Transcript Quantity Theory of Money.

Monetarism
Keynesianism is to Keynes
as Monetarism is to
A. Alan Greenspan.
B. Paul O’Neill.
C. Claude Monet.
D. Milton Friedman.
Derrick Jeter earns a lot
of money.
Steve Forbes has a lot of
money.
It’s better to buy a house
when money is cheap.
I need to cash a check to
get some money.
Money facilitates the
exchange of goods and
services.
Derrick Jeter earns a lot
of money.
Steve Forbes has a lot of
money.
CASH
It’s better to buy a house
when money is cheap.
CREDIT
I need to cash a check to
get some money.
INCOME
Money facilitates the
exchange of goods and
services.
MONEY
WEALTH
MV = PQ
V is the velocity of money.
P is the price level.
Q is the economy’s output.
PQ is total expenditures (E).
MV = PQ
M is the money supply.
M1 = $ 1,181.81 billion
M2 = $ 5,464.94 billion
MZM = $ 5,677.96 billion
MV = PQ
This is the “Equation of Exchange.”
The equation of exchange is so near and
dear to Milton Friedman’s heart that he
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The equation of exchange is so near and
dear to Milton Friedman’s heart that he
A. tasteful appearance on his head stone.
B. spelled out in pansies in flower garden.
C. parody to the popular Y.M.C.A.
D. vanity license plate number.
MV = PQ
M1 = $ 1,181.81 billion
US Population = 286,528,728
Per capita M1 = $4,124.57
Per family of four: $16,298.28
E = PQ
E = PQ = Y
E is total expenditures (PQ)
Y is total income
Y = $ 10,221.60 billion
MV = Y
M1 = $ 1,181.81 billion
Y = $ 10,221.60 billion
V = Y/M = 8.64
MV = PQ
In normal times:
V doesn’t change much.
Q changes in the low single digits.
MV = PQ
So, what happens when M is
doubled—say, from $ 1,181.81
billion to $ 2,363.62 billion?
P would also double.
But the doubling of P takes time.
Milton Friedman (1912-
• MV = PQ
• Inflation is
always and
everywhere
a monetary
phenomenon!!!
Sidewalk Survey on Dexter Avenue:
“What’s the cause of inflation?”
Greed.
Oil companies.
Medical industry.
Home-building industry.
Labor unions.
The Jane Fonda bull-by-the-horn
approach to ending inflation.
Identify major groups of products
whose prices have risen the most:
energy, medical, housing, food.
Enact pricing policies that hold the
prices in these areas down and
thereby counter the inflationary
pressures.
What about the major groups of
products whose prices have fallen
the most:
computers, cameras, electronics.
Is the economic activity in these
areas creating deflationary
pressures?
MV = PQ
CPI = avg.(p1, p2, p3, p4, p5, … pn)
The P in the equation of exchange
is measured by the CPI (or the
WPI or GPI), which is a price
index. The index tracks the
average of all prices.
?
CPI = avg.(p1, p2, p3, p4, poil, … pn)
Good arithmetic; bad economics.
MV = PQ
CPI = avg.(p1, p2, p3, p4, poil, … pn)
Many
Some other prices go down.
up, too.
--the
(firewood).
--theprice
priceofofsubstitutes
complements
(RV’s)
--the
and services
for which
--theprice
priceofofgoods
so-called
“normal”
oil
in
a
substantial
input
(airfares).
goods generally (restaurant meals).
10. Suppose that unrest in the Middle East causes a
reduction in the supply of oil flowing to the U.S.,
which leads to a 20% increase in the price of oil.
Economists who accept the quantity theory of money
will claim that
A. prices in general will rise because everything
depends upon (is related to) oil.
B. the Federal Reserve should increase the money
supply so that people can pay the higher gas prices.
C. whatever the Federal Reserve does, there will be
substantial inflation–although not a 20% inflation rate.
D. there will be no inflation in the U.S. so long as the
Federal Reserve does not increase the money supply.
31. Suppose that new taxes on tobacco products
cause the tax-included price of cigarettes to
double. Microeconomists would predict that the
quantity of tobacco products bought will fall only
slightly and that total spending on cigarettes will
more-than-double. Monetarists would claim that
the tax will
A. result in a slightly higher rate of inflation.
B. cause the Federal Reserve to undertake
compensatory policy actions.
C. have no effect on the general price level.
D. result in a slightly higher velocity of money.
Milton Friedman (1912-
)
• MV = PQ
• Inflation is
always and
everywhere
a monetary
phenomenon!!!
Keynesianism
vs
Monetarism
Monetarism
MV = PQ
Monetarism
MV = PQ
18-30 months
In the long run, increases in M
affect nothing but P (and W).
Monetarism
MV = PQ
18-30 months
This is the Quantity Theory of Money.
Monetarism
MV = PQ
Policy recommendation: Increase M
at a slow, steady rate (2 or 3%) to
match the long-run rate of growth.
Monetarism
MV = PQ
With this “Monetarist Rule” in effect
(2 or 3%) and a constanct V, the
rate of inflation would be zero.
Keynesianism
MV = PQ
Keynesianism
MV = P(QC+QI)
Prices are “sticky downward.”
Investment suffers from a waning of “animal spirits.”
Consumption falls as the economy spirals downward.
Keynesianism
MV = P(QC+QI)
People begin to hoard money (“V” falls)
and may even become “fetishistic” in
their money-hoarding propensities.
Keynesianism
MV = P(QC+QI +QG)
The government should increase the
money supply enough to offset people’s
“fetishistic” propensities and….
Keynesianism
MV = P(QC+QI +QG)
…to finance the fiscal policy (such as an
increase in government spending)
required to drive the economy back to its
full-employment level of income.
Milton Friedman (1912-
)
• MV = PQ
• Inflation is
always and
everywhere
a monetary
phenomenon!!!