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Example research essay topic: Free Market Economy 1950 And 1960 - 2,403 words

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Keynesianism, Monetarism And The Shift Of Economic Keynesianism, Monetarism And The Shift Of Economic Policy Q 1: How and why were Keynesian economic policies abandoned in the UK? Keynesianism was the economic model followed by governments in the UK from the 1950 s up until the late 1970 s. In the 1950 s and 1960 s, the name? Butskellism?

was given to Chancellor Butler and Chancellor Gaitskell? s Keynesian approach to management of the economy, with an overall aim of maintaining full employment by substantial government intervention. Keynes rejected the idea of laissez faire (? leave alone? ) policies that left the market to regulate wages and prices. He said that if the economy were left alone in this way, there would be a recession, meaning more people being laid-off from their jobs and reduced real wages. More unemployment would then result in less consumer confidence and hence a decrease in aggregate demand.

Keynes also rejected the socialist idea of the economy being stimulated by the redistribution of wealth to the poor? this would destroy the incentive to achieve and so competition would fade, resulting in inferior total output and making recession much more likely. Governments used Keynes? theory of? demand management? as a solution to recessions.

He said that a government should? spend its way out? of a recession by lowering taxes and investing more in projects and programmes which would create new job opportunities and create wealth. Those who take up the jobs would have more money in their pockets and so their extra spending (increased demand) would stimulate the economy more. Keynes? idea was that if demand was threatening to rise too much, the government should reduce the Budget deficit by raising taxes and cutting government expenditure to reduce demand.

In the same way, if there was a substantial rise in unemployment, the government should increase the Budget deficit by investing in new projects and lowering taxes. There was little criticism of Keynesianism until the late 1970 s because the society as a whole was pretty wealthy. There was consistent full employment and great prosperity in the 1950 s and 1960 s. Earnings were growing faster than prices, meaning that real wages were high and more people were able to buy expensive durable goods such as televisions and cars.

Taxes were also low, people had more money to spend and overall wealth was high. But by the mid- 1970 s, however, Keynesian policies did not seem able to prevent? stagflation? (high inflation combined with high unemployment). The average rate of inflation between 1950 and 1970 was 4. 5 % but by 1975, this rate had rocketed to 24. 2 %. Unemployment grew rapidly from 2. 5 % in 1970 to about 6 % by the end of that decade. It was discovered that by Keynes?

system of demand management it was impossible to maintain stable low unemployment in the long term. The economy still tended to go from mild boom to mild recession. When unemployment was low, economic growth and inflation was high, increasing the balance of payments deficit. By reducing demand, the balance of payments deficit was reduced and inflation curbed but the economy then moved into mild recession and unemployment grew. A recession encouraged the government to intervene and increase the level of demand and as a result, the cycle would begin again. This chain of events was known as the?

Stop-Go cycle. ? The goal of Keynesian economics, full employment, caused difficulties in other areas of the economy. When full employment occurs, labour is in short supply, pushing up the price of labour. Wage increases would most likely be followed by sharper (relative) increases in the price level of goods and services, caused by businesses needing to compensate paying out higher wages, which would affect the consumer. Higher prices would then lead to demands for still higher wages, and so in short, Keynesian policies, with their goal of full employment were shown to actually produce spiralling inflation. In the 1960 s and 1970 s, the link between wage levels and inflation led to increased links between government, management and unions.

Labour and Conservative governments both tried to make suitable incomes policies, hoping that wage restraint would keep inflation down, but it was particularly difficult since management and unions broke agreements in place. The failure to generate a workable incomes policy meant the prior mentioned inflationary spiral could not be broken. There was quickly heavy criticism of Keynesianism. Economists saw that governments needed to be vigilant in taking into account lags in spending when using active fiscal policy (manipulating government expenditure). Governments were accused of de stabilising the economy by using this approach, such as in 1972 when the Chancellor tried to stimulate the economy when it was (supposedly) moving into a boom at its own accord. Active fiscal policy also relies heavily on accurate and reliable predictions.

Economic forecasting is a very precise business, and there is little room for error or inaccuracy. Therefore, it was realised that any government would have tremendous difficulty in maintaining successful economic activity by the Keynesian approach, when the variables involved could easily be misinterpreted or were to too many decimals making them simply impossible to predict. Constant increases in demand were only fuelling inflation, and had no effect on unemployment. Supporters of Keynes? theory blamed external factors such the oil price shock of 1973 - 74 and the collapse of the system of managed exchange rates.

The government tried to maintain demand while weakening inflation using incomes policies with closer links with the unions. When this failed, they allowed unemployment to rise to counter inflation. When this got out of hand, they let inflation rise to counter unemployment. By the middle of the 1970 s the whole scenario had escalated way out of proportion, and faced with quickly rising inflation and mounting unemployment, the Labour government asked the IMF for a loan. To receive the loan, the government had to make sharp spending cuts, in effect ending Keynesianism. In 1976, the Labour Prime Minister, James Callaghan, announced that Keynesianism wasnt working and the government?

s aim then became to control inflation. A Conservative government, under Margaret Thatcher, was elected to office in 1979 and openly abandoned the Keynesian goal of full unemployment. The reduction of inflation, not the reduction of unemployment, was the Conservative government? s main goal, marking a turning point in post-war management of the economy. Q 2: What have been the major effects of this policy shift (until 1992)? To achieve its goal of low inflation, the government confided in a laissez faire version of monetarism.

