A Comparison of Keynesian, Austrian, and Monetarist theories on Inflation and the Business Cycle Elizabeth Dalzen University of Wisconsin— Superior
Transcript
Slide 1
Elizabeth Dalzen University of WisconsinSuperior
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Keynesian Theories Money Illusion/Animal spirits Keynes on Says
Law Liquidity Trap Non-keynesian Austrian economics Austrian
Business Cycle Theory Classical Classical vs. Keynes Monetarism
Quantity Theory of Money Inflation and Side Effects Government
Spending
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People think in nominal terms, not real terms Deflation price
level, nominal wages, real wages price level, nominal wages, real
wages surplus Involuntary unemployment Animal spirits: A
spontaneous urge to action rather than inaction* Decisions are made
in the short-run, In the long run, we are all dead.** Confidence
*Keynes, The General Theory of Employment, Interest, and Money
**Keynes, A Tract on Monetary Reform
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Says Law: People produce in order to consume No general gluts
What if suppliers dont spend? Hoarding (saving without investing)
AD unemployment AD Recession
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As the interest rate approaches zero, stronger liquidity
preference Individuals dont save (invest), banks dont lend Flat LM
curve Impotent monetary policy Confidence
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If Money illusion Glut of unemployment Low interest rates
Deflation Low consumer and business confidence Hoarding/Liquidity
Trap Dearth of investment Then Increase national income by shifting
IS curve, increasing AD Govt. should spend, spend, SPEND!
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Expansion of credit by banks A central bank is necessary for
banks to expand credit if banks were truly competitive, any
expansion of credit by one bank would quickly pile up the debts of
that bank in its competitors, and its competitors would quickly
call upon the expanding bank for redemption in cash* *Rothbard,
Economic Depressions: Their Cause and Cure
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Credit expansion Inflationary Boom Domestic prices bid up
imports Gold flows out of the country as payment for imports As
banks gold stores dwindle, panic! Fractional reserve banking Banks
call in loans, Money supply (deflation) Economy contracts Balance
of payments reverses
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Interest rate artificially depressed Malinvestment Low i rate
is only temporary Overinvestment in capital goods Not enough
savings to buy all producers goods Capital is heterogeneous
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Gold Standard Money supply shouldnt increase, even if the
population or supply of goods increases Deflation problems
Government sanctioned M counterfeiting
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Smallest decision making unit: the individual Homo economicus
Rational Self-interested Utility maximizing Assume perfect
information
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Money illusion/stickiness Example: Deflation Workers resist
nominal wages Businesses have 2 options: Raise prices cost-push
inflation Lay off wokers Workers seek new jobs Businesses offer
wages that reflect workers real worth (if no minimum wage laws,
labor unions, etc.) Stickiness due to: Time lags with change in
price level Contract length Labor unions
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Misrepresentation of Says Law Say never said that depressions
and unemployment are impossible Says Law: supply creates its own
demand, so no general gluts requires flexible, self-correcting
markets A temporary glut in the labor market is not a general glut
Hoarding: why?
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Keynesian economic man: Ruled by animal spirits Doesnt make
decisions for the long-run Incapable of thinking in real terms But
somehow responds rationally to lower interest rates by investing
less of his money?
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Also has roots in classical economics Disagree with both
Keynesians and Austrians on inflation and the business cycle Milton
Friedman
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Quantity theory of money: M*V=P*Q M=quantity of money in
circulation V=velocity of money P=price level Q=index of the real
value of final expenditures Keynes: V is inherently unstable M, V
move in opposite directions Friedman: M, V move in the same
direction
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Inflation is always a monetary phenomenon M and P are not
independent M P Since M*V=P*Q, we have M+V=P+Q Assume velocity is
stable (V=0) P=0 if and only if M=Q To avoid inflation, the growth
rate of the money supply should be set equal to the growth rate of
output
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Monetarists want monetary policy that creates a stable
framework Reducing inflation is not technically difficult, but
there are political barriers Possible side effects of reducing
inflation: Recession Unemployment
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In a liquidity trap: Even if the Fed increases M, banks
hesitate to lend (low interest rates) Bypass the banks, give money
directly to consumers Aggregate Demand boosted without increasing
government spending
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Where does the money come from? Increased tax revenue Borrowing
from the private sector Government spends money that otherwise
would have been spent in the private sector Printing money Implicit
tax on holders of dollar denominated assets No legislation
involved
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Keynesian Theories Money Illusion/Animal spirits Keynes on Says
Law Liquidity Trap Non-keynesian Austrian economics Austrian
Business Cycle Theory Classical Classical vs. Keynes Monetarism
Quantity Theory of Money Inflation and Side Effects Government
Spending
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