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PART THREE: MACROECONOMIC THEORY AFTER KEYNES
CHAPTER 9: THE MONETARIST COUNTERREVOLUTION
Additional Questions
Essay Questions and/or Problems:
1. What do Keynesians believe caused the Great Depression?
2. Compare and contrast the monetarist and Keynesian views to the inherent
stability/instability of the economy. How do these views inform their opinions about the use
of discretionary policy?
3. Compare and contrast the Monetarist theory of money demand curve with the Keynesian
theory of money demand. Specifically, make sure to talk about how each model views the
behavior of velocity over the business cycle.
4. Compare and contrast the long-run and short-run effects of a permanent increase in the rate
of money growth in the Monetarist model.
5. If interest rates rise, what happens to the price of bonds on the secondary market? How
does this fact affect the demand for money and velocity in the Monetarist and Keynesian
models?
6. Milton Friedman and others view the instability of velocity in the 1980s as the result of a
number of one-time events during that decade. What were these events?
7. In the Monetarist model, how long is the long-run? How does the transition between the
long run and the short run take place?
8. During the Great Depression, the money supply fell by more than 25%. Explain this fact
and the role it played in the Great Depression from the Monetarist and Keynesian
perspectives.
.
9. What do Monetarists believe about the slope of the IS and LM curves and why? What do
these beliefs imply about the effectiveness of monetary policy.
10. What do Keynesians believe about the slope of the money demand curve and why? What
do these beliefs imply about the effectiveness of monetary policy.
94 CHAPTER 9
Additional Essay Questions and/or Problems:
11. Show how the IS and LM schedules look according to the monetarist theory. For this
monetarist case, illustrate the effects of
(a). an fall in taxes;
(b). a fall in autonomous investment demand; and
c. an increase in the money stock.
12. How does the classical aggregate demand curve differ from the Monetarist aggregate
demand curve? Illustrate this using the monetarist special case for the IS and LM schedules.
Using the classical and Monetarist models, discuss how the aggregate demand curve shifts
with an increase in the money stock and with an increase in government spending.
13. On what theoretical grounds did early Keynesian economists base their belief that monetary
policy would be ineffective in curing a depression or serious recession?
14. Suppose that there is an autonomous decrease in investment. Evaluate the effects of this
shock within the monetarist model. Consider the effects on output and the interest rate.
Explain the economic processes at work. Compare and contrast these results with the
Keynesian IS-LM model.
15. Assume that the LM curve in an economy is given by Y = 1000r – 500 + 2Ms, and the IS
curve is given by Y = 4000 – 1000r + u, where u is a shock that is equal to +100 half the
time and -100 half the time. Government policymakers want to keep output as close as
possible to 3250.
(a). If policymakers set Ms = 1000 and keep it there, what will Y be as u changes?
(b). If policymakers set the interest rate equal to 2 and keep it there, what will Y be as u
changes?
(c). Which rule works better? What does this example have to do with the arguments of the
Monetarists.
16. Explain the Monetarist’s perspective on the Keynesian liquidity trap. Is is an important
factor in determining the effectiveness of monetary policy according to Monetarists?
17. One way to think about Monetarism is that it is a theory that argues that monetary policy is
very powerful, and as a result should never be used. Explain.
18. Consider a financial crisis, such as occurred in the US during 2008, when housing prices,
stock prices, and other asset prices declined dramatically. Compare and contrast the impact
would this have on the money market in the Monetarist and Keynesian models. Explain.
THE MONETARIST COUNTERREVOLUTION 95
Multiple-Choice Questions:
1. Which of the following statements is(are) correct
2. Keynesians argue that the interest elasticity of the demand for money is
3. The classical and Monetarist models agree that
4. The monetarists would expect a tax cut to have a strong effect on output only if the
spending increase was
5. One important difference between early and later Keynesians is that
6. The monetarists emphasize the
7. Which of the following is not a possible source of instability in velocity in the Monetarist
model?
8. Friedman’s theory of money demand differs from Keynes’ in that
9. The difference between the monetarist and Keynesian views on discretionary monetary
policy is that the monetarists
10. In the modern Keynesian model, velocity
11. According to the monetarist theory, an increase in government spending would have
12. In the Monetarist model, the long-run holds when
13. In the monetarist model, an autonomous increase in investment demand would have
14. Keynesians believe that the interest elasticity of money demand
15. Keynes and many of his contemporaries believed that money was
16. If interest rates rise, then velocity should ____ in the Keynesian model and _____ in the
Monetarist model.
17. The experience of the United States and other industrialized countries in the 1930s
contradicts the classical view of the labor market where the money wage adjusts quickly to
maintain full employment. On this issue
18. In the classical and monetarist aggregate demand curves:
19. According to Keynes, the money demand function
20. How can the Cambridge equation be restated according to Friedman’s money demand
21. Since the 1980s,
22. According to the monetarist view, the
23. Monetarists emphasize
24. If the Fed followed through on plans to be more open to and more quickly provide the
public with information about monetary policy, then we would expect to see
25. Monetarists believe that changes in the money stock
26. Monetarists assume that people form their expectations only by
27. Friedman and others view changes in velocity as the result of changes in
28. In the Monetarist model,
29. One thing that Keynesians and Monetarists agree about is
30. Early Keynesians concluded that the quantity of money was not important because they
assumed
31. If the central bank targets interest rates, then the LM curve is
32. According to monetarists,
33. Which of the following is correct? Whenever the monetary authority pegs the interest rate,
34. The Monetarist model differs from the classical model in that
35. According to the second monetarist proposition, which of the following factors do not
determine the level of real output in the long run?
36. Both the classical and monetarist models assume all of the following except
37. According to the Monetarists, the real effect of monetary policy on output is
38. Monetarists believe in all of the following except
39. Targeting money growth will lead to stable output growth only if
40. According to the monetarists, the ratio of nominal GDP to the money stock should be
41. The monetarist explanations of the Great Depression focus on
42. If the central bank targets a rate of nominal GDP growth, then it would have to _____
money growth when nominal GDP fell below its target in order to _____ inflation and ____
real GDP.
43. A liquidity trap is
44. According to the early Keynesians,
45. In the monetarist model, an increase in both government spending and taxes would
46. The monetarists believe that the LM schedule
47. The third monetarist proposition asserts that in the short run,
48. In the Keynesian model, and expected increase in the interest rate
49. The Keynesians believe that
50. _____ believe that the primary causes of the Depression were autonomous declines in
aggregate demand initiated by shocks to the IS curve
51. According to the monetarists, the rise in (M1) velocity in the mid-1990s can be attributed to
52. Monetarists argue that the interest elasticity of the demand for money is
53. A monetarists would expect an increase in government spending to have a strong effect on
output only if the spending increase was
54. Monetarist and Keynesian theories of money demand differs in that
55. Keynesians view changes in velocity as the result of changes in