The aim was to reduce government spending and borrowing and to provide the conditions in which the market could regulate itself. The Conservative government was planning a reduced level of state intervention, which is in direct conflict with Keynesian thinking, and wanted to dismantle the structures set up during the period of Keynesianism, replacing them with its own free-market solutions. There were three branches to British monetarism in the early 1980 s. The government aimed to meet annual targets to control the money supply (the amount of money in circulation), it aimed to reduce the level of government spending each year, and it aimed to remove state controls to create a free market economy. Thatcher believed that the nation should not live on credit, and instead the Budget should be balanced. Reducing the level of public expenditure as a means of controlling inflation relied on the belief that if government spending exceeded public income the result would be an increase in the money supply.

Monetarists, unlike Keynesian's, would not invest government money to stimulate the economy if that investment created a deficit. To reduce the level of government spending, in his first Budget, Geoffrey Howe placed cash limits on the public sector, sold some public assets to aid the financing of the PSBR and switched the emphasis from direct taxation to indirect taxation. Howe? s Budget signified a move away from Keynes? idea of demand management, which would have tried to curb unemployment by permitting a deficit, and instead attempted to reduce the deficit even if that meant higher unemployment. By the mid- 1980 s, the government had achieved a Budget surplus, but the level of public spending increased every year from the time the Conservatives came into power.

This was mainly caused by the huge growth in unemployment, which not only put a heavy financial burden on the government in the form of unemployment benefits, but also caused the government to receive less revenue in the form of taxes. When unemployment is grows, less income tax is collected since people out of work do not pay it, and less indirect tax is collected since unemployed people cannot afford to buy as many goods and services which have indirect taxes applied to them. The situation of more benefit being paid out than tax being received certainly did not help the government fulfil its aim of reducing spending. Income policies were abandoned at the beginning of the Conservatives? first term in office meaning that wage negotiations were to be made by employers and their workers, and so the market would decide the level of settlements, not the government. This was another clear move away from the Keynesian era, as was the programme of privatisation that took off after 1983.

Privatisation appealed to the government since it would allow it to raise money without having to borrow, and also money raised by privatisation wouldnt affect the money supply so was not an inflationary policy. Privatisation was directly in line with the governments plan to create a free market, because it reduces the state? s direct involvement with the economy. Market forces can have more control over the economy when the public sector is reduced in size by the selling-off of state-owned assets.

As well as (in theory) increasing efficiency, privatisation had other advantages to the government. It provided the Treasury with a great deal of income, helping to fund tax cuts, and the sale of shares and previously council property to the public encouraged large numbers of ordinary people to become shareholders or homeowners for the first time. The government hoped to gain more voters by increasing the proportion of people with a vested interest in the capitalist system. The government believed that inflation could be partly controlled by restricting the money supply, and so laid down annual targets to reduce the amount of cash in circulation as part of its Medium Term Financial Strategy.

To meet the targets, it was believed that if interest rates were set high enough, the demand for money would be less. Secondly, the government would fund the Public Sector Borrowing Requirement (PSBR)? the Budget deficit? without printing money.

Thirdly, the government would allow the exchange rate to float in order to prevent the trade of foreign currencies from affecting the domestic money supply. However, the government was not at all successful at controlling the money supply, never once meeting its target. In fact, the money supply grew at over twice the rate set by the government in the early 1980 s. Inflation did fall in this period (1979 - 85) but ironically, it fell when the money supply was increasing.

Therefore the monetarists? claim that inflation would only fall if the money supply was restricted was proved false. The government had used the broad? M 3? measure of money supply, which included money in accounts and deposits in banks as well as all notes and coins in circulation in its calculations.

The alternative was the narrower measure? M 0? which included only notes and coins in circulation plus the balances of banks with the Bank of England. In November 1985, M 3 was abandoned in favour of M 0. Most economists dismissed this M 0 as an unrealistic measure of money supply since it does not take into account that most of today? s society is plastic dominated and relatively cashless.

From 1986, controlling the money supply was no longer a main concern for the government. After the money supply fiasco, the Chancellor, Nigel Lawson argued that British monetary policy was bound by the exchange rate of the pound. Between 1985 and 1989, Lawson attempted to manage the economy with the exchange rate and the level of interest rates. Lawson saw benefit in a closer economic relationship with Europe, concerned with the importance of the exchange rate, and pressed for UK entry to the Exchange Rate Mechanism (ERM). Thatcher disagreed, favouring an alignment with the US Dollar. This damaging conflict forced Lawson to resign in 1989.

He was replaced as chancellor by John Major, who tried to distance himself as much as possible from Lawson by declaring that Lawson shouldn? t have allowed demand to rise as sharply as it did in 1987 and 1988. Major became chancellor at the end of a period of a small boom and when the economy was heading for recession. It was when he was chancellor that the UK joined the ERM. Major, as Prime Minister, promised to pursue the same general direction, in terms of economic policy, as Margaret Thatcher had. The main economic aims remained the same: encourage free market economy; lower direct taxation and public spending; maintain low inflation.

The main instrument for constraining inflation was to remain within the ERM. Being seen as a loyal? Thatcherite, ? Major faced difficulty in showing that he was?

his own man. ? This was done by coming across as? caring? and making economic policy adjustments just before the 1992 general election. He abandoned the unpopular poll tax and was willing to increase public spending even if it meant creating a large Budget deficit. Because the economy remained in recession until beyond the 1992 election, the possibility for government action was poor.

The shift in government policy from Keynesianism to Monetarism can be said to have had negative effects on the British economy. ? By the mid- 1980 s, most people agreed that there was no simple connection between the rate of interest, increases in money supply and the rate of inflation. ? (Adapted from Hall &# 038; Jacques 1983 and Anderton 1995) One could argue that the Conservative government had to spend significantly more to recover from the recession of 1990 - 92, since not spending very much for such a while (going against Keynesianism) had made the situation worse.


Free research essays on topics related to: margaret thatcher, free market economy, balance of payments, laissez faire, 1950 and 1960

Research essay sample on Free Market Economy 1950 And 1960

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