What are the theories of Economics?

May 7, 2017
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Two major theories have been battling in America: Keynesian Economic Theory and the Chicago School Economic Theory propounded by the late economist Milton Friedman. Their conflicting positions have struggled for dominance in fixing the economy for decades. Understanding these two views helps to clarify the differences between liberal and conservative economic thinking in America today.

In order to understand these two economic worldviews we Americans need to clearly understand the core philosophies.

Keynesian economic theory comes from John Maynard Keynes (1883-1946). His economic theory refined the concept that the economy runs in cycles of boom periods of prosperity followed by economic downturns called busts where unemployment rises and businesses cut back productivity. Keynes’ solution to the problem was for the government to pump money into the economy during times of busts and recession, going into debt if necessary, to increase employment and productivity. During times of prosperity Keynes’ advice was to reduce government participation by cutting back spending and raising taxes.

Under this perspective the Federal Reserve would regulate the money supply by increasing or decreasing interest rates (monetary policy). Congress, in turn, would regulate taxation and government spending (fiscal policy) to maintain high employment. Both Republican George W. Bush, and Democrat Barack Obama have followed Keynes’ ideas. Both have attempted to stimulate job creation by pumping government money into the economy.

Keynesians have trumpeted the stable economic growth the U.S. experienced from the end of World War II into the 1970s. According to Keynesians, government regulation of business is necessary for stable growth and high employment.

The second and opposing view of the economy comes from University of Chicago economist Milton Friedman (1912 -2006). Friedman believed and taught that the government interfered in the economy and should instead play a dramatically lesser role, preferring to abolish the Federal Reserve, but accepting its existence solely to slowly increase the money supply. He believed that the role of government should be reduced to 10 percent of the Gross Domestic Product. Government’s job is to stay out of the affairs of business (laissez-faire-government keeps its hands off the economy, cutting back on regulations, and instead allows the market – supply and demand – to determine prices and wages.)

Friedman also rejected the belief that full employment was desirable or possible.

The smaller the government the better it was for the economy. Ronald Reagan used his ideas during his presidency. Friedman considered one of his greatest contributions to be that of creating an all-volunteer military. Friedman also strongly advocated school vouchers as early as 1955. He favored the end of the U.S. Postal Service, allowing private enterprise to take over the job.

Friedman’s ideas are also credited with helping several countries transition from command economies (Chile and Poland to name two) to the prosperous capitalist and democratic societies they are today.

Keynesian economists blame Friedman’s ideas for the brutal repression and torture of Chileans under Pinochet to attain a capitalist society, and for helping create the lax regulation and banking excesses that brought about the 2007-10 global economic crisis.

As you can see, these radically differing ideas of the role government should play in the economy are fiercely debated in the nation. Two men, Keynes and Friedman, have helped to shape the arguments that are the basis for the conflicting economic Congressional views creating gridlock in Washington, D.C., today.

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