Transcript The Keynesian/Monetarist Debates

NS3040
Fall Term 2014
Keynesian/Monetarist Debates
Keynes-Monetarist I
Keynesian vs. Monetarist Doctrine: Policy Issues
• Many areas of disagreement between the two schools.
• The chapter draws on rather extreme positions of each school to
sharpen their differences.
• In actuality the differences between the two schools are often not
as extreme as painted here.
• The main areas of disagreement:
• Rules vs. Discretion – what should guide policy makers?
• Monetary vs. Fiscal Policy – which is stronger in managing the
economy?
• Monetary aggregates vs. money market conditions as a policy
guide
• Fixed vs. flexible exchange rates – which are better?
• Trade-off vs. no trade-off – disagreement over constraints on
policymaking
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Keynes-Monetarist II
Rules vs. Discretion.
• Should policy makers by confided by a set policy rule, or
should they have the flexibility to respond to economic
problems as they develop?
• Debate centers around the timing of policy impacts.
• Keynesians contend that their models are such that they
can offset expected ups and downs in the economy.
• Monetarists contend that the record shows discretionary
policy has been destabilizing more than stabilizing.
• Issue centers around a series of policy lags – the lag
between the time a problem develops and the final impact
of the policy action.
• Keynesians contend lags are fairly predictable
• Monetarist – lags are long and variable making their
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pattern impossible to systematically counter.
Keynes-Monetarist III
Rules vs. discretion (contd.)
• The monetarist problem is finding the best rule to follow.
• Originally it was the money supply defined as M1 (currency and
coin and demand deposits) – what people use to settle
transactions
• That rule broke down with financial deregulation and the
proliferation of financial instruments
• Now use the Taylor Rule – basically controlling short term
interest rates to hit inflation targets.
• Might work, but Federal Reserve has taken on employment as
one of its targets, so can not follow rule.
• Rule difficult to apply because in a crisis situation everyone
expects a strong (discretionary) response.
• -- can’t just say our hands are tied because we have this rule
that is very technical and hard to explain to the voters.
• Of course things may change so that the Taylor Rule needs to 4
be modified – then have no rule
Keynes-Monetarist IV
• Fiscal vs Monetary Policy – depends on shapes of LM
and IS curves
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Keynes-Monetarist V
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Keynes-Monetarist VI
• Monetary Aggregates vs. Money Market Conditions as a
policy guide
• What should the authorities by focused on – the money
supply or interest rates?
• Depends on which has more stable links to real income.
• Specifically would targeting the money supply give more
predictable results or would targeting interest rates?
• Depends on the relative stability of the Keynesian vs
Monetary multipliers
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Keynes-Monetarist VII
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Keynes-Monetarist VIII
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Keynes-Monetarist IX
• Fixed vs. Flexible Exchange Rates
• Positions between the two schools not as sharp
• In general monetarists like markets so prefer flexible
exchange rates
• Keynesians skeptical of market efficiency so usually opt
for fixed rates.
• Currently, however some countries can clearly be
managed better with fixed exchange rates – fiscal policy
strong, financial markets underdeveloped – China
• In other cases good financial markets and dysfunctional
fiscal policy – U.S. -- better to go with monetary policy
and flexible exchange rates
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Keynes-Monetarist X
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Rational Expectations
Spin-off from the monetarist school
Argument centers on rational behavior and information.
Rational expectations economists feel any government
policy will ultimately come at a cost
Rational people know this and will take action to avoid
the cost – or at least prepare themselves for the time
when it hits
Examples – monetary expansion – should lower interest
rates and stimulate investment
Rational expectations suggest people anticipate the
inflationary effects of money supply increases and
actually raise interest rates to avoid negative rates of
return.
Easy to see following the S&L crisis in the late 1970s. 11
Keynes-Monetarist XI
• Ricardian (yes, same fellow) equivalence.
• Government has a fiscal stimulus financed by debt to
increase economic activity
• Rational people know sooner or later their tax bill will go
up to pay for the deficit – cut consumption so the fiscal
stimulus is neutralized.
• Rational expectations economists claim the government
policy can’t affect the economy because rational people
can’t be fooled and will protect themselves
• Often produce detailed statistical studies supporting
their case – especially for Ricardian equivalence which
seems a little too rational
• Keynesians contend there are still enough stupid people
out there so monetary/fiscal policies are effective
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Keynes-Monetarist XI
• Trade-off, no trade-off
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Keynes-Monetarist XII
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Problem of short vs. long run
Monetarists assume economy is fairly competitive
Keynesians look more at market rigidities
In the short run a fiscal stimulus might reduce
unemployment – if there is a wage lag behind prices
Employment could increase because the real wage is
suppressed.
In the longer term however workers want a cost of living
increase to compensate for the price inflation
Real wage back to starting point and so is unemployment
Trade-off is a short-run illusion
Monetarists – can not reduce unemployment at going
wages unless increase productivity of workers.
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