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PHYSIOCRACY

start from 1760s(?)

18th-century France( Age of Enlightenment )

Physiocracy is founded by François Quesnay (1694-1774)

Vincent de Gournay (1712–1759)

Anne-Robert-Jacques Turgot (1727–1781)

the belief that government policy should not interfere with the operation of natural economic laws and that land is the source of all wealth

It is generally regarded as the first scientific school of economics.

keywords: free and land

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Mercantilism was a political movement and an economic theory, dominant in Europe between 1600 and 1800. The term "mercantilism" was not in fact coined until 1763, by Victor de Riqueti, marquis de Mirabeau, and was popularized by Adam Smith in 1776. In fact, Adam Smith was the first person to organize formally most of the contributions of mercantilists in his book The Wealth of Nations (Niehaus 1990: 6).

By the end of the 18th century, scholars, such as Adam Smith and David Hume, began to evaluate and critique the merits of mercantilist theory. Contrary to established beliefs, the scholars realized that wealth was not finite, but could be created through the productive allocation of labor.
Mercantilist policies also failed to account for the benefits of trade, such as comparative advantage and economies of scale.

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What is Mercantilism?

History of Mercantilism

Originating in 16th-century Europe, mercantilism began with the emergence of the nation-state. The dominant economic theory was that the global supply of wealth was finite, and it was in the nation's best interest to accumulate as much as possible. During that time, wealth was measured by a country's quantity of silver and gold. To accumulate more wealth, European countries, such as Britain and France, would focus on maximizing their exports and minimizing imports, which resulted in a favorable balance of trade.

For countries with a negative trade balance with a mercantilist country, the difference would be paid back in silver or gold. To maintain a favorable trade balance, the early mercantilist countries would enact imperialist policies by setting up colonies in smaller nations.

The aim was to extract raw material to send back to the home country, where it would be refined into manufactured goods. The goods would then be resold to the colonies, allowing early mercantilist nations to accumulate wealth through a positive trade balance.

Mercantilist Ideology

As an economic theory, mercantilism relies on government intervention to regulate international trade and protect domestic industries. Mercantilist policies involve the protection of domestic corporations through regulations and the promotion of trade surpluses. In the context of international trade, a favorable trade balance is achieved through government regulations, such as tariffs and restrictions on imports.

From Mercantilism to the Market Economy

By the end of the 18th century, scholars, such as Adam Smith and David Hume, began to evaluate and critique the merits of mercantilist theory. Contrary to established beliefs, the scholars realized that wealth was not finite, but could be created through the productive allocation of labor.

Under a mercantilist system, the restriction of imports meant consumers obtained access to fewer goods at higher prices. Under a system of free trade, consumers benefit from lower prices due to increased competition and greater access to goods from across the world.

Present-Day Mercantilism

Although mercantilism is mostly viewed as an outdated economic theory, there has been an emergence of mercantilist policies in recent times. Present-day mercantilism typically refers to protectionist policies that restrict imports to support domestic industries. It can sometimes be referred to as neomercantilism.

Modern mercantilist policies include tariffs on imports, subsidizing domestic industries, devaluation of currencies, and restrictions on the migration of foreign labor. Mercantilist policies can also explain the recent escalation of tariffs and trade restrictions between the US and China.

Related Readings

In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful:

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Originating in 16th-century Europe, mercantilism began with the emergence of the nation-state. The dominant economic theory was that the global supply of wealth was finite, and it was in the nation's best interest to accumulate as much as possible. During that time, wealth was measured by a country's quantity of silver and gold.

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Start 1776 by Adam Smith
Classical economics refers to the school of thought of economics that originated in the late 18th and early 19th centuries, especially in Britain. It focused on economic growth and economic freedom, advocating laissez-faire ideas and belief in free competition.

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The term neoclassical economics was coined in 1900

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The term neoclassical economics was coined in 1900

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1）
the key early assumptions of neoclassical economics is that utility to consumers, not the cost of production, is the most important factor in determining the value of a product or service. This approach was developed in the late 19th century based on books by William Stanley Jevons, Carl Menger, and Léon Walras.

Classical economists assume that the most important factor in a product's price is its cost of production.

Neoclassical economists argue that the consumer's perception of a product's value is the driving factor in its price.

They call the difference between actual production costs and retail price the economic surplus.

