Final Orthodox Monetarism

Question 1

Exogenous changes in the level of M cause

Answer 1

endogenous (equilibrating) changes in the price level

Question 2

The price level is proportional to the

Answer 2

nominal quantity of money, ceteris paribus

Question 3

Money is what in the long run?

Answer 3

Neutral

Question 4

Results of the neutrality of money in the long run

Answer 4

It cannot permanently change V or y
i.e. M only affects nominal variables in the long-run, not real variables

Question 5

Phillips Curve

Answer 5

Stipulates that there is a trade-off between inflation and unemployment

Negative relationship between inflation and unemployment.

Higher prices = higher nominal wages = labor market expansion, and vice versa.

Question 6

What problems did the Expectation Augmented Phillips Curve
solve?

Answer 6

The Expectation
Augmented Phillips Curve solved the problem of inflation and unemployment not being that
detrimental to the operations of the economy by increasing the potential effect of adaptive
expectations formed on the historical data has on shaping the economy and its fluctuations.

Question 7

Accelerationist Hypothesis

Answer 7

any attempt to main-
tain unemployment permanently below the natural rate would result in
accelerating inflation and require the authorities to increase continuously the
rate of monetary expansion

Question 8

Each time the monetary authority increases money growth (and thereofer inflation) to reduce unemployment via the SRPC, there is a brief period where

Answer 8

inflation is higher than expectations

Question 9

In order to continuously lower unemployment, money growth must

Answer 9

increase at larger and larger increments to “trick” the public, before their adaptive expectations adjust
LR result is very high inflation, with unemployment still on the LRPC.

Question 10

Costs of Monetary Contraction

Answer 10

Lower M means Lower P (unexpected), lower y and higher Un (natural rate of unemployment)

Question 11

orthodox monetarist approach the output–employment costs associated with monetary contraction depend upon three main factors

Answer 11

first, whether the authorities pursue a rapid or gradual reduction in the rate of monetary expansion

second, the extent of institutional adaptations – for example, whether or not wage contracts are indexed

third, the speed with which economic agents adjust their inflationary expectations downwards.

Question 12

Active policy

Answer 12

government responds to economic conditions by using a specific policy

Question 13

Passive policy

Answer 13

macroeconomic policy is conducted according to a preset series of rule

Question 14

automatic stabilizers

Answer 14

macroeconomic policy is conducted according to a preset series of rule

Question 15

Time Inconsistency

Answer 15

The tendency of policymakers to announce policies in advance to influence the expectations of private decision-makers and then to follow different policies after those expectations have been formed and acted upon

Question 16

Monetarist Objections to Discretionary Policy

Answer 16

Central bank policy moves are too often ill‑timed or ill-measured due to “long and variable lags“ from ΔM to Δ other variables

activist policy in practice pushes y farther away from y_n rather than closer

Periods of slow gM are periods of slow gY, so policy isn’t offsetting M^d shocks

Question 17

Monetarists believe changes in the money stock are the predominant, though not the only, factor explaining changes in

Answer 17

money income

Question 18

Monetarists believe the economy is

Answer 18

inherently stable unless disturbed by erratic monetary growth. When subjected to some disturbance, it will return fairly rapidly to the neighbourhood of long-run equilibrium at the natural rate of unemployment.

Question 19

Monetarists believe there is no trade-off between what, in the long run?

Answer 19

There is no trade-off between unemployment and inflation in the long run; that is, the long-run Phillips curve is vertical at the natural rate of unemployment.

Question 20

Monetarists believe in what are essentially monetary phenomena.

Answer 20

Inflation and the balance of payments are essentially monetary phenomena.`

Question 21

Monetarists believe in the conduct of economic policy the authorities should follow what?

Answer 21

some rule for monetary aggregates to ensure long-run price stability, with fiscal policy assigned to its traditional roles of influencing the distribu- tion of income and wealth, and the allocation of resources.

Question 22

The k% rule

Answer 22

Make some measure of the money stock grow at a constant rate (k%) per year.

Choose a value of k that is consistent with zero secular inflation

Tighten the Fed’s control over the monetary base (H) by eliminating gold redemption of the dollar (Nixon did this) and closing the discount window (no loans to banks)

Reduce variability in the money multiplier (M/H) by: 100% reserve requirements on all bank-issued components of the target M. Or, make reserve ratios uniform across all of M2 and fix the ratios permanently. Pay competitive interest on reserve deposits with the Fed to reduce the interest-sensitivity of reserve demand

Question 23

Problems with the k% rule

Answer 23

Velocity turned out not to be stable.

Real income differential

Question 24

Benefits of the k% rule

Answer 24

Simple rule: Easily monitored, Easily implemented, Easily understood

Low bureaucratic costs: Most central bankers could have been let go

Question 25

Friedman: Freeze the Monetary Base

Answer 25

Variant of the k% rule
M=H
k=0

Friedman grew fond of public choice considerations, and opted for a rule that reduces the chance that obstinate bankers could thwart it. CB bureaucracy could be sent home

Commercial banks would be allowed to issue currency. Free banking

Would allow for a mild price deflation
If gy outruns gV (since gM=0, gP= 0) due to innovations in the payments system.

Question 26

Monetarism and the Business Cycle

Answer 26

Changes in the money supply were a driver of business cycles

Not a symptom of, as many thought
They identified an absolute monetary contraction that occurred in 6 periods, each of which corresponded to recessions or depressions

Question 27

Key Idea of Monetarism and the Business Cycle and its meaning

Answer 27

Monetary disequilibrium

Specifically, if allowed to persist, an excess demand for money (and the accompanying deflation), can cause a recession.

Question 28

Costs of bank runs

Answer 28

1. Depositors lose deposits
2. Shareholders lose out
   2a. After the run, banks liquidate assets quickly to try and stay liquid.
   2b. Assets are sold at low prices to move them quickly. “Fire sale losses”.
3. To Borrowers
   3a. Interrupts bank-borrower relationship
4. For banking panics
   4a. Money supply contracts
   4b. Can cause recession in its own right