How To Turn Old-School Economic Theories Into Forward-Thinking Economic Strategies

11 mins

How To Turn Old-School Economic Theories Into Forward-Thinking Economic Strategies

Friedman And Monetarism

Chicago-style deregulation and efficient markets

2 mins

The main man of the 1970s and ‘80s was American economist Milton Friedman. An advisor to both Ronald Reagan and Margaret Thatcher, he was a key figure in what’s now known as the Chicago school of economics and the theory known as monetarism.

Friedman was not a fan of Keynesian economics. While Keynes’s concerns lay in government spending (fiscal policy), Friedman was much more concerned with cold, hard cash (monetary policy). His big worry was inflation – particularly because by the end of the ‘70s, Keynes’s ideas had led to “stagflation”: high inflation, high unemployment, and low growth 😳

Friedman blamed Keynesian policies for printing too much money, which caused this inflation. He thought inflation could always be dealt with by shrinking the “money supply”: reducing government spending and increasing interest rates, which would in turn make it more expensive to borrow cash. Less money in the economy means less spending, and that decreased demand should bring prices down – reducing inflation. That worked: when the Federal Reserve restricted US money supply in 1979, inflation finally decreased. However, that did also cause a recession.

Rather than encouraging governments to spend more, Friedman advocated a smaller government – one that deregulated industries and let markets operate freely. He thought individual people could always spend money more efficiently than a government could, and so the economy would be better off with lower taxes and reduced government spending. The wider Chicago school came to be known for its libertarian views, which remained very popular during decades of deregulation and booming growth 🎉

One offshoot of Chicago economics was Eugene Fama’s efficient market hypothesis. According to Fama, markets are always perfectly efficient. Basically, all available information about a company is already reflected in its share price, and stock markets reflect new information instantly. This means assets can never be overpriced, and market bubbles can never exist.

History kind of disproved that, though... Some people might have put too much faith in this theory back in 2008 when it became clear that markets weren’t as great at accurately assessing risk as everyone had thought. As millions of people were affected by the worst economic crisis since the ‘30s, people reconsidered their love for the Windy City and its economists.

That brings us to now. Current economic thinking is a mix of all the above: a bit of Keynesian economics to deal with recessions, a bit of monetarism to keep everything in check, and a mostly hands-off approach to markets (known as the “new neoclassical synthesis”). But that consensus could be about to shatter. There’s a new kid on the block: meet MMT.

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