ch18 Alternative Views in Macroeconomics.pptVIP

Prepared by: Fernando Quijano Shelly Tefft;;In one sense, Keynesian economics is the foundation of all of macroeconomics. Now used more narrowly, Keynesian sometimes refers to economists who advocate active government intervention in the macroeconomy. We begin with an old debate—that between Keynesians and monetarists.;The debate between monetarist and Keynesian economics is complicated because it means different things to different people. If we consider the main monetarist message to be that “money matters,” then almost all economists would agree. Monetarism, however, is usually considered to go beyond the notion that money matters.;velocity of money The number of times a dollar bill changes hands, on average, during a year; the ratio of nominal GDP to the stock of money. ;We can expand this definition slightly by noting that nominal income (GDP) is equal to real output (income) (Y) times the overall price level (P):;The key assumption of the quantity theory of money is that the velocity of money is constant (or virtually constant) over time. If we let V denote the constant value of V, the equation for the quantity theory can be written as follows:;Velocity has not been constant over the period from 1960 to 2010. There is a long-term trend—velocity has been rising. There are also fluctuations, some of them quite large.;In the “strict monetarist” view, changes in M affect only P and not Y, so inflation (an increase in P) is always a purely monetary phenomenon. The price level will not change if the money supply does not change. There is considerable disagreement as to whether the strict monetarist view is a good approximation of reality. Almost all economists agree, however, that sustained inflation—inflation that continues over many periods—is a purely monetary phenomenon. Inflation cannot continue indefinitely without increases in the money supply.;Monetarists were skeptical of the Fed’s ability to “manage” the economy—to expand the money supply during bad t