GLOBAL FINANCE

countries took up the idea of government intervention with enthu-
siasm, and ``Keynesian'' economics came to mean active government
participation in the economy at all times. Keynes, in fact, was against
the high taxation levels required by a permanently large public sector,
but during post-war reconstruction the political arguments for state
involvement in production, such as the nationalization of industries,
became popular, particularly in Europe. The US, too, adopted aspects
of Keynesianism, believing that the state could successfully ``fine tune''
the economy to stabilize production output and employment levels.

The recession of the 1970s and 80s revealed problems with this

approach and there is now a general feeling that the neo-Keynesian
methods were not precise enough instruments to control an economy,
particularly during prosperous periods. Keynes himself, a polymath
intellectual with a penchant for currency speculation, might well have
been horrified to see the way his ideas were applied after his death,
although he would no doubt have applauded the general increase in
living standards that has been achieved in developed countries since
the Second World War.

MONETARISM AND MILTON FRIEDMAN

Monetarism emerged as a response to the perceived ineffectiveness
of state intervention during the 1970s and 80s. To understand its
proposals, we need to examine the concept of the velocity of money.

Suppose A purchases goods from B for $100 in January. B may hold

the money until April before spending it with C, who holds it until
July when she spends it with D, who doesn't spend the $100 until
December. The $100 has changed hands four times during the year, so
its ``velocity'' is 4.

In the real world, GDP is used (imperfectly) as a substitute for the

total value of transactions in an economy. The velocity of money is
calculated as the ratio of nominal GDP to the money supply. If the total
value of finished goods and services produced in one year is $9trn and
the money supply is $1trn, the velocity of money is 9/1 = 9.

The quantity theory of money assumes that the velocity of money

remains virtually constant over time. If this is true, then changes in the
supply (stock) of money will be equal to changes in nominal GDP and
the demand for money does not depend on interest rates.