Monetarist vs Keynesian – Economic Policy and Assumptions

Monetarist vs Keynesian – Economic Policy and Assumptions

Keynes vs Monetarists – The Macro Showdown

Imagine two economists walk into a bar (yes, the start of every good IB economics lesson). One orders a pint and says, “When things go wrong, the government needs to step in.” The other sips a black coffee and replies, “Let the market fix itself, mate.”

Welcome to the world of Keynesian vs Monetarist economics.

The Keynesian Mindset: "Wages Don’t Budge"

Key assumption? Wage inflexibility. John Maynard Keynes believed wages don’t fall easily. Not because the laws of economics say so - but because real people hate pay cuts.

Ever tried telling a footballer they’ll now earn less for missing the net all season? Or tried asking a teacher to accept a 10% pay cut because “it’s good for economic equilibrium”? That’s the problem. Workers (and their unions) resist wage reductions, especially in recessions. This makes wages sticky downwards.

Result? The economy gets stuck in a deflationary gap. Unemployment rises, output falls, and everyone waits for something to give.

The Keynesian Fix: Intervene!

Keynesians say, “Don’t just sit there – spend some money!” To restore full employment and boost growth, the government should use:

• Expansionary fiscal policy – like tax cuts or increased government spending.

• Loose monetary policy – such as cutting interest rates to boost borrowing and investment.

Case in point? After the 2008 financial crisis, countries like the USA, UK, and China rolled out massive stimulus packages. In the US, the Obama administration injected $831 billion into the economy. Roads were built, jobs were saved, and the worst was (sort of) avoided.

The Monetarist Model: "Markets Know Best"

Milton Friedman and his monetarist crew took one look at that and went, “You’re doing it wrong.” For them, long-term macroeconomic equilibrium always returns - no government help needed.

Their belief? Markets self-correct. If unemployment rises, wages will fall. Eventually, employers will start hiring again. The Long-Run Aggregate Supply (LRAS) curve is vertical at full employment (YF), and the market naturally returns to that point.

Unemployment? That’s just natural unemployment - people between jobs or changing careers. It's not a crisis. It’s Monday.

The Monetarist Fix: Don’t Fix It!

In the monetarist view, government spending only makes things worse in the long run:

• It creates inflation.

• It adds public debt.

• It distorts incentives and crowds out private sector investment.

So what’s their solution? Supply-side policies:

• Improve education and training

• Cut red tape and taxes

• Invest in tech and infrastructure

These shift the LRAS outwards - growing the economy without inflation.

Example? Singapore. Rather than throwing money at recessions, it focuses on training programmes, low taxes, and innovation incentives. The result? High growth, low inflation, and strong productivity.

So... Who’s Right?

It depends.

When COVID-19 struck, Keynesian tools were everywhere. Governments had to step in - furlough schemes, unemployment benefits, stimulus cheques. The free market alone wouldn’t have saved jobs in sectors like hospitality or airlines. Demand had evaporated. Wages didn’t “flex”. Intervention was essential.

But during boom years? Monetarists argue that central banks and governments should step back and let supply-side efficiency drive growth.

Final Takeaway (and what to write in your exam)

Feature Keynesians Monetarists

Wages Sticky Flexible

Government role Essential in recessions Often harmful

Policy tools Fiscal and monetary Supply-side only

Equilibrium Can occur below YF Always returns to YF

Real-world examples 2008 crisis, COVID-19 Singapore, Germany (long-term focus)

Story to Remember

Imagine a classroom. Students (workers) haven’t done their homework (output is down). The Keynesian teacher says, “Let’s give them chocolate (stimulus) and get them motivated!” The Monetarist teacher says, “Take away the chairs. When they get tired of standing, they’ll sit down and study.”

Whichever you agree with, just remember - in economics, assumptions shape the answers.