Keynes vs. Friedman the case of USD/EUR

For those of you who are not familiar with the two most famous economists of the 20^th century, John Maynard Keynes and Milton Friedman had competing theories about how economies should be managed in times of crisis. Their theories are still at the forefront of almost all major economies in one way or another.

Keynes argued that the free market by itself would not always result in full employment and some level of government spending/intervention was required in order to stimulate aggregate demand to a sufficient level to encourage full employment. Friedman disagreed that government spending was the answer preferring to rely on monetary policy to achieve this objective. More specifically, using lower interest rates to stimulate aggregate demand by directly reducing the cost of borrowing.  

Whilst Keynes policies were popular through until the 1970s, many economies have gradually moved to Friedman style management over the last 30 to 40 years following criticism of Keynes theories from a number of leading economist with Friedman being the most vocal and articulate. However as Bob Dylan once sang “the times they are a-changing”! What we have now is a giant laboratory with the U.S focusing on Keynesian Economics through government spending and the Euro Zone focusing on monetary policy because austerity measures limit a government’s ability to borrow money to stimulate the economy.

Until this week, it was impossible to call a winner with both regions seemingly showing no signs of recovery. However, November may well mark a historic time in the U.S with the unemployment rate falling to its lowest level in more than two and a half years, a clear indicator that they unemployment trend might be reversing.

Improvements in the U.S economy should see movement towards the USD in preference to the EUR causing a depreciation of the EUR/USD. We did see a slight sell off towards the latter half of last week, but markets still remain unconvinced one way or another. This pair should be watched closely especially if news in the U.S continues to improve with no signs of life in Europe.