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Macroeconomics Monetary policy is the matter of a controversy between two schools of economics, monetarist and Keynesian. Although Monetarists and Keynesian's agree on goals, at some points, they disagree over the effectiveness of monetary and fiscal policies that affect real output. In this paper, I will discuss the key theoretical assumptions that creates this difference. Monetarists and Keynesian's disagree on priorities, strategies, and targets. These issues we will discuss. Monetarists or Keynesian's share common goals: First, business does not cycle.
As production is measured by real gross national product, it has to grow steadily, together with the capacity of the economy and its labor force. Second, a stable and low rate of price inflation has to be close to zero. Third, the highest rates of capacity utilization and employment have to be consistent with a stable trend of prices. Fourth, there must be high trend growth of productivity and real GNP per worker. Monetary policies are demand-side macroeconomic policies.
Their work is to encourage or discourage spending on goods and services. Economy-wide recessions and booms does not reflect fluctuations in the economy's productive capacity. Economic recessions and picks are the result of fluctuations in aggregate demand. Monetary policy tries get rid of such fluctuations. It is not a supply-side instrument. Central banks have no handle on productivity and real economic growth. (Greider, 1994).
One of the conflict questions is that if policymakers should give priority to price stability or to full employment? American and European monetary policies changed a lot after the deep recession in 1981 - 82. It resulted in a six-year recovery. Keeping a watchful eye on employment and real output, and on wages and prices, the Fed decreases interest rates when the economic slows down and increases the rates when the economy overheats. During this catch-up recovery the economy grew at a faster rate than it could sustain thereafter.
The Fed slowed its growth to a measured pace as full employment was restored. Here is the crucial issue: Expansionary monetary policy, the both schools agree, increases aggregate spending on goods and services-by consumers, businesses, governments, and foreigners. Will these new demands raise real output and employment? Or will they just raise prices and facilitate inflation? This is the question that shows the difference that we will discuss. (Albert, 1895).
Keynesian's say the answers depend on circumstances. Full employment means that everyone who is productive enough to be worth the real wages, at that wage is employed. In these circumstances, increased spending brings inflation. Sometimes, however, qualified workers are unwillingly unemployed.
It happens in the result of demand absence for the products they would produce. More spending will put them to work. Competition from firms with excess capacity and from idle workers will keep extra spending from inflation increase. Monetarists answer that the natural way out from excess supply is price reduction. There can be several reasons for that.
Usually, wages do not adjust to unemployment. Government regulations keep them artificially high. The last reason is that jobless prefer unemployment compensation to work at current wages. Anyway, monetarists think that this problem is not remediable by monetary policy.
Injections of new spending would be weak and inflationary. (Greider, 1994). Regardless of these two views as to the real output and unemployment, experience from recessions tells us that downward adjustments of wages and prices cannot avoid damage to output and employment. More then that, wage and price cuts may actually reduce demand by creating expectations of further deflation. The famous Phillips's curve showed wage inflation varying inversely with unemployment.
Keynesian's interpreted it as following: less unemployment at the cost of a finite boost in inflation. Milton Friedman convinced the economics profession in 1968 that if monetary policy persistently attempts to bring unemployment below "the natural rate of unemployment", which is about four percent, it will only boost the inflation rate. The monetary policy should never concern itself with unemployment, production, or real output. But in situations of Keynesian slack, demand expansion can improve real macroeconomic performance without accelerating prices. (Greider, 1994). Monetarist-Keynesian controversy is exemplified by Federal Reserve and Bundesbank policies in the eighties. The issue is this: how actively and frequently should policymakers respond to observed and expected departures from their targets?
Monetarist vision is to follow the same routine regardless of the economic situation, trying to guess the economy fluctuations. Keynesian's say that every situation is unique, therefore, appropriate steps have to be taken. From their point of view, the policy makers have to be very reactive and proactive to always changing economic environment. Monetary and fiscal policies are distinct only in financially developed countries, where the government does not have to cover budget deficits by printing money but can sell obligations to pay money in the future, like U.
S. Treasury bills, notes, and bonds. Printing money leads to inflation and negatively influence the real output. In the United States, Congress and the president decide on expenditure programs and tax codes and thus-subject to the vagaries of the economy-on the budget deficit (or surplus).
This deficit (or surplus) adds to (or subtracts from) the federal debt accumulated from past budgets. The Federal Reserve decides how much of debt will take the form of currency or its equivalent. The rest consists of interest-bearing Treasury securities. Those central bank decisions are the essence of monetary policy. (Albert, 1895). In monetarists' view, government budgets have important supply-side effects. for good or ill But they have no demand-side role unless they create changes in monetary policy.
In Keynesian theory fiscal policy is a distinct demand-side instrument. The government affects aggregate demand directly by its own expenditures and indirectly by its taxes. Bibliography: Albert, H. Eg uchi, R.
Farmer, and Y. Suzuki. Monetary Policy in Our Times. 1995. Greider, William. How the Federal Reserve Runs the Country. New York: Economic Eng.
Press, 1994.
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