Dislocation of the 1970's initiated an international search for an alternative economic philosophy to that of J.M. Keynes. This led to a growing "reliance upon monetarism and neoclassical economics of the market". The final form of the alternative became crystallized in a policy direction adopted by Margaret Thatcher and Ronald Reagan known as supply side economics.
Supply side economics was "a renaissance of the classical economics of Adam Smith and Jean Baptiste Say". David Ricardo's Comparative Advantage Theory also features in supply side economics. The policy direction was developed during the 1970's with input from four Nobel Prize winning economists: Robert Mundell, Milton Friedman, James Buchanan, and Friedrich Hayek. Mundell and Friedman were Chicago School monetarists. Hayek came from the Austrian School of thought whilst Buchanan was sympathetic to Austrian economics. Another Chicago School economist involved was Arthur Laffer of the famous Laffer Curve phenomena.
By assuming full employment, nineteenth century theories excluded unemployment from consideration. Consequently, any deviation from full employment was temporary or frictional unemployment caused by workers moving between jobs. Amongst leading twentieth century classical/neoclassical theorists was Professor Pigou of Cambridge University. Pigou believed that the business cycle was a smoothly functioning system that experienced temporary dislocation. He asserted that flexible wage rates would adjust the system and return it to full employment. This view of the business cycle is recognized in economic literature as a restatement of Says Law of Markets in terms of the demand for labour.
Say's Law of Markets applied to a modern economy leads to an economic policy direction characterised by:
- no-industry policy and removal of government intervention in market behaviour
- minimum government involvement in wage determination
- curbing trade union power and minimizing unemployment support
Enter Friedman's Natural Rate of Unemployment
...that simple Keynesian world in which some reduction in unemployment could, apparently, always be at the cost of some more inflation. More inflation simply leads to more unemployment. Bill Hayden
The quotation from Bill Hayden's 1975 Budget is amongst the first made by an Australian public figure that enunciates the concept of Friedman's natural rate of unemployment. It signifies a major shift in Australian economic thinking from the economics of Keynes to monetarism. Implicitly, this rejects Curtain's White Paper on Full Employment and returns to the alternative Say's Law of Markets.
The natural rate of unemployment describes the equilibrium point of an economy beyond which economic expansion to increase employment will produce inflationary pressures. Conversely, an employment rate below natural rate of unemployment produces deflationary pressures. Full employment becomes defined as the natural rate of unemployment consistent with the equilibrium level of real wages. Economic expansion beyond the natural rate of unemployment requires supply side structural change
By 1974-75 both major political parties were converts to monetarism. By 1975, the Federal Treasury had accepted the concept of a natural rate of unemployment. In its 1975 Annual Report, the Reserve Board of Australia accepted the link between increased inflation and unemployment. Political, institutional, and professional acceptance of the Friedman/Phelps natural rate of unemployment inevitably meant economic reform policies directed to supply side phenomena.
Role of the RBA
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