“The Great Depression, like most other periods of severe unemployment,” wrote American economist Milton Friedman, “was produced by government mismanagement rather than by any inherent instability of the private economy.” Friedman’s early career was defined by his support of the Keynesian principles that embraced large-scale government intervention through spending in order to stimulate a depressive economy. The Keynesian Revolution enjoyed success in the aftermath of the Great Depression and World War II where governments around the world circulated money into their economies by investing in rebuilding infrastructure and boosting employment. As the economic growth the world enjoyed from the Keynesian fiscal policies melted into an environment of stagflation of the 1970s (which involves low growth and high inflation), Friedman began to investigate the flaws in the Keynesian philosophy of dealing with economics. His epiphany set the groundwork for the development of a new branch of neoclassical economics: monetarism.
Monetarism and Neoclassical Economics
Friedman became the leader of the monetarist economists who enjoyed greater influence as large deficits, high inflation, increased unemployment, and a slow down in growth all created an environment of disenchantment towards Keynesian economic principles. In particular, Milton Friedman stressed that Keynesian economics were a short-term solution and not viable because of two primary reasons: Government inefficiencies and the lack of focus on money. Concerning the latter, Friedman introduced the idea of Monetarism in order to counter Keynesian economics lack of focus on the importance of money control in the economy. For monetarist economists, the macro level control and supply of money was the most important determinant of price levels and overall economic stability. As inflation skyrocketed in the 1970s, Friedman argued that the inability for Keynesian economics to stabilize prices was because of its narrow-focused solution of increasing money supply which was a counterproductive strategy. The battle cry for monetarist economists was that in a market where value was determined by the supply and demand of money, Keynesian economics ignored the obvious reality that money mattered.
Monetarism’s key argument was that government’s solution to boosting economy by injecting more money into the economy may appear to be reasonable in the short-term, but it was a self-defeating practice. “Too much money chasing too few goods,” wrote Milton Friedman as a response to the notion that massive deficits and rapid money supply were somehow good for the overall economy. Monetarist economists view government influence on the economy in any form cynically. Whether it is via means of taxes or stimulant spending, government is not the most effective in micromanaging the stabilization of prices and in regulating economic performance. The role of the Federal Reserve Bank should be limited to conducting monetary policy. That is, in controlling and understanding the demand for money should be its most important function, according to studies from monetarist economists such as David Laidler and Anna Schwartz.
“Governments never learn. Only people learn,” wrote Milton Friedman. Monetarism believed that left to its own devices, the market would maintain a level of equilibrium. The fluctuations in the value of money have coincided with periods of increased active manipulation of the economy by the government. The foundation of the macroeconomics espoused by monetarist economists echoed the microeconomics principles supported by neoclassical economics. Scholars of neoclassical economics such as Alfred Marshall supported the idea of laissez faire economy: as little influence from the government as possible. Indeed, Monetarism believed that all government manipulation did was destabilize money demand and supply, which creates a cycle of inflation or deflation. Neoclassical economics believed that humans were inherently “rational”, and that the free market was the best way to insure that they would be able to satisfy their nature of being value maximizers and loss minimizers.
Monetarism and neoclassical economics paralleled one another in their belief that the market was constantly stable and function well provided that money supply remains stable. In their pursuit for quick votes or lack of understanding that economies may slowdown, government officials break a cardinal rule by changing the supply of money circulating in the economy. The Quantity Theory of Money links the growth of money supply with the growth of prices and inflation. Thus, the large deficits and interference in the free market by governments are not helpful because individuals are able to stabilize the economy naturally provided money supply remains constant. Monetarist economists and neoclassical economists believed that less was more concerning the relationship between the influence of Government and the health of the economy.