2）

Neoclassical economics is derived from classical economics with the introduction of marginalism.

Neoclassical economics emphasizes the choices (demand) of consumers. Personal preferences, allocation of resources, and some other factors can influence consumer demand.

The study of neoclassical economics depends on mathematical models. It implements a mathematical approach instead of a historical concept.

https://corporatefinanceinstitute.com/resources/knowledge/economics/neoclassical-economics/

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What Is Neoclassical Economics?

Neoclassical economics is a broad theory that focuses on supply and demand as the driving forces behind the production, pricing, and consumption of goods and services. It emerged in around 1900 to compete with the earlier theories of classical economics.

Key Takeaways

One of the key early assumptions of neoclassical economics is that utility to consumers, not the cost of production, is the most important factor in determining the value of a product or service. This approach was developed in the late 19th century based on books by William Stanley Jevons, Carl Menger, and Léon Walras.

Neoclassical economics theories underlie modern-day economics, along with the tenets of Keynesian economics. Although the neoclassical approach is the most widely taught theory of economics, it has its detractors.

Understanding Neoclassical Economics

The term neoclassical economics was coined in 1900.﻿﻿ Neoclassical economists believe that a consumer's first concern is to maximize personal satisfaction. Therefore, they make purchasing decisions based on their evaluations of the utility of a product or service. This theory coincides with rational behavior theory, which states that people act rationally when making economic decisions.

Further, neoclassical economics stipulates that a product or service often has value above and beyond its production costs. While classical economic theory assumes that a product's value derives from the cost of materials plus the cost of labor, neoclassical economists say that consumer perceptions of the value of a product affect its price and demand.

Finally, this economic theory states that competition leads to an efficient allocation of resources within an economy. The forces of supply and demand create market equilibrium.

In contrast to Keynesian economics, the neoclassical school states that savings determine investment. It concludes that equilibrium in the market and growth at full employment should be the primary economic priorities of government.

The Case Against Neoclassical Economics

Its critics believe that the neoclassical approach cannot accurately describe actual economies. They maintain that the assumption that consumers behave rationally in making choices ignores the vulnerability of human nature to emotional responses.

Some critics also blame neoclassical economics for inequalities in global debt and trade relations because the theory holds that labor rights and living conditions will inevitably improve as a result of economic growth.

A Neoclassical Crisis?

Followers of neoclassical economics believe that there is no upper limit to the profits that can be made by smart capitalists since the value of a product is driven by consumer perception. This difference between the actual costs of the product and the price it is sold for is termed the economic surplus.

However, this type of thinking could be said to have led to the 2008 financial crisis. In the leadup to that crisis, modern economists believed that synthetic financial instruments had no price ceiling because investors in them perceived the housing market as limitless in its potential for growth. Both the economists and the investors were wrong, and the market for those financial instruments crashed.

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Neoclassical economics is a broad theory that focuses on supply and demand as the driving forces behind the production, pricing, and consumption of goods and services. It emerged in around 1900 to compete with the earlier theories of classical economics.

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Economist: Karl Max
Evolvement: Marxian economics arose as a critique of classical political economy and later as a critique of capitalism.
Theory: Marx claimed there are two major flaws in capitalism that lead to exploitation: the chaotic nature of the free market(surplus products and surplus value)and surplus labor.

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The Austrian School is a heterodox school of economic thought that is based on methodological individualism, the concept that social phenomena result exclusively from the motivations and actions of individuals.
The Austrian school holds that prices are determined by subjective factors like an individual's preference to buy or not to buy a particular good

KEY TAKEAWAYS

Carl Menger, an Austrian economist who wrote Principles of Economics in 1871, is considered by many to be the founder of the Austrian school of economics.

The key ideas of the Austrian school have evolved over the years through the input of various economists.

The main thinkers behind current state of this theory are Carl Menger, Eugen Boehm von Bawerk, Friedrich August von Hayek, Fritz Machlup, Joseph Schumpeter, Murray Rothbard and especially Ludwig von Mises – accomplished entrepreneurs, economists, philosophers and authors of revolutionary books and theses.

The Austrian school uses logic of a priori thinking to discover economic laws of universal application, whereas other mainstream schools of economics make use of data and mathematical models.

The early concepts of the Austrian school contributed significantly to the theory of diminishing marginal utility.

