9.

1 MONETARIST PROPOSITIONS
page -192

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.

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 higly stable, that it could be taken as determined independently of the other terms in the equation. As a result, changes in the quantity of money would be reflected either in prices or in output).

 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 with the 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 evidence against 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.

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).

Effects of an increase in Government Spending: The Keynesian View

r LM

r1

Interest Rate

r0

IS(G1) IS(G0) Y0 Y1 Y

Income (Output)

The higher level of income causes a higher transactions demand for money. - bringing money demand back to equality with the unchanged money supply requires a rise in the interest rate. -at the high interest rate the speculative demand for money will have declined, and the demand for transactions balance at a given level of income will also have fallen. -the same money supply can support a higher income level. Other-velocity varies positively with the interest rate.

Early Keynesian View of Monetary Policy Ineffectiveness

r LM0 LM1

Interest Rate

r1 r0

IS0 Y0 Y1 Income Y

Friedmans restatement of the quantity theory

Classical :Quantity theory of money MV=PT Friedman :Md=KPY Friedman money demand function stable. Keynesian Unstable, money just medium of transaction.

2nd theory
Money segmentation Friedman does not segment money Keynes: Segment money demand to 1)speculative demand 2)precautionary demand 3)Transaction balance

3rd theory
Demand theory Friedman: Include yield for bonds, equeties, durable goods. Keynes:Choice of the money VS bond

Friedman monetarist Position

9.3 FISCAL AND MONETARY POLICY

FISCAL POLICY
MONETARIST VIEW (Friedman)
Fiscal policy largely ineffective. What matters is what happen to the Quantity of Money.

KEYNESIAN VIEW
Fiscal policy was effective.

Noninterventionist

Interventionist

Friedmans view (p.g 203)

Effects of changes in the government budget holding 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 of policy in action.

do not argue
The type of policy changes will be ineffective

Friedman

do argue
The policy effect will come mainly because the supply of money

The controversy over what he refers to as the

effect of a change in the federal budget itself

MONETARY POLICY
Friedman
believe this policy action have substantial and sustained effect on nominal income.

Keynesian Both concern not whether this policy can effect the income but how this policy should be used to stabilize income.

Contrast with Keynesian (p.g 206)

believe both policy should be actively adjusted to offset shock to the economy
Concerning the need for active stabilization activity

Explanation

he believe we can stabilize economy, can predict shock and design policies to combat them

Aggregate demand Quantity of money still constant

IS0 IS1

r0 r1

Y0Y1 Effect Investment

Money Demand < Money Supply

According monetarist money is the dominant determinant of nominal income.

Differ on the view of proper role of monetary policy.

CONCLUSION

both believe monetary policy have strong affect

Keynesian belief fiscal policy(nonmonetary) action influence economy activity