Economy Stabilization with the Use of Fiscal Policy. Keynesianism and Monetarism


The most common theories of economic regulation are Keynesianism and Monetarism. Many economists investigate pros and cons of each theory. However, at the same time, some of them consider the idea that both theories are helpful in the federal government managing during different periods. Thus, this idea and both theories should be described and investigated.

The Major Differences between the Keynesians and the Monetarists

a) Keynesianism is the theory of economic growth. Basic postulates of the federal government managing are:

1) State intervention is of great necessity;

2) Money supply is neutral to the production;

3) Budget deficit is a way to stimulate demand;

4) The main problem is unemployment;

5) Employment depends on aggregate demand;

6) A flexible monetary policy is of considerable importance (Blinder, n.d.).

Keynesianism advocates for the fact that the free market system is devoid of an internal mechanism to insure macroeconomic balance. Thus, imbalance between savings and expected investment decline business activity, which increases inflation and affects the level of unemployment. Moreover, change of total resources of consumer and investment goods affects the level of output and employment. Therefore, Keynesianism declares active federal government management of the economy through fiscal policy (flexible changes of tax rates and government spending) (Blinder, n.d.).

Monetarism is the theory of economic equilibrium. The basic postulates are:

1) The market is capable of self-regulation;

2) A stable monetary policy is needed;

3) Money supply is the cause of price rising and changes of market conditions;

4) Budget deficit is the cause of inflation;

5) The economy sets the level of output and employment;

6) Inflation is the main problem (Jahan & Papageorgiou, 2014).

Monetarists urge to minimize government intervention in the economy, allowing only fiscal policy. Consequently, the market system is able to achieve macroeconomic balance automatically. Moreover, flexibility of prices and wages guarantees impact of the total cost change on the price of goods and resources rather than on the levels of production and employment. The essence of monetary policy in the federal government management is to regulate the volume of money supply in order to stabilize the domestic market (Jahan & Papageorgiou, 2014).

b) However, it would be wrong to draw a sharp distinction between the approaches of Keynesianism and Monetarism to the problem of economic regulation. Since the majority believes that the universal rules of economic regulation do not exist, elements of the two theories can be useful.

Firstly, the both theories are constructed in relation to the market economy.

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Secondly, they complement each other, making determination of total income.

Third, Keynes justifies quantitative dependence of income on expenditures, while Friedman emphasizes the dependence on money. Both theorists show recurrence of income (spending or money have antecedence, they are variables, income is a function) (Blinder, n.d.).

Therefore, the specific choice of the federal government management depends on the system of scientific and methodological preferences chosen for a particular economic stage.

The Connection between Difficulties of Asian Economies and a Recessionary Gap in the United States

In the period of 1973-1980, oil has risen. Extrapolating the situation to 1997-1998, it is possible to say that the difficulties of Asian economies with which the United States is working in various areas (in the field of energy, for example) make the higher production costs per unit of output of American manufacturers in almost all sectors. Thus, inflation caused by rising costs will arise. As a result, this increase in costs will move the aggregate supply curve to the leeft and cause a higher level of prices and the reduction of real output and employment (Barsky & Kilian, 2004).

Higher oil prices will have an impact on the international currency markets and will create a risk of reducing the value of the dollar. The depreciation of the dollar may strengthen inflation. As a result of all these factors, the United States economy may have a recessionary gap.

Coordination of Monetary and Fiscal Policy Measures During the Recession of 2008

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A period of optimism in the real estate sector preceded the crisis, and house prices began to rise. Moreover, many property owners have increased the level of consumption. Afterward, the increased level of real estate offered the exceeded level of demand, and prices began to fall. As a result, this led to the largest drop in the level of consumption after the Second World War. The reason for the recession was explained by Keynesians. Monetarist explanation, on the contrary, was not suitable for the analysis of causes. The volume of money and credit continued to grow until the financial crisis (Blinder, n.d.).

However, while the Keynesians were right about the cause of the crisis, monetarists showed the right decision to change the situation. FRS head Ben Bernanke has provided a guarantee of bank deposits with the Federal Reserve and expanded the scope of warranty on public funds and accounts. Apparently, virtually no investor lost money during the crisis. Keynesian “liquidity trap”, in fact, slowed down the Federal Reserve, while the central bank set the interest rate almost near zero. However, Bernanke has initiated a number of measures to avoid this limitation. Firstly, the Fed “saturated the banks with money supply.” It was a guarantee that the banks will have enough money to survive in case of any amount of deposit withdrawals. Second, the FRS began to use its own credit services to inhibit the growth of interest rates for private loans. The panic subsided, equity markets have risen, and consumer confidence has risen. However, the Obama fiscal stimulus consisting of tax cuts and increased public spending also played a role in the economic recovery. As a consequence, these measures have stimulated consumption.

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