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During the Great Depression of the 1930s, existing economic theory was unable either to explain the causes of the severe worldwide economic collapse or to provide an adequate public policy solution to jump-start production and employment.

prolonged periods of high unemployment. An economy’s output of goods and services is the sum of four components: consumption, investment, government purchases, and net exports (the difference between what a country sells to and buys from foreign countries). Any increase in demand has to come from one of these four components. But during a recession, strong forces often dampen demand as spending goes down.

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Finance & Development,
Sarwat Jahan, Ahmed Saber Mahmud, and Chris Papageorgiou PDF version The central tenet of this school of thought is that government intervention can stabilize the economy
Just how important is money? Few would deny that it plays a key role in the economy.

During the Great Depression of the 1930s, existing economic theory was unable either to explain the causes of the severe worldwide economic collapse or to provide an adequate public policy solution to jump-start production and employment.

British economist John Maynard Keynes spearheaded a revolution in economic thinking that overturned the then-prevailing idea that free markets would automatically provide full employment-that is, that everyone who wanted a job would have one as long as workers were flexible in their wage demands (see box). The main plank of Keynes's theory, which has come to bear his name, is the assertion that aggregate demand-measured as the sum of spending by households, businesses, and the government-is 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.

The revolutionary idea

Keynes argued that inadequate overall demand could lead to prolonged periods of high unemployment. An economy's output of goods and services is the sum of four components: consumption, investment, government purchases, and net exports (the difference between what a country sells to and buys from foreign countries). Any increase in demand has to come from one of these four components. But during a recession, strong forces often dampen demand as spending goes down. For example, during economic downturns uncertainty often erodes consumer confidence, causing them to reduce their spending, especially on discretionary purchases like a house or a car. This reduction in spending by consumers can result in less investment spending by businesses, as firms respond to weakened demand for their products. This puts the task of increasing output on the shoulders of the government. According to Keynesian economics, state intervention is necessary to moderate the booms and busts in economic activity, otherwise known as the business cycle.

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. These market failures sometimes call for active policies by the government, such as a fiscal stimulus package (explained below). Therefore, Keynesian economics supports a mixed economy guided mainly by the private sector but partly operated by the government.

* 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. Keynesians believe that, because prices are somewhat rigid, fluctuations in any component of spending-consumption, investment, or government expenditures-cause output to change. If government spending increases, for example, and all other spending components remain constant, then output will increase. Keynesian models of economic activity also include a multiplier effect; that is, output changes by some multiple of the increase or decrease in spending that caused the change. If the fiscal multiplier is greater than one, then a one dollar increase in government spending would result in an increase in output greater than one dollar.

Keynes the master

Keynesian economics gets its name, theories, and principles from British economist John Maynard Keynes (1883-1946), who is regarded as the founder of modern macroeconomics. His most famous work, The General Theory of Employment, Interest and Money, was published in 1936. But its 1930 precursor, A Treatise on Money, is often regarded as more important to economic thought. Until then economics analyzed only static conditions-essentially doing detailed examination of a snapshot of a rapidly moving process. Keynes, in Treatise, created a dynamic approach that converted economics into a study of the flow of incomes and expenditures. He opened up new vistas for economic analysis.

In The Economic Consequences of the Peace in 1919, Keynes predicted that the crushing conditions the Versailles peace treaty placed on Germany to end World War I would lead to another European war.

He remembered the lessons from Versailles and from the Great Depression, when he led the British delegation at the 1944 Bretton Woods conference-which set down rules to ensure the stability of the international financial system and facilitated the rebuilding of nations devastated by World War II. Along with U.S. Treasury official Harry Dexter White, Keynes is considered the intellectual founding father of the International Monetary Fund and the World Bank, which were created at Bretton Woods.

Stabilizing the economy

No policy prescriptions follow from these three tenets alone. What distinguishes Keynesians from other economists is their belief in activist policies to reduce the amplitude of the business cycle, which they rank among the most important of all economic problems.

Rather than seeing unbalanced government budgets as wrong, Keynes advocated so-called countercyclical fiscal policies that act against the direction of the business cycle. For example, Keynesian economists would advocate deficit spending on labor-intensive infrastructure projects to stimulate employment and stabilize wages during economic downturns. They would raise taxes to cool the economy and prevent inflation when there is abundant demand-side growth. Monetary policy could also be used to stimulate the economy-for example, by reducing interest rates to encourage investment. The exception occurs during a liquidity trap, when increases in the money stock fail to lower interest rates and, therefore, do not boost output and employment.

