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