ECON 0280 Lecture Notes 10 Part 2

ECON 0280 Lecture Notes 10 Part 2 - Monetarism Monetarism...

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Monetarism Monetarism was developed by Milton Friedman as a response to Keynesian theorythe and became popular due to the inflation problems of the 1970s; it includes some Keynesian and some classical ideas. Friedman adopted the basic Keynesian system, such as the idea of short-run rigidities, the upward sloping short run AS and thus the fact that monetary policy could affect output in the short run. However, he argued that Keynesians had misinterpreted data from the Great Depression and thus the Keynesian theory of changes in AD (and thus business cycles) was inaccurate. Friedman revived the quantity theory by finding a counter-criticism to Keynes’ rejection of it. Recall the equation of exchange: MV=PY. He argued that velocity was indeed inherently stable. His argument was based on the idea that the central bank controls the money supply; during the 1930s the central bank “allowed” the money supply to fall due to bad policy; it was this fall in M that caused the fall in V in the 1930s, not inherent instability of V. He concluded that a change in the money supply will indeed cause a predictable change in nominal income PY, and thus volatile M thus is the source of all business cycles. He generally agreed with Keynesians on the use of adaptive expectations and thus the short run AS was upward sloping. Therefore, in the short run money is not neutral since an increase in the money supply will shift AD to the right and cause both P and Y to change, while in the long run AS will shift and the economy will return to the natural rate of output. Therefore, his revision of the quantity theory simply indicates that in the short run changes in money can indeed affect output; in the long run changes in money will affect prices but not output, as the classical model said. His major disagreement with Keynesians was on the factors that shift AD. Keynes had argued that volatile investment was the dominant cause of AD fluctuations, which needed to be corrected through discretionary policy. He argued that the reason for volatile investment in the Great Depression was not due to “herd mentality,” it was actually due to poorly conducted monetary policy. He presented evidence that the Fed had been overly contractionary during the depression;
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ECON 0280 Lecture Notes 10 Part 2 - Monetarism Monetarism...

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