Keynes argued that governments should solve problems in the short run rather than wait for market forces to fix things over the long run, because, as he wrote, "In the long run, we are all dead." This does not mean that Keynesians advocate adjusting policies every few months to keep the economy at full employment. In fact, they believe that governments cannot know enough to fine-tune successfully.

Keynesianism evolves

Even though his ideas were widely accepted while Keynes was alive, they were also scrutinized and contested by several contemporary thinkers. 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.

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." Keynesian theory's popularity waned then because it had no appropriate policy response for stagflation. Monetarist economists doubted the ability of governments to regulate the business cycle with fiscal policy and argued that judicious use of monetary policy (essentially controlling the supply of money to affect interest rates) could alleviate the crisis (see " What Is Monetarism?" in the March 2014 F&D). 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, expansionary monetary policy leads to inflation only. 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-the idea that a change in the stock of money affects only nominal variables in the economy, such as prices and wages, and has no effect on real variables, like employment and output.

Both Keynesians and monetarists came under scrutiny with the rise of the new classical school during the mid-1970s. The new classical school asserted that policymakers are ineffective because individual market participants can anticipate the changes from a policy and act in advance to counteract them. 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.

The global financial crisis of 2007-08 caused a resurgence in Keynesian thought. It was the theoretical underpinnings of economic policies in response to the crisis by many governments, including in the United States and the United Kingdom. As the global recession was unfurling in late 2008, Harvard professor N. Gregory Mankiw wrote in the New York Times, "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 themselves 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."

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.■

Sarwat Jahan is an Economist and Chris Papageorgiou is a Deputy Division Chief in the IMF's Strategy, Policy, and Review Department. Ahmed Saber Mahmud is the Associate Director of Applied Economics at Johns Hopkins University.

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What Is Keynesian Economics? - Back to Basics - Finance & Development, September 2014

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Finance & Development, Sarwat Jahan, Ahmed Saber Mahmud, and Chris Papageorgiou PDF version The central tenet of this school of thought is that government intervention can stabilize the economy Just how important is money?

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Influencing figures in Keynesian Economics

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Influencing figures in Keynesian Economics

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The most important figure is John Maynard Keynes, who came up with his theory in order to understand and face the Great Depression. He believed that government should increase spending and decrease taxation in order to stimulate the economy.

Another significant figure would be a student of Keynes, who developed the "multiplier effect" that support Keynes' countercyclical fiscal policy.

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What Is Keynesian Economics?

Keynesian economics is a macroeconomic theory of total spending in the economy and its effects on output, employment, and inflation. It was developed by British economist John Maynard Keynes during the 1930s in an attempt to understand the Great Depression.

The central belief of Keynesian economics is that government intervention can stabilize the economy. Keynes' theory was the first to sharply separate the study of economic behavior and individual incentives from the study of broad aggregate variables and constructs.

Based on his theory, Keynes advocated for increased government expenditures and lower taxes to stimulate demand and pull the global economy out of the Depression. Subsequently, Keynesian economics was used to refer to the concept that optimal economic performance could be achieved-and economic slumps could be prevented-by influencing aggregate demand through economic intervention by the government. Keynesian economists believe that such intervention can achieve full employment and price stability.

Key Takeaways

Understanding Keynesian Economics

Keynesian economics represented a new way of looking at spending, output, and inflation. Previously, what Keynes dubbed classical economic thinking held that cyclical swings in employment and economic output create profit opportunities that individuals and entrepreneurs would have an incentive to pursue, and in so doing, they correct the imbalances in the economy.

According to Keynes' construction of this so-called classical theory, if aggregate demand in the economy fell, the resulting weakness in production and jobs would precipitate a decline in prices and wages. A lower level of inflation and wages would induce employers to make capital investments and employ more people, stimulating employment and restoring economic growth. Keynes believed, however, that the depth and persistence of the Great Depression severely tested this hypothesis.

In his book The General Theory of Employment, Interest and Money and other works, Keynes argued against his construction of classical theory, asserting that, during recessions, business pessimism and certain characteristics of market economies would exacerbate economic weakness and cause aggregate demand to plunge further.

