Monetarism

In the 1950s and 1960s, monetarists, most notably Milton Friedman, began to argue that Keynesian fiscal policy had negative long-run effects. Unlike Keynesians, monetarists insisted that money is neutral, meaning that in the long run, changes in the money supply

will only change the (7)_____ level and have no effect on output and employment. They

argued that governments should abandon any attempt to manage the level of (8)________ in

the economy through fiscal policy. On the contrary, they should try to make sure that there is constant and non-inflationary growth in the money supply.

Monetarists argue that recessions are not caused by long-run market failures but by short-run errors by firms and workers who do not reduce their prices and wages quickly enough when demand falls. When economic agents recognize that prices and wages have to fall, the economy will come back to normal. Since the government will not be able to

recognize a coming (9) _____ any more quickly than the companies that make up the

economy, it will only be able to act at the same time as everyone else is recognizing the need to cut prices and wages. Consequently, its fiscal measures will take effect when the economy is already recovering, and so will merely make the next swing in the business cycle even greater.