Four Theories On The Economy

The economies of the world all follow general cycles of growth and contraction as a part of the normal business cycle. For many generation it was accepted as fact and never put in to question or formed into a cohesive reason why.  However as our knowledge of economics grew several different theories on the economy developed.  To this day their are proponents to each of the theories and no one theory stands above others.

Rational Expectations Theory

The Rational Expectations Theory notes that everyone in an economy behaves in rational ways and will look at all the government policy decisions and devise ways to counter act them, therefore cancelling out the effectiveness of the policy.

Keynesian Theory

During the Great Depression with high unemployment and higher inflation, the governments of the world needed to act in such a fashion that would actually curb the negatives of the economy but there was no economic theory that supported government intervention as a benefit. Then John Maynard Keynes, a British economist, proposed Keynesian economics, which promotes the use of government stimulus as a means to achieving economic stability and to smooth the swings of the business cycle.

For example, during times of growth and prosperity the government should reduce spending and increase taxation to curb higher inflation and during times of recession the government should lower taxes and increase government spending. This will allow people to keep more of their money and create jobs through the government spending. These types of policies are meant to be adjusted to reflect the economic realities.

Supply-Side Economics

The theory behind supply-side economics is to create an economy of growth and prosperity the market should be allowed to operate with minimal government intervention. The only government involvement should be in the form of changes in the taxation rates. The thinking behind this is that a reduction in the marginal tax rate will allow for people to keep more of their money which they will in-turn reinvest that money into the economy, therefore creating more growth.

Monetarist Theory

The final of the economic theories discussed here is the monetarist theory which believes that the economy is stable by nature and left on its own will return back to normal growth. Under this theory, active fiscal and monetary policy is discouraged and the only government involvement should be to expand the money supply at the same rate as the overall long term growth rate of the economy. By doing this, the economy has a focus of staying on track with a relatively fixed inflation rate and should keep the economy stable within a manageable range.

Are Any Of These Theories More Right?

Although there have been different points of view presented in this article there really isn't one view that is more correct than another. All theories believe that economic growth is important and that having a stable economy is valuable to all within it. The main difference between them all is at what level should the government be involved to help out. During times of great crises the Keynesian theory generally holds more weight as it deals with a lot of government intervention to bring the economy back in line. Whereas, in times of great prosperity, supply-side or monetarist theories may be more present since they advocate only minimal government involvement.