For example, Keynesian economics disputes the notion held by some economists that lower wages can restore full employment because labor demand curves slope downward like any other normal demand curve.

Similarly, poor business conditions may cause companies to reduce capital investment rather than take advantage of lower prices to invest in new plants and equipment. This also would have the effect of reducing overall expenditures and employment.

Keynesian Economics and the Great Depression

Keynesian economics is sometimes referred to as "depression economics," as Keynes' General Theory was written during a time of deep depression-not only in his native United Kingdom, but worldwide. The famous 1936 book was informed by Keynes' understanding of events arising during the Great Depression, which Keynes believed could not be explained by classical economic theory as he portrayed it in his book.

Other economists had argued that, in the wake of any widespread downturn in the economy, businesses and investors taking advantage of lower input prices in pursuit of their own self-interest would return output and prices to a state of equilibrium, unless otherwise prevented from doing so. Keynes believed that the Great Depression seemed to counter this theory.

Output was low, and unemployment remained high during this time. The Great Depression inspired Keynes to think differently about the nature of the economy. From these theories, he established real-world applications that could have implications for a society in economic crisis.

Keynes rejected the idea that the economy would return to a natural state of equilibrium. Instead, he argued that, once an economic downturn sets in, for whatever reason, the fear and gloom that it engenders among businesses and investors will tend to become self-fulfilling and can lead to a sustained period of depressed economic activity and unemployment.

In response to this, Keynes advocated a countercyclical fiscal policy in which, during periods of economic woe, the government should undertake deficit spending to make up for the decline in investment and boost consumer spending to stabilize aggregate demand.

Keynes was highly critical of the British government at the time. The government greatly increased welfare spending and raised taxes to balance the national books. Keynes said that this would not encourage people to spend their money, thereby leaving the economy unstimulated and unable to recover and return to a successful state.

Keynes also criticized the idea of excessive saving, unless it was for a specific purpose such as retirement or education. He saw it as dangerous for the economy because the more money sitting stagnant, the less money is in the economy stimulating growth. This was another of Keynes' theories geared toward preventing deep economic depressions.

Many economists have criticized Keynes' approach. They argue that businesses responding to economic incentives will tend to return the economy to a state of equilibrium unless the government prevents them from doing so by interfering with prices and wages, making it appear as though the market is self-regulating.

On the other hand, Keynes, who was writing while the world was mired in a period of deep economic depression, was not as optimistic about the natural equilibrium of the market. He believed that the government was in a better position than market forces when it came to creating a robust economy.

Keynesian Economics and Fiscal Policy

The multiplier effect, developed by Keynes' student Richard Kahn, is one of the chief components of Keynesian countercyclical fiscal policy. According to Keynes' theory of fiscal stimulus, an injection of government spending eventually leads to added business activity and even more spending. This theory proposes that spending boosts aggregate output and generates more income. If workers are willing to spend their extra income, the resulting growth in gross domestic product (GDP) could be even greater than the initial stimulus amount.

The magnitude of the Keynesian multiplier is directly related to the marginal propensity to consume. Its concept is simple. Spending from one consumer becomes income for a business that then spends on equipment, worker wages, energy, materials, purchased services, taxes, and investor returns. That worker's income can then be spent, and the cycle continues. Keynes and his followers believed that individuals should save less and spend more, raising their marginal propensity to consume to effect full employment and economic growth.

In this theory, one dollar spent in fiscal stimulus eventually creates more than one dollar in growth. This appeared to be a coup for government economists, who could provide justification for politically popular spending projects on a national scale.

This theory was the dominant paradigm in academic economics for decades. Eventually, other economists, such as Milton Friedman and Murray Rothbard, showed that the Keynesian model misrepresented the relationship between savings, investment, and economic growth. Many economists still rely on multiplier-generated models, although most acknowledge that fiscal stimulus is far less effective than the original multiplier model suggests.

The fiscal multiplier commonly associated with the Keynesian theory is one of two broad multipliers in economics. The other multiplier is known as the money multiplier. This multiplier refers to the money creation process that results from a system of fractional reserve banking. The money multiplier is less controversial than its Keynesian fiscal counterpart.

Keynesian Economics and Monetary Policy

Keynesian economics focus on demand-side solutions to recessionary periods. The intervention of government in economic processes is an important part of the Keynesian arsenal for battling unemployment, underemployment, and low economic demand. The emphasis on direct government intervention in the economy often places Keynesian theorists at odds with those who argue for limited government involvement in the markets.

