Essay Plans

Outline the Monetarist and non-Monetarist approaches to inflation.

SYNOPSIS:

Go through Monetarist views then Keynesian. Include exchange controls and eclectic theory.

POINTS:

  1. The Monetarist approach:

    • Inflation is caused by excess monetary demand.
    • This is itself determined by the rate of expansion of the world money supply (fixed exchange rate system).
    • or ... rate of growth of the UK money supply (floating exchange rate)
    • To reduce money supply growth the government must first reduce the budget deficit.

  2. To reduce the budget deficit means deflationary policy, i.e. cut government spending more than taxes. Unemployment rises above the Natural Rate (define and briefly explain this concept).

  3. Inflation rate is now below the expected rate so expectations are revised downwards; money wage claims revised downwards hence inflation falls.

  4. Go through the problems:-

    • Which money supply? (Friedman states the monetary base; UK government used to concentrate on £M3).
    • CAN the government control the money supply?
      Yes in 76/77, 79/80, 82/83, 83/84, 84/85.
      No in 78/79, 77/78, 80/81, 81/82.
    • What speed will wage claim expectations be revised downwards? If slow then a long period of unemployment is the consequence of low inflation - politically dangerous!!
    • AUTOMATIC full employment will be achieved when inflation has been eliminated. Assumes mobility of factors - can a redundant miner really become a brain surgeon? High inflation increased savings (to minimise the real fall in money) thus with inflation low spending increases creating demand.
    • Restrictive money supply policy tends to raise interest rates (i.e. UK 1988/9) which in themselves raise inflation (mortgages). Also, it is easier to borrow money when there is high interest rates as more people are willing to lend.

  5. Concentrating on the MV = PT formulae, more observations may be made:-

    • At a state of underemployment T may not be fixed as if M is reduced less houses may be built hence T NOT P will fall.
    • The Cairncross argument: at Christmas the money supply rises because of an increase in transactions thus T leads to a rise in M as well as M leading to a rise in T.
    • If a rise in M may lead to a rise in P and/or T AND more goods can be produced the effect of a rising money supply will fall less on prices and MORE on the number of transactions.
    • The non-monetarist view
      • discussion on incomes policy
      • fiscal policy - raise taxes/cut government expenditure

  6. Difficulties of cutting government expenditure include unemployment, impracticality (a hospital with no roof) a rise in unemployment will increase public expenditure, cannot have half a motorway etc.

  7. Problems of raising taxes : wage rises increases, union trouble, disincentive to work.
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