Keynesianism was designed after the war and with the view to achieving full employment within the economy, it was found to be very effective.
However Keynesianism failed during the 1970’s bringing its use to a close. Keynesianism’s biggest problem was its failure to deal with inflation. Cyclical Unemployment – This is caused by an insufficient demand for goods and services in the national and international economy. Cyclical Unemployment gets its name because trade tends to follow a series of booms and slumps.
During a boom the demand for goods/services is high, resulting in full employment, during a slump the opposite happens.Between 1945-1970 the economy was experiencing a boom and Keynesianism was at its peak, employment was high. After 1970 the level of unemployment grew. During such slumps in the economy Keynesianism is less effective and not practical.
Structural Unemployment – This is where the structure of the economy changes. Certain industries may decline due to a sharp fall in demand for goods/services. As this happens new industries take over. Regional Unemployment is similar to structural unemployment accept that those industries in decline are locally based, as a result the local economy falls into depression.Fractional Unemployment – This occurs when people are between jobs; they leave one job to look for another and feel confident of finding one. This is also known as short-term unemployment. Technical Unemployment – Due to the introduction of new technology companies can achieve higher levels of productivity. This results in an excess of man power and results in a less labour.
(Companies become capital intensive). Keynesianism also faced the problem of balance of payments. The problem arose due to the fact that predictions could not be made with reference to whether or not consumers would spend their money on imports.People spending their money on foreign imports meant that money was leaving the UK, not circulating within the UK economy. As a direct result of this the pound was devalued during the 60’s under Wilson and floated by Heath during the 70’s.
It was Keynes belief that when full-employment is achieved money shall be put back into the British economy; “Balance of Payments” was a contradiction to this. Inflation is highlighted by Keynesianism, which is inherently inflationary. As full-employment became closer to being achieved under Keynesianism Trade Union bargaining power strengthened.
Unions pushed for wage rises; increasing inflation. In the 1970’s inflation and unemployment increased by the same amount, this is said to be “stagflation” when this happens. Previously a trade-off had been between unemployment and inflation. Some economists argued the reason for an increase in inflation was due to a rise in oil prices out with government control. Some economists felt high inflation, economic and political problems represented signs for change. Due the problems highlighted earlier, Keynesianism was shelved by the Callaghan Administration. MonetarismMonetarism was regard by economist to be the way forward after Keynesianism was shelved by the Callaghan Administration. Monetarists believe that inflation should be the key factor controlled by the government, unlike Keynesianism’s practice where employment was the main variable which had to be controlled.
There is disagreement between economists of the precise cause for inflation. There are three main explanations offered. Cost-push – This is when prices of goods are for up by producers as arsult of high production costs. Demand-pull Inflation – This is Keynes take on inflation.There is also the explanation favoured by the mmonetrists – Monetry Inflation; where there is toomuch money in the money supply in relation to the amount of goods/services available in the economy. The government is said to created inflation by following Keynesianism policies on demand management. Government spending has out weighed earnings through taxation. This deficit must be supplemented through public sector borrowing as shown in the diagram below.
Economic recession and balance of payment deficits are problems encountered by monetarism.Experiments carried out during the Thatcher Administration coincided with a world recession and can not be blamed. However, it can be argued that the recession was a bad time for certain key industries as the government withdrew its support.
In a bid to reduce inflation, interest rates increased making borrowing more expensive and the exchange rate high. The exchange rates made British goods more expensive when exporting which declined. Reliance on the export market meant that the manufacturing industry suffered badly.