Question

How are Monetarists different from Keynesian perspective? Provide examples of two policies each that will be undertaken by Monetarists and by Keynesian supporters and their reasoning as to why their respective policies are better than the other

Answer 1

The main difference between the Monetarists and the Keynesian perspectives are:

Role of money: Monetarists believe that money supply has a dominant influence on income, while Keynesians defy any great influence of money supply on income. It can be understand by the cambridge equation:

M=kPY, where M is money stock, k is the proportion of income held as money, PY is nominal GDP of the economy. Monetarist believe k to be stable, so that any change in M leads to a change in PY. Now, some of the change would be reflected in P and some in Y. So, Y (real GDP) moves in the short run. Of course, Monetraist say that in the long run, only P would change and Y will remain stable.

Keynesians, on the other hand, believe that k is not stable, i.e. the money people hold is a function of interest rate. As a result, any change in M can be diffused between k,P and Y, and hence there can be no significant effect on Y.

These arguments are represented in the way Monetarists and Keynesians decides on slopes of IS and LM curves. According to Monetarists, LM curve is relatively steeper that the IS curve, whereas for Keynesians, IS curve is relatively steeper than LM curve.

Government vs Private sector: Keynesians argue that reason of business cycle is mainly private sector. Monetarist believe that it is government sector which is unstable.

Money demand: Keynesians devide money demand into main 2 categories: transaction purposes and speculative purposes. These purposes make the money demand unstable. But monetarists do not categorise money demand as such. According to them, money demand is a function of prices, income, rate of return on consumer goods and bonds, which makes money demand stable

Policy aims: Due to above reasons, the ways to maintain stability is suggested differently by both schools. Keynesians advocate to maintain low rates so as to induce private invstments as it is more effective. Monetarists advocate maintaining money stock (stable and low inflation).

Policy examples of Monetarists: Trying to stimulate economy through monetary policies, in an event of recession, it might advocate increasing money supply. It would stimlate poeple to demand more, factories will produce more, and economy will be back on track.

Some tools that monetarists use are: interest rates, money supply, reserve requirements etc. This might be better than Keynesians policy of government interventions because it saves economy from large fiscal deficits. It also does not lead to unnecessary government intervention, which increases inefficiency.

Policy examples of Keynesian: They advocate that fiscal policy is better at stabilising economy. Direct benefit transfers, providing people with state-sponsored jobs and lower interest rates are some policies that they prefer to undertake. They might be effective than Monetarists propositions when financial institutions in an economy are weak. Frequent changes in money supply can also cause instability and uncertainty.