Keynes Vs. Freidman

Posted by Ali Reda | Posted in | Posted on 3/07/2013

Classical economists claimed that free markets regulate themselves, when free of any intervention. Adam Smith referred to a so-called invisible hand, which will move markets towards their natural equilibrium, without requiring any outside intervention assuming Say's Law: supply creates its own demand - that is, aggregate production will generate an income enough to purchase all the output produced; this implicitly assumes, in contrast to Keynes, that there will be net saving or spending of cash or financial instruments.

Keynes argues that it is wrong to assume that competitive markets will, in the long run, deliver full employment or that full employment is the natural, self-righting, equilibrium state of a monetary economy. On the contrary, under-employment and under-investment are likely to be the natural state unless active measures are taken. The central argument of The General Theory is that the level of employment is determined, not by the price of labour as in neoclassical economics, but by the spending of money (aggregate demand). What made the General Theory so radical was Keynes's proof that it was possible for a free market economy to settle into states in which workers and machines remained idle for prolonged periods of time.... The only way to revive business confidence and get the private sector spending again was by cutting taxes and letting business and individuals keep more of their income so they could spend it. Or, better yet, having the government spend more money directly. If the private sector couldn't or wouldn't spend, the government would have to do it. For Keynes, the government had to be prepared to act as the spender of last resort, just as the central bank acted as the lender of last resort. Keynesian economics advocates a mixed economy – predominantly private sector, but with a role for government intervention during recessions

Freidman theorized there existed a "natural" rate of unemployment, and argued that governments could increase employment above this rate (e.g., by increasing aggregate demand) only at the risk of causing inflation to accelerate which is his theory of Monetarism, Friedman argued that laissez-faire government policy is more desirable than government intervention in the economy, Governments should aim for a neutral monetary policy oriented toward long-run economic growth, by gradual expansion of the money supply. He advocated the quantity theory of money, that general prices are determined by money. Therefore active monetary (e.g. easy credit) or fiscal (e.g. tax and spend) policy can have unintended negative effects.

The quantity theory of money is the theory that money supply has a direct, proportional relationship with the price level.

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