monetarists say: “it ain’t broke, so don’t fix it.”

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Monetarism is a main theoretical and policy alternative to Keynesian macro economics. The principal elements and tenets of monetarism are summarized as follows: Monetarism is a modern, upgraded version of the Classical system (or the Full- Employment model). The economic system naturally tends to full-employment of resources--there is no systemic insufficiency of aggregate demand as claimed by Keynes and his followers. Fluctuations of real GDP and employment can be explained by: (a) the failure of money wages and prices to quickly adjust to Monetarists say: “It ain’t broke, so don’t fix it.” Monetarism

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Monetarists say: “It ain’t broke, so don’t fix it.”. Monetarism.  Monetarism is a main theoretical and policy alternative to Keynesian macro economics. The principal elements and tenets of monetarism are summarized as follows: - PowerPoint PPT Presentation

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Page 1: Monetarists say: “It ain’t broke, so don’t fix it.”

Monetarism is a main theoretical and policy alternative to Keynesian macro economics. The principal elements and tenets of monetarism are summarized as follows:

Monetarism is a modern, upgraded version of the Classical system (or the Full-Employment model).

The economic system naturally tends to full-employment of resources--there is no systemic insufficiency of aggregate demand as claimed by Keynes and his followers.

Fluctuations of real GDP and employment can be explained by: (a) the failure of money wages and prices to quickly adjust to changing market conditions; and/or (b) erratic or unforeseen changes in the money supply (MS).

Monetarists say:“It ain’t broke, so

don’t fix it.”Monetarism

Page 2: Monetarists say: “It ain’t broke, so don’t fix it.”

Monetarism begins with the equation of exchange:

MV PY [1]

where:

• M is the nominal money supply;

•V is the income velocity of money, that is, the average number of times per year a unit of the money supply circulates in exchange for newly-produced goods and services;

•P is a price index measuring the average prices of goods and services that make up GDP; and

•Y is real output (or GDP) measured in units.

Page 3: Monetarists say: “It ain’t broke, so don’t fix it.”

MV = spending for newly-produced goods and services in a year.

PY = the market value of of new goods and services produced in a year, or nominal GDP (also equal to nominal income).

The equation of exchange isan identity. That is, it is

true by definition

Page 4: Monetarists say: “It ain’t broke, so don’t fix it.”

M is autonomous--that is, determined by the FED.

The evidence shows that V fluctuates in a narrow range (or at least this is what the monetarists claim) so that if we treat V as a constant, we are not far from the truth.

Y is determined by the equilibrium in the labor market in conjunction with the short-run aggregate production function. That is, Y= Yf.

Thus we can write:

MV = PYf [2]Hence:

•Money is neutral

•“Inflation is always and everywhere a monetary phenomenon.”

Page 5: Monetarists say: “It ain’t broke, so don’t fix it.”

Long run aggregate supply (LRAS)

Pric

e le

v el

Real GDP

AD1

AD2

Yf0

1

2

Money is neutralThe increase in

the money supply stimulates AD—but

real GDP and employment are

unaffected