260
I
n the 25 years following
World War II Keynesian
policies, which advocated an
active state intervention in the
economy, made the Western world
prosperous. In the words of British
Prime Minister Harold Macmillan,
people had “never had it so good.”
However, in the early 1970s an
oil crisis triggered an economic
downturn. Unemployment and
inflation both rose rapidly. The
Keynesian model no longer
seemed to be working.
For some years conservative
economists had been arguing for a
return to more free market policies,
and now their arguments were
being taken more seriously. US
economist Milton Friedman (p.199),
was now the foremost economist of
the Chicago School, which opposed
Keynesian ideas. He suggested thatrather than tackling unemployment,
inflation should be the focus of
economic policy, and the only role
of the state should be in controlling
the money supply and allowing
markets to work—a doctrine
known as monetarism.Rise of the Right
As faith in Keynesian policies
waned, the right-wing parties
of Ronald Reagan and Margaret
Thatcher, both staunch believers in
Friedman’s monetarist economics,
took power in the US and Britain.
The policies they introduced in the
1980s marked a return to the old
beliefs in the stability, efficiency,
and growth of markets if left
to their own devices.
The social policies of so-called
Reaganomics and Thatcherism
were influenced by the Austrian-born economist Friedrich Hayek
(p.177), who put the individual, not
the state, at the heart of economic
thinking, and by economists
who saw tax cuts as a means
of increasing tax revenue.
Liberalization became the
new watchword. Deregulation of
financial institutions not only made
it easier for firms to borrow, but also
allowed lenders to indulge in the
new forms of financial engineering
that promised high returns with
zero risk. Throughout the 1980s
the economic mood was changing
worldwide. Reforms in the Soviet
Union were to lead to the eventual
breakup of the Soviet bloc,
reinforcing conservative
economists’ views that socialist
policies did not work. Mainland
Europe, however, resisted the
American swing from KeynesINTRODUCTION
1970
1971
1973
1973 1974
1974 1977
1979
OPEC, a group of
oil-producing countries,
begin an oil embargo,
plunging the world into
economic crisis.President Richard Nixon
breaks the link
between the US dollar
and the price of gold
on the advice of
Milton Friedman.Psychologists Amos
Tversky and Daniel
Kahneman publish
Prospect Theory,
the foundation of
behavioral economics.Augusto Pinochet seizes
power in a coup in Chile,
which becomes
the first country to
implement monetarist
economic policies.George Akerlof
describes markets where
one buyer has better
information than
another, and opens up
a new field of
information economics.
Arthur Laffer explains
the Laffer curve, which
shows how increased
taxes can lead to
decreased revenue.Edward Prescott and
Finn Kydland
argue for
independent
central banks.Hyman Minsky
outlines his
financial instability
hypothesis, showing
how stability leads
to instability.