ECON 1113 1st Edition Lecture 24 Outline of Last Lecture I The Government Budget Deficit continued A The Short Run Effects B The Long Run Effects Outline of Current Lecture I Keynesians vs Monetarists A Views about the Causes of Economic Fluctuations B Technical Differences C An Illustration D Policy Implications E Views about Velocity Current Lecture I Keynesians vs Monetarists A Views about the Causes of Economic Fluctuations 1 Keynesian a Believe the economy is inherently unstable and subject to various shocks b Thus advocate the use of active economic policies especially fiscal policies 2 Monetarists a Believe the economy is inherently stable and much of the observed instability is due to inappropriate economic policies b Thus advocate passive or rules based policies B Technical Differences 1 Keynesian a Believe money demand is interest elastic b Emphasize the precautionary and speculative motives c Believe investment spending is interest inelastic d Believe velocity is unstable and moves opposite to changes in the money supply 2 Monetarists a Believe money demand is interest inelastic b Emphasize the transactions motive c Believe investment spending is interest elastic These notes represent a detailed interpretation of the professor s lecture GradeBuddy is best used as a supplement to your own notes not as a substitute d Believe velocity is very stable and analytically can be treated as a constant C An Illustration 1 Keynesian Diagrams a Money Market i Vertical money supply curve 100 ii Flat money demand curve iii If the money supply doubles the interest rate will go down slightly b Investment Market i Steep MEI curve ii If money supply doubles the lower interest rate in correlation with a steep MEI will increase investment spending slightly c Domestic Product or Income i The initial Y equilibrium value equals 400 ii The small increase in I will raise the PTE by the change in I equivalently iii In this example the multiplier is 5 and delta I equals 10 such that PTE increases by 50 iv The new Y value becomes 450 2 Monetarist Diagrams a Money Market i Vertical money supply curve 100 ii Steep money demand curve iii If the money supply doubles the interest rate will go down significantly b Investment Market i Flat MEI curve ii If money supply doubles the lower interest rate in correlation with a flat MEI will increase investment spending significantly c Domestic Product or Income i The initial Y equilibrium value equals 400 ii The large increase in I will raise the PTE by the change in I equivalently iii In this example the multiplier is 5 and delta I equals 60 such that PTE increases by 300 iv The new Y value becomes 700 v D Policy Implications 1 Suppose the Fed doubles the money supply from 100 to 200 II 2 Keynesian a Conclude monetary policy changes in money supply do not have large effects on Y b Hence fiscal policies changes in G and T should be used to change Y 3 Monetarist a Conclude monetary policy changes in money supply have quite powerful effect on Y so much so that they usually result in inflation b Hence the Fed should use monetary policy primarily to control inflation E Views about Velocity 1 At a point in time MSV PQ Y 2 Both views MS0V0 Y0 a Assume the money supply is originally 100 such that nominal GDP is 400 causing velocity to equal 4 from the above example b Then suppose money supply doubles as it does about to 200 c Keynesian i If money supply now equals 200 and the new nominal GDP equals 450 then velocity must equal 2 25 ii The Keynesian change in velocity is great then 1 75 iii This explains beliefs that increasing the money supply will decrease velocity significantly exemplifying an unstable nature of velocity d Monetarist i If money supply now equals 200 and the new nominal GDP equals 700 then velocity must equal 3 5 ii The Monetarist change in velocity is small then 0 5 iii This explains beliefs that increasing money supply will decrease velocity minimally exemplifying a stable nature of velocity You are here to enrich the world and you impoverish yourself if you forget the errand Woodrow Wilson