Question

a) Although Keynesian economics provided alternative solutions to address the economic depression of the 1930s, it is not free of limitations. Write an essay in which you evaluate the relevance of the criticisms of Keynes and Keynesianism in Africa.

(b) Write an essay in which you explain why, according to Milton Friedman, "inflation is always and everywhere a monetary phenomenon".

Answer 1

a)

Keynes theory says that the markets are imperfect and not self-sustaining. There may be an under employment situation where the output is below the full potential level. The Government plays a major role in boosting the aggregate demand and there exists inflexibility in wages and prices.

However, this theory has been criticised on multiple grounds:

- Economy cannot be moved to full employment output by using Keynes theory. There is always under employment.

- Using Keynes theory, there may be a situation of Liquidity Trap. Increase in the money supply is completely absorbed in speculative balances.

- There is interest inelasticity of investment. Changes in the interest rate causes no impact in the investment level

Keynes theory was implemented in South African manufacturing sector where African Government increases its spending on economy's infrastructure raising the overall aggregate demand. However, such policy faced several of the above bottlenecks and failed to boost the economy.

b)

Milton Friedman says that Inflation is always a monetary phenomenon. It is based on the idea that increase in money supply will directly cause the price to increases creating inflation in the economy.

According to the Quantity Theory of Money:

M*V = P*Y

where M = Money Supply

V = velocity

P = price level

Y = Real GDP

It is assumed that V and Y are constant and do not change. So, any increase in M will directly increase P and price is the nominal variable.

So, it can be concluded that inflation is a monetary phenomenon.