KEY CONCEPTS AND THINKERS

Monetarism is not a monolithic ideology, and there is little general

agreement amongst monetarists on definitions, let alone on how its prin-
ciples should be applied. Almost everyone, including non-monetarists,
agrees that prolonged inflation is a purely monetary phenomenon.
In other words, inflation cannot go on indefinitely unless there is an
increase in the money supply, which is controlled or at least strongly
influenced by a nation's central bank.

Monetarist guru Milton Friedman (see Chapter 9) believes that

central banks should restrict themselves to keeping the money supply
growing in line with real output growth.

SUPPLY-SIDE ECONOMICS

The stagflation of the 1970s gave rise to the idea that the real problem
was that too much taxation and regulation was reducing incentives to
work, invest and save. The solution was therefore to stimulate supply
rather than demand, which had been the main focus of orthodox
approaches. Tax cuts would encourage both individuals and companies
to spend and invest, while lower regulations would help businesses
to grow. This would lead to an increase in the supply of labor, since
more people would want to work, or work harder, and there would be
more capital available for investment. Both inflation and unemployment
would fall.

The Laffer Curve (see Fig. 8.1) illustrates the argument for reducing

taxation.

According to Laffer, if the tax rate is 0%, then people will want to

work, but the government will receive no tax revenues. If the tax rate
is 100%, no one will want to work because all their income will go
to the government, so the government will still receive no revenues.
Since the curve is symmetrical, there are pairs of points (one on the
upper part of the curve and one on the lower, for instance A and B in
Figure 8.1) where tax revenues to the government will be equal, but
the lower part of the curve will relate to a higher supply of labor than
the upper part because the tax rate will be lower.

The ``Reaganomics'' of the 1980s brought in substantial tax cuts

in 1981 in an attempt to set rates on the lower part of the curve.
The US economy promptly came out of recession, inflation fell, and,