The Rise of Monetarism

Abstract

With most of the Keynesian system incorporated into the neoclassical synthesis a truce emerged in the Keynes/classics debate. The terms of the truce were as follows:

• (1) with the incorporation of the Pigou effect into the Keynesian model it was generally accepted that underemployment equilibrium did depend on the assumption of rigid wages;

• (2) it was also agreed that the Pigou effect, though logically correct, was empirically weak;

• (3) therefore a self-regulating economic system with an automatic tendency to full employment was regarded as untenable in practice;

• (4) it was also accepted that the fairly high interest elasticity of the money demand function and the fairly low interest elasticity of the investment function meant that monetary policy was a weak and ineffectual policy tool in times of depression;

• (5) therefore it was agreed that discretionary fiscal policies were required whenever aggregate demand was insufficient to absorb the current level of G.N.P.

Keynesians appeared therefore to have won the policy debate even though they had lost the theoretical honours.