Wages and employment, Keynesians argue, are slower to respond to the needs of the market and require government intervention to stay on track. Furthermore, they argue, prices do not react quickly and change only gradually when monetary policy interventions are made, giving rise to a branch of Keynesian economics known as monetarism.

If prices are slow to change, this makes it possible to use money supply as a tool and change interest rates to encourage borrowing and lending. Lowering interest rates is one way that governments can meaningfully intervene in economic systems, thereby encouraging consumption and investment spending. Short-term demand increases initiated by interest rate cuts reinvigorate the economic system and restore employment and demand for services. The new economic activity then feeds continued growth and employment.

Without intervention, Keynesian theorists believe, this cycle is disrupted, and market growth becomes more unstable and prone to excessive fluctuation. Keeping interest rates low is an attempt to stimulate the economic cycle by encouraging businesses and individuals to borrow more money. They then spend the money that they borrow. This new spending stimulates the economy. Lowering interest rates, however, does not always lead directly to economic improvement.

Monetarist economists focus on managing the money supply and lower interest rates as a solution to economic woes, but they generally try to avoid the zero-bound problem. As interest rates approach zero, stimulating the economy by lowering interest rates becomes less effective because it reduces the incentive to invest, rather than simply hold money in cash or close substitutes like short-term Treasurys. Interest rate manipulation may no longer be enough to generate new economic activity if it can't spur investment, and the attempt at generating economic recovery may stall completely. This is a type of liquidity trap.

When lowering interest rates fails to deliver results, Keynesian economists argue that other strategies must be employed, primarily fiscal policy. Other interventionist policies include direct control of the labor supply, changing tax rates to increase or decrease the money supply indirectly, changing monetary policy, or placing controls on the supply of goods and services until employment and demand are restored.

Keynesian Economics and the 2007-08 Financial Crisis

In response to the Great Recession and financial crisis of 2007-2008, the Congress and Executive branch undertook several measures that drew from Keynesian economic theory. The federal government bailed out debt-ridden companies in several industries including banks, insurers, and automakers. It also took into conservatorship Fannie Mae and Freddie Mac, the two major market makers and guarantors of mortgages and home loans.

In 2009, President Obama signed the American Recovery and Reinvestment Act, an $831-billion government stimulus package designed to save existing jobs and create new ones. It included tax cuts/credits and unemployment benefits for families; it also earmarked expenditures for healthcare, infrastructure, and education.

These stimulus measures and federal interventions helped America's economy recover, preventing the Great Recession from becoming another full-blown depression.

COVID-19 Stimulus

Who Was John Maynard Keynes?

John Maynard Keynes (1883-1946) was a British economist, best known as the founder of Keynesian economics and the father of modern macroeconomics. Keynes studied at one of the most elite schools in England, the King's College at Cambridge University, earning an undergraduate degree in mathematics from the latter in 1905. He excelled at math but received almost no formal training in economics.

How Does Keynesian Economics Differ From Classical Economics?

According to Keynes, classical economics held that swings in employment and economic output create profit opportunities that individuals and entrepreneurs have an incentive to pursue, eventually correcting imbalances in the economy. In contrast, Keynes argued that, during recessions, business pessimism and certain characteristics of market economies would exacerbate economic weakness and cause aggregate demand to plunge further. Keynesian economics holds that, during periods of economic woe, governments should undertake deficit spending to make up for the decline in investment and boost consumer spending to stabilize aggregate demand.

What Is Monetarism?

Monetarism is a macroeconomic theory stating that governments can foster economic stability by targeting the growth rate of the money supply. Closely associated with economist Milton Friedman, monetarism is a branch of Keynesian economics that emphasizes the use of monetary policy over fiscal policy to manage aggregate demand, which contrasts with the theories of most Keynesian economists.

The Bottom Line

John Maynard Keynes and Keynesian economics were revolutionary in the 1930s and did much to shape post-World War II economies in the mid-20th century. His theories came under attack in the 1970s, saw a resurgence in the 2000s, and are still debated today. Keynesian economics, recognizes the role of government finance in sparking aggregate demand. Federal spending and tax cuts leave more money in peoples' pockets, which can stimulate demand and investment. Unlike free market economists, Keynesian economics welcomes limited government intervention and stimulus during times of recession.

