Card Set Information
Equation of Exchange
M^s x V= P x Y
M^s- money supply
V- velocity of money
P- price level
Assumptions of Classical Model (QT)
1. V is constant (spending habits of households are stable)
2. People demand money for transaction purpose.
3. Y is at Y*P (self adjusting economy)
The Monetarist Transmission Mechanism
M^s to Transactions to AD to Prices - everything
Restrictive monetary policy to limit inflationary effects
Keynesian Liquidity Preference Theory of Money
Demand for money-
Following the monetarist keynesians saw a transaction demand for money
Keynesian Speculative Demand
Money is viewed as an asset (or alternative form of wealth)
Other assets we will call bonds
Viewing money as an asset- if we had money we incur an opportunity cost which is the rate of return on bonds.
4 Determinants of Demand for Money
1. Changes in the price level- if prices level increases than MD will increase. VV
2. Changes in GDP- if GDP increases then MD will increase. VV
3. Changes in technology- the atm reduces MD beause they reduce our demand for cash.
4. Changes in institutions- when regulation Q was eliminated in 1980- interest rates were then paid on demand deposites
Fed increases Ms
People have surplus money
They use that money to purchase bonds
As the purchase bonds- the price of bonds rise
As the price of bonds increase, rules of return on bonds fall.
Economy is self adjusting.
Says law- supply creates its own demand.
Policy minimum government intervention.
Economy not self adjusting.
AD can be deficient
Government should intervene to stimulate AD
Reformulate the Q theory of money.
He incorporated the speculative demand for money into the model.
Argued speculative demand is not as important as transactions demand.
Central bank should follow a policy rule.
Look at equation.
Natural Rate or Fooling Model
1. Workers mispercieve movements in the price level.
2. The economy is at capacity (y=y*p; unemployment = natural rate.)
3. The policy makers do not recognize the natural rate of unemployment.
Rational Expectations Model- Robert Lucas
Both workers and employers can misprecieve movements in the price levels.
Both workers and employers would work to develope rational expectations where they accurately predict movements in the price level.
Workers and employers are rational actors so they will continually seek information to accurately predict prices.
Real Business Cycle
Finn K. and Edward Prescott
The business represents fluctuation in the potential GDP.
To this point we have argued the business cycle is denotations in actual from potential GDP.
Policy- nothing can be done on the demand side to stabalize the economy. Monetary and fiscal policy are ineffective.
New Keynesian Economics
Do sticky prices gum up the economy.
DEveloped hypothesis exploring why prices in the economy are rigid.
Menu costs, explicit and implicit contracts.
See SRAS as being stable. So if there is a shock that reduces AD. The economy can become stuck below full employment. GRAPH