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

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Introduction

"Keynesian policies are incompatible with price stability" "Monetarist's policies are incompatible with full employment". Discuss the validity of these two statements Every school of thought is like a man who has talked to himself for a hundred years and is delighted with his own mind, however stupid it may be. (J.W. Goethe, 1817, Principles of Natural Science) Keynesian policies are incompatible with price stability. How? * Markets need help to clear o The economy can be at equilibrium at many different times, not just at full employment * When inflation increases, tighter monetary policy may be used to cool it off, which will weaken AD? Is this contrary to Keynesian belief? * Keynesian economics is a theory of total spending [AD] in the economy and its effects on output and employment o AD is influenced by public & private economic decisions, which are determined by political outcomes/economic objectives or consumer/producer expectations o Some Keynesians believe in debt neutrality, which contrarily purports that consumers use rational expectations and will assume low taxes as a long-run liability and save accordingly. * Believe AD has its greatest impact in the short run on output and employment, not on prices o Phillips curve * Demand side policies alone cannot succeed completely * There will always be unwanted inflation and unemployment o Inflation changes slowly when unemployment changes * In the long run we are all dead therefore what matters now is the short run o The principle of cumulative causation (an initial event can cause an ultimate effect that is much larger) ...read more.

Middle

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. ...read more.

Conclusion

* 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. 1 ...read more.

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