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Monetarists say: “It ain’t broke, so don’t fix it.”

Monetarists say: “It ain’t broke, so don’t fix it.”. Monetarism.  Monetarism is a main theoretical and policy alternative to Keynesian macro economics. The principal elements and tenets of monetarism are summarized as follows:

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Monetarists say: “It ain’t broke, so don’t fix it.”

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  1. Monetarists say: “It ain’t broke, so don’t fix it.” Monetarism  Monetarism is a main theoretical and policy alternative to Keynesian macro economics. The principal elements and tenets of monetarism are summarized as follows: • Monetarism is a modern, upgraded version of the Classical system (or the Full-Employment model). • The economic system naturally tends to full-employment of resources--there is no systemic insufficiency of aggregate demand as claimed by Keynes and his followers. • Fluctuations of real GDP and employment can be explained by: (a) the failure of money wages and prices to quickly adjust to changing market conditions; and/or (b) erratic or unforeseen changes in the money supply (MS).

  2. The equation of exchange •  Monetarism begins with the equation of exchange: • MV  PY [1] • where: • M is the nominal money supply; • V is the income velocity of money, that is, the average number of times per year a unit of the money supply circulates in exchange for newly-produced goods and services; • P is a price index measuring the average prices of goods and services that make up GDP; and • Y is real output (or GDP) measured in units.

  3. Notes on the equation of exchange  MV = spending for newly-produced goods and services in a year.  PY = the market value of of new goods and services produced in a year, or nominal GDP (also equal to nominal income). The equation of exchange is an identity. That is, it is true by definition

  4. Monetarist "spin" on the equation of exchange  M is autonomous--that is, determined by the FED.  The evidence shows that V fluctuates in a narrow range (or at least this is what the monetarists claim) so that if we treat V as a constant, we are not far from the truth.  Y is determined by the equilibrium in the labor market in conjunction with the short-run aggregate production function. That is, Y= Yf. Thus we can write: MV = PYf [2] • Hence: • Money is neutral • “Inflation is always and everywhere a monetary phenomenon.”

  5. Money is neutral The increase inthe money supply stimulates AD—but real GDP and employment are unaffected Long run aggregate supply (LRAS) Price level 2 1 AD2 AD1 0 Yf Real GDP

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