long-term output and unemployment by discouraging investment

* Preference towards supply-side policies - restrain monopoly influences on prices and income by union power, mergers and takeovers

o Sees government's role in the market is simply to eliminate imperfections which get in the way of laws of supply and demand to clear markets including labour

o The following imperfections should be overcome; inflation because it distorts the price mechanism, i.e government spending should equal taxation, so leakages are equal to injections, so no net effect [debt neutrality?], price fixing and minimum wages distort the market for goods and services, regulation of markets, abuse of monopoly powers, especially union power which affects the price mechanism

* Milton Freidman showed that monetary policy could not be used to wipe out unemployment. Keynes offer of demand management could affect the natural rate of unemployment

* Fine-tuning the natural rate of full unemployment upward can lead to more demand for goods than cannot be met by supply, leading to a higher demand for imported goods, which can cause balance of payment problems

* To achieve full employment assumes governmental role in demand management, this is contrary to minimal intervention advocated by classical monetarists

* Government involvement in demand management means that government expenditure is utilised to give the economy a sufficient boost to move it closer to full employment, Monetarists view this as contrary to laissez faire which underpins classical economics. Government expenditure leads to higher inflation which is a phenomenon not desirable to monetarist policy makers.

* Monetarist policy would advocate an approach where market forces apply laws of supply and demand to bring about full employment, this can mean that there a surplus of involuntary unemployment which is a cost to the public and underused factor of production.

* Monetarist view prices and wages as perfectly flexible which enables automatic full employment, a vertical AS curve. Keynesians disagree and warn that the economy can get stuck before market forces push the economy toward full employment. Monetary policy accepts that short-run unemployment is acceptable as in the long-run as market forces adjust to reach full employment.

Conclusion

* Human development theory

o Green economics & welfare economics

* Labour is more than a stock of a factor of production and as a social scientist the results of a laissez faire approach leads to many social and economic ills as found in the periods where only monetarist's policies have been applied such as during the eighties where all efforts were put into combating inflation. Inflation came down at the price of unemployment doubling, output and investment dropping. Eventually in 1986 Bank of England abandoned monetarism.

* The danger of policies which only give weight to long run outcomes risk the real or actual short run problems like poverty and geographical inequalities which are not necessarily considered as a macroeconomic objective for free market advocates. These in turn lead to massive fluctuations in output and economic well being.

* Full employment and price stability cannot be attained at the same time, at least not with monetary and fiscal policies. A trade off between inflation and unemployment have to be made in achieving macroeconomic objectives.