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A Keynes vs Monetarist view
 Looks at the role that
fiscal policy can play
in stabilizing the economy.
 Keynesian theory suggests that higher government
spending in a recession can help the economy
recover quicker.
 Keynesians say it is a mistake to wait for markets to
clear like classical economic theory suggests
In a recession, people
responded to the threat of
unemployment by

increasing saving
&
reducing spending
RECESSION
Government
intervention
STIMULATES AD and REAL GDP

What about
Policy Tools?
Which ones can be
used to stimulate AD
 Wages may be ‘sticky downward’/ inflexible’
 Workers do not accept nominal wage
cuts,
 Firms have to lay off workers
 This can lead to
involuntary unemployment.
 The economy slows down
In a recession,
an economy has spare capacity,
SO:
increasing AD will have an impact on
real output and only minimal effect on
the price level.
INCREASE SPENDING
(C
+ I + G + X – M).
 Keynesians believe
there is a multiplier effect
This means
 an initial injection (eg increased government spending)
into the circular flow can lead to a bigger final increase in
real GDP
“It is more important to
reduce unemployment
than inflation”
Keynesians support expansionary fiscal policy
in a recession.
Keynesians reject real
business cycle theories
(an idea that the government can have no influence
over the economic cycle)
WHAT
does this
mean???
The economy is naturally stable.
• Markets work well when left to themselves.
• Government interference can weaken the economy
• Fiscal Policy is often bad policy.
• A small role for government is good.
 Monetarists stress the importance of
controlling the money
supply to keep inflation low
 Focus on MONETARY POLICY TOOLS which
increase or decrease the supply of money and
credit.
MV=PQ
 IN THE SHORT RUN velocity is stable. This implies that in
the short run, changes in the money supply are the
dominant forces that change nominal GDP.
MV=PQ)
IN THE LONG RUN the economy is at potential
output, so changes in the money supply only
lead to higher prices, not higher output
SHORT RUN?
LONG RUN?


SHOW THE DIFFENCE BY DRAWING THE AD/AS GRAPHS.
Monetarists stress the role of the natural rate
of unemployment (supply side
unemployment)
say … “REDUCE INFLATION”
Monetarists more likely to
place emphasis on
reducing inflation than
keeping unemployment low
MONETARISTS
"Inflation is always and everywhere
a monetary phenomenon."
KEYNESIAN
REGULATOR?
POLICY ?
POLICY TOOLS?
AD?
AS?
GRAPH(S)
MONETARIST