They argue that the LM curve is downward sloping as opposed to the horizontal

They argue that the lm curve is downward sloping as

This preview shows page 3 - 4 out of 9 pages.

the idea of a liquidity trap. They argue that the LM curve is downward sloping as opposed to the horizontal LM curve proposed by the Keynesians. Consequently, changes in the level of output can only be affected through changes in the LM curve. This makes the monetary policy effective in bringing about changes in economic growth. Monetarists again support their argument of the effectiveness of monetary policy in impacting on economic growth using the equation of exchange proposed by Irvin Fisher. They do convert this equation of exchange into quantity of money theory, which is stated as follows: MV = PY … ………………………………………………………………………………… .... (1) Where M denotes the supply of money over which the South African Reserve Bank (SARB) has some control over, P denotes the price level, Y denotes the level of output and V denotes velocity of circulation. Monetarists assume that velocity is constant, and when V is constant equation (1) indicates a one-to-one relationship between changes in the stock of money and changes in the value of national income. As a result, equation (1) will be transformed into equation (2) below, where k represents a constant. M = kPY …………………………………………………………………………..…...…….. (2) According to equation (2) changes in output can only be brought through changes in money supply. Therefore the direct link between the monetary sector and the real sector of the economy comes from the argument of a constant velocity. This explains the basis for the monetarist’s argument that changes in monetary policy will impact economic growth. Nevertheless monetarists do also acknowledge that the economy may not always be operating at the full employment level of real GDP. Monetarists therefore believe that in the short-run, expansionary monetary policies may increase the level of real GDP by increasing aggregate demand. However, in the long-run when the economy is operating at the full employment level they consent that the classical quantity theory remains a good approximation of the link between the supply of money, the price level, and the real GDP. The Keynesians conversely holds that the link between the money stock and the level of national income is weak. Keynes detects a major error in the theory of assuming that changes in the quantity of money have a direct influence on the level of prices without affecting other variables (Cittadino et al, 2007). Although Keynesians admit that this might be true in the long run, they however state that what is experienced in reality is that variations in the quantity of money do bear upon the way people use money and banks, and on the employment of reserves by banks. Keynes rejects the notion that the economy is always at or near the natural level of real GDP so that Y (output) in the equation of exchange can be regarded as fixed. They also decline the assumption that velocity is constant as proposed by the classical. As a result, changes in the stock of money cannot lead to changes in output. As a result, the Keynesians argue that there is an indirect link between the money supply and real GDP.
Image of page 3
Image of page 4

You've reached the end of your free preview.

Want to read all 9 pages?

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Stuck? We have tutors online 24/7 who can help you get unstuck.
A+ icon
Ask Expert Tutors You can ask You can ask You can ask (will expire )
Answers in as fast as 15 minutes