DSST Money & Banking Part 1

No strong automatic tendency to full employment many

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no strong automatic tendency to full employment, many believed that if government policy were used to ensure it, the  economy would behave as classical or neoclassical theory predicted. In the post-WWII years, Keynes's policy ideas were widely accepted. For the first time, governments prepared good  quality economic statistics on an ongoing basis and had a theory that told them what to do. In this era of new liberalism  and social democracy, most western capitalist countries enjoyed low, stable unemployment and modest inflation. It was with John Hicks that Keynesian economics produced a clear model which policy-makers could use to attempt to  understand and control economic activity. This model, the  IS-LM model is nearly as influential as Keynes' original  analysis in determining actual policy and economics education. It relates aggregate demand and employment to  three exogenous quantities, i.e., the amount of money in circulation, the government budget, and the state of  business expectations . This model was very popular with economists after World War II because it could be understood  in terms of general equilibrium theory. This encouraged a much more static vision of macroeconomics than that described  above. The second main part of a Keynesian policy-makers theoretical apparatus was the  Phillips curve . This curve, which was  more of an empirical observation than a theory,  indicated that increased employment, and decreased  unemployment, implied increased inflation . Keynes had only predicted that falling unemployment would cause a  higher price, not a higher inflation rate. Thus, the economist could use the IS-LM model to predict, for example, that an  increase in the money supply would raise output and employment—and then use the Phillips curve to predict an increase  in inflation.  Through the 1950s, moderate degrees of government demand leading industrial development, and use of fiscal and  monetary counter-cyclical policies continued, and reached a peak in the "go go" 1960s, where it seemed to many  Keynesians that prosperity was now permanent. However, with the oil shock of 1973, and the economic problems of the  1970s, modern liberal economics began to fall out of favor. During this time, many economies experienced high and rising  unemployment, coupled with high and rising inflation, contradicting the Phillips curve's prediction. This stagflation meant  that both expansionary (anti-recession) and contractionary (anti-inflation) policies had to be applied simultaneously, a  clear impossibility. This dilemma led to the rise of ideas based upon more classical analysis, including monetarism, 
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