A Keynes vs Monetarist view

 Looks at the role that fiscal policy can play in stabilizing the economy.
 Keynesian theory suggests that higher government spending in a recession can help the economy recover quicker.
 Keynesians say it is a mistake to wait for markets to clear like classical economic theory suggests

 In a recession, people responded to the threat of unemployment by

RECESSION
Government intervention
STIMULATES AD and REAL GDP



What about
Policy Tools?
Which ones can be used to stimulate AD

 Wages may be ‘sticky downward’/ inflexible
’
 Workers do not accept nominal wage cuts
,
 Firms have to lay off workers
 This can lead to involuntary unemployment.
 The economy slows down

In a recession, an economy has spare capacity,
SO: increasing AD will have an impact on real output and only minimal effect on the price level
.

INCREASE SPENDING
(
C + I + G + X – M).

 Keynesians believe there is a multiplier effect
This means
 an initial injection (eg increased government spending) into the circular flow can lead to a bigger final increase in real GDP

“It is more important to reduce unemployment than inflation”

Keynesians support expansionary fiscal policy in a recession.
Keynesians reject real business cycle theories
(an idea that the government can have no influence over the economic cycle)

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 The economy is naturally stable.
Markets work well when left to themselves.
Government interference can weaken the economy
Fiscal Policy is often bad policy.
A small role for government is good.

 Monetarists stress the importance of
to keep inflation low
 Focus on MONETARY POLICY TOOLS which increase or decrease the supply of money and credit.


 IN THE SHORT RUN velocity is stable. This implies that in the short run, changes in the money supply are the dominant forces that change nominal GDP.

 MV=PQ)
IN THE LONG RUN the economy is at potential output, so changes in the money supply only lead to higher prices, not higher output


SHORT RUN?
LONG RUN?

SHOW THE DIFFENCE BY DRAWING THE AD/AS GRAPHS.

 Monetarists stress the role of the natural rate of unemployment (supply side unemployment)

MONETARISTS say … “REDUCE INFLATION”
Monetarists more likely to place emphasis on reducing inflation than keeping unemployment low

"Inflation is always and everywhere a monetary phenomenon."

REGULATOR?
POLICY ?
POLICY TOOLS?
AD?
AS?
GRAPH(S)
KEYNESIAN MONETARIST