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Keynesian Economics Theory: Definition and How It's Used

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Keynesian economics comprise a theory of total spending in the economy and its effects on output and inflation, as developed by John Maynard Keynes.

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Chicago School of Economics (Monetarism)

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Chicago School of Economics (Monetarism)

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1960s

Students at Chicago university (leading: Milton Friedman)

Monetarism is a macroeconomic theory which states that governments can foster economic stability by targeting the growth rate of the money supply. Essentially, it is a set of views based on the belief that the total amount of money in an economy is the primary determinant of economic growth.

Monetarism builds on the Keynesian theory by assuming the same macroeconomic framework and integrating the equation of exchange, but instead focuses on the role played by money supply. Because they believe that V can be relatively easily predicted, monetarists argue that the equation of exchange could be resuscitated as an approach to stabilization policy, and they favor the use of monetary policy to do so.

Monetarism Definition (investopedia.com)

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What Is Monetarism?

Monetarism is a macroeconomic theory which states that governments can foster economic stability by targeting the growth rate of the money supply. Essentially, it is a set of views based on the belief that the total amount of money in an economy is the primary determinant of economic growth.

Understanding Monetarism

Monetarism is an economic school of thought which states that the supply of money in an economy is the primary driver of economic growth. As the availability of money in the system increases, aggregate demand for goods and services goes up. An increase in aggregate demand encourages job creation, which reduces the rate of unemployment and stimulates economic growth.

Monetary policy, an economic tool used in monetarism, is implemented to adjust interest rates that, in turn, control the money supply. When interest rates are increased, people have more of an incentive to save than to spend, thereby reducing or contracting the money supply. Contrarily, when interest rates are lowered following an expansionary monetary scheme, the cost of borrowing decreases, which means people can borrow more and spend more, thereby stimulating the economy.

Milton Friedman and Monetarism

Monetarism is closely associated with economist Milton Friedman, who argued, based on the quantity theory of money, that the government should keep the money supply fairly steady, expanding it slightly each year to allow for the natural growth of the economy. Due to the inflationary effects that can be brought about by the excessive expansion of the money supply, Friedman, who formulated the theory of monetarism, asserted that monetary policy should be done by targeting the growth rate of the money supply to maintain economic and price stability.

In his book, A Monetary History of the United States 1867- 1960, Friedman proposed a fixed growth rate called the K-percent rule, suggesting that money supply should grow at a constant annual rate tied to the growth of nominal gross domestic product (GDP) and be expressed as a fixed percentage per year. This way, the money supply will be expected to grow moderately, businesses will be able to anticipate the changes to the money supply every year and plan accordingly, the economy will grow at a steady rate, and inflation will be kept at low levels.

The Quantity Theory of Money

Central to monetarism is the "quantity theory of money," which monetarists adopted from earlier economic theories and integrated into the general Keynesian framework of macroeconomics. The quantity theory of money can be summarized in the equation of exchange, formulated by John Stuart Mill, which states that the money supply, multiplied by the rate at which money is spent per year, equals the nominal expenditures in the economy. The formula is given as:

A key point to note is that monetarists believe that changes to M (money supply) are the driver of the equation. In short, a change in M directly affects and determines employment, inflation (P), and production (Q). In the original version of the quantity theory of money, V is held to be constant, but this assumption was dropped by John Maynard Keynes and is not assumed by the monetarists, who instead believe that V is easily predictable.

Economic growth is a function of economic activity (Q) and inflation (P). If V is constant (or at least predictable), then an increase (or decrease) in M will lead to an increase (or decrease) in either P or Q.

An increase in P denotes that Q will remain constant, while an increase in Q means that P will be relatively constant. According to monetarism, variations in the money supply will affect price levels over the long term and economic output in the short term. A change in the money supply, therefore, will directly determine prices, production, and employment.

Monetarism vs. Keynesian Economics

The view that velocity is constant is a source of contention among Keynesians, who believe that velocity should not be constant since the economy is volatile and subject to periodic instability. Instead, Keynes' liquidity preference theory emphasizes how changes in money demand (and thus velocity) influence the price level and aggregate demand.

