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9.1 MONETARIST PROPOSITIONS

page -192


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Four Proportions that characterize the

monetarist position:

1. The supply of money is the dominant influence on nominal

income.

2. In the long run, the influence of money is on the price level

and other nominal magnitudes. Real variables, such as

output and employment are determined by real, not

monetary factors.

3. In the short run, the supply of money does influence real

variables. Money is the dominant factor causing cyclical

movements in output and employment.

4. The private sector is inherently stable. Instability in the

economy is primirily the result of government policy.


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9.2 THE REFORMULATION OF THE QUANTITY

THEORY OF MONEY.

Milton Friedman described the classical quantity theory as follows:

(In monetary theory, analysis was taken to mean that in the quantity

equation MV=PT , the term for velocity could be regarded as higlystable, that it could be taken as determined independently of the other

terms in the equation. As a result, changes in the quantity of money wouldbe reflected either in prices or in output).


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In proposition 1 of monetarism, stable velocity means not

only that changes in M will cause changes in PT but also that

only changes in M can change PT.

The quantity theory had come into disrepute, together withthe rest of classical economics, as a result of the Great

Depression of the 1930s.

Friedman belived that the events of the 1930s had been

improperly assessed and did not, in fact, offer evidenceagainst the quantity theory of money.

The need to restate the quantity theory in terms that took

account of Keyness contribution. His purpose was to reassert

the importance of money.


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Money and the Early Keynesians.

-within that framework money-determinant of economic

activity.

-factors other than money could also affect the level of

economic activity- (increase in government spending).


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r

Y

LM

InterestR

ate

Income (Output)

IS(G1)

IS(G0)

r1

r0

Y0 Y1

Effects of an increase in Government Spending: The Keynesian View


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The higher level of income causes a highertransactions demand for money.

- bringing money demand back to equality withthe unchanged money supply requires a rise inthe interest rate.

-at the high interest rate the speculativedemand for money will have declined, and thedemand for transactions balance at a givenlevel of income will also have fallen.

-the same money supply can support a higherincome level. Other-velocity varies positivelywith the interest rate.


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r

Y

LM0LM1

r1

r0

Y0Y1

InterestRate

Income

Early Keynesian View of Monetary Policy Ineffectiveness

IS0


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Classical :Quantity theory of money

MV=PT

Friedman :Md=KPY Friedmanmoney demand function stable.

Keynesian Unstable, money just medium of

transaction.

Friedmans restatement of the

quantity theory


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Money segmentation

Friedman does not segment money

Keynes: Segment money demand to1)speculative demand

2)precautionary demand

3)Transaction balance

2nd theory


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Demand theory

Friedman: Include yield for bonds, equeties,

durable goods.

Keynes:Choice of the money VS bond

3rd theory


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Friedman monetarist Position


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9.3

FISCAL AND MONETARY

POLICY


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FISCAL POLICY

MONETARIST VIEW(Friedman)

KEYNESIAN VIEW

Fiscal policy largely ineffective.

What matters is what happen to the

Quantity of Money.

Fiscal policy was effective.

Noninterventionist Interventionist


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Friedmans view (p.g 203)

Effects of changes in the government budgetholding constant the quantity of money.

Situation

1) G , (T )

Printing money/

Selling Bonds

2) T , (G )

#However, if this situation involve printing money there are both ofpolicy in action.


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do not argueThe type of policy changes will be ineffective

Friedman do argue

The policy effect will come mainly because thesupply of money

The controversy over what he refers to as theeffect of a change in the federal budget itself


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Contrast with Keynesian (p.g 206)

believe both policy should be actively adjustedto offset shock to the economy

Concerning the need for activestabilization activity

Explanation

he believe we can stabilize economy, can

predict shock and design policies to

combat them


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G IS0 IS1 r0 r1 Y0Y1

Aggregate

demand

Quantity ofmoney still

constant

Money Demand < Money Supply E r Effect

Investment


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According monetaristmoney is the dominant

determinant of nominalincome.

bothbelieve

monetarypolicy have

strongaffect

Keynesian belief fiscalpolicy(nonmonetary)

action influenceeconomy activity

Differ on the

view ofproper roleof monetary

policy.

CONCLUSION

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