The Fiscal and Monetary Policy– Understanding Friedman’s Monetarism

The role that a government would have to play in the economy has been under debate for centuries. Several economists have come up with various explanations as to why or why not the government should intervene in the economy. Adam Smith in his pioneering work The Wealth of Nations stated that the governments should allow the markets to function autonomously. However, this classical proposition failed during the Great Depression. John M. Keynes during this period advocated active government intervention to stimulate the demand in the economy. This policy was replaced by the policy of monetarism proposed by Friedman in the 1970s.

Economies of today, universally, have two important policies- the fiscal policy and monetary policy. The fiscal policy would be the economic policy adopted by the government. It involves the realms of public finance, focusing on taxation and expenditure. These policies are often reflected in the government budgets. The important aspect that needs to be noted is that it reflects the political orientation of the government and was generally done on a yearly basis.

On the other hand, the monetary policy is pursued by the Central Bank of the economy. It basically controls the money supply and the rate of interest in the nation. These aspects are given to a relatively autonomous body because they would have long term implications on inflation unlike the management of demand in the economy through taxation and expenditure. Therefore, they were adjusted as the economic situation demanded. This is one of the primary reasons as to why the policies pursued by the government and the Central bank need to be kept separate.

The relative autonomy of the Central Bank is essential because of the role that their policies have on inflation. The control of the amount of money that circulates in the economy and the benchmark interest rate will have implications for the level of inflation in the economy. Inflation in the long term will impact the growth prospects and the living standards of the people. The government. however, is subject to change and is influenced by the political ideologies that they subscribe to. Therefore, to ensure long term stability of the economy, an autonomous monetary policy and an autonomous body to formulate and implement it are necessary.

Milton Friedman, one of the pioneers of neoclassical economic thought, emphasised on the role that monetary policy plays in the economy. He argued that recessions like the Great Depression were a product of an excessively intervening government. Therefore, recessions can be avoided by gradually increasing the monetary base of the economy i.e., by printing more currency. However, Friedman stated that since the Keynesian revolution in the 1930s, the monetary policy was relegated to the side-lines. The view that money did not matter was questioned by Friedman who said that an economy would contract when the circulation of money does not grow with time.

He actively advocated this policy and was able to bring the governments to implement this policy. This advocacy hastened the process of moving towards a more free market which would have otherwise happened at a very slow pace. The problem was that despite the steady growth in the supply of money, recessions were not prevented. The actual performance of the American economy showed that the progress was not as high as projected and there was a parallel growth of inequality. When we look into the inequalities that have been created, it becomes imperative to understand that monetarism also advocated for the dismantling of the social security institutions.

Monetary policy had not proven to be as effective as it claimed to be. Similarly, the excessive government intervention has also discouraged the growth of private enterprises that may be efficient and drive the economy towards growth and development. We cannot completely abandon the role of the government or completely allow the government to regulate the market. It is important to understand that the government and the Central Bank have their respective functions in the economy. Beyond this, these are functions that need to be kept distinct from each other for long-term stability of economy. Therefore, it does not seem logical to place the government or the Central Bank over each other but to view them as co-existing autonomous entities.

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