Monetarism builds on the Keynesian theory by assuming the same macroeconomic framework and integrating the equation of exchange (with V swinging cyclically, as Keynes argued), but instead focuses on the role played by money supply. Because they believe that V can be relatively easily predicted, monetarists argue that the equation of exchange could be resuscitated as an approach to stabilization policy, and they favor the use of monetary policy to do so.

Proponents of monetarism generally believe that controlling an economy through fiscal policy is a poor decision because it necessarily introduces microeconomic distortions that reduce economic efficiency. They prefer monetary policy as a tool to manage aggregate demand in a way that will be more neutral from a microeconomics standpoint and that avoids the deadweight losses and social costs that fiscal policy creates in markets.

History of Monetarism

Monetarism gained prominence in the 1970s, a decade characterized by high and rising inflation and slow economic growth. The policies of monetarism were responsible for bringing down inflation in the United States and the United Kingdom. After U.S. inflation peaked at 20% in 1979, the Fed switched its operating strategy to reflect monetarist theory. During this time period, economists, governments, and investors eagerly jumped at every new money supply statistic.

In the years that followed, however, monetarism fell out of favor with many economists, as the link between different measures of money supply and inflation proved to be less clear than most monetarist theories had suggested. In addition, monetarism's ability to explain the U.S. economy waned in the following decades. Many central banks today have stopped setting monetary targets and instead have adopted strict inflation targets.

Although most modern economists reject the emphasis on money growth that monetarists purported in the past, some core tenets of the theory have become a mainstay in nonmonetarist analysis. One of the most important of these ideas is that inflation cannot continue indefinitely without increases in the money supply. In addition, it is the responsibility (although not the primary goal) of the central bank to control inflation.

That being said, monetarist interpretations of past economic events are still relevant today. Ben Bernanke, former Fed Chairman, cited the work of Friedman in his decision to lower interest rates and increase the U.S. money supply in order to boost the economy during the global recession that began in 2007 in the United States.﻿﻿

Real-World Examples of Monetarism

In Friedman's seminal work, A Monetary History of the United States, 1867-1960, whichhe wrote with fellow economist Anna Schwartz, the two economists argued that failed monetary policy executed by the Federal Reserve was responsible for the Great Depression in the U.S. in the 1930s. In the view of Friedman and Schwartz, the Fed failed to relieve downward pressure on the money supply, and their eventual actions to reduce the money supply were the opposite of what they should have done. According to Friedman and Schwartz, markets tend towards a stable center; markets will behave erratically if the money supply is not properly set.

In 1979, when Paul Volcker became the Chairman of the Federal Reserve, he made combatting inflation the primary goal of the central bank. In keeping with Friedman and Schwartz's recommendations, Volcker restricted the money supply in order to do this. He raised the federal funds rate to 20% in 1980. At this time, this strategy for fighting stagflation (high inflation combined with high unemployment and stagnant demand) was successful. Volcker's policies drastically reduced the money supply, consumers stopped purchasing as much, and businesses stopped raising prices. However, while this caused inflation to greatly decline, it resulted in a big recession (the 1980-82 recession).

During the same time period, Britain was also struggling with severe inflation. When Margaret Thatcher was elected prime minister in 1979, she also implemented a set of monetarist policies to combat the rising prices in the country. By 1983, inflation in Britain had been halved, from 10% to 5%.

However, the popularity of monetarism was relatively brief. In the 1980s and 1990s, the link between the money supply and nominal GDP broke down; the quantity theory of money-the backbone of monetarism-was called into question and many economists who had recommended the policies of monetarism in the 1970s abandoned the approach.

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Monetarism is a macroeconomic theory which states that governments can foster economic stability by targeting the growth rate of the money supply. Essentially, it is a set of views based on the belief that the total amount of money in an economy is the primary determinant of economic growth.

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Some important ideas in the field can be traced back to 18th-century Scottish economist Adam Smith. He recognized that people are often overconfident in their own abilities, more afraid of losing than they are eager to win and more likely to pursue short-term than long-term benefits. These ideas (overconfidence, loss aversion and self-control) are foundational concepts in behavioral economics today. More recently, behavioral economics has early roots in the work of Israeli psychologists Amos Tversky and Daniel Kahneman on uncertainty and risk. In the 1970s and ’80s, Tversky and Kahneman identified several consistent biases in the way people make judgments, finding that people often rely on easily recalled information, rather than actual data, when evaluating the likelihood of a particular outcome, a concept known as the “availability heuristic.”

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