Macroeconomics

‭Long-Run Efects of Monetary Policy‬ ‭Friedrich‬ ‭Hayek‬ ‭(F.A.‬ ‭Hayek),‬ ‭a‬ ‭major‬ ‭contributor‬ ‭to‬ ‭Austrian‬ ‭Economics‬ ‭and‬ ‭a‬ ‭strong‬ ‭believer‬ ‭in‬ ‭free-market‬‭capitalism,‬‭introduced‬‭the‬‭theory‬‭of‬ ‭money‬‭neutrality‬ ‭which‬‭states‬‭that‬ ‭changes‬‭in‬‭money‬ ‭supply‬ ‭affect‬ ‭only‬ ‭nominal‬ ‭values‬ ‭,‬ ‭including‬ ‭the‬ ‭price‬ ‭level,‬ ‭exchange‬ ‭rate,‬ ‭and‬ ‭wages.‬ ‭Due‬ ‭to‬ ‭the‬ ‭assumption‬ ‭that‬ ‭prices‬ ‭are‬ ‭highly‬ ‭flexible‬ ‭in‬‭the‬‭long‬‭run‬ ‭(‬ ‭refer‬‭to‬‭Chapter‬‭3‬‭Section‬‭D:‬‭Short-Run‬‭and‬ ‭Long-Run‬‭Analyses),‬ ‭real‬‭economic‬‭variables‬‭including‬‭the‬‭employment‬‭level,‬‭the‬‭real‬‭interest‬‭rate,‬ ‭and‬‭real‬‭GDP‬‭do‬‭not‬‭change‬‭with‬‭a‬‭change‬‭in‬‭money‬‭supply‬ ‭.‬‭By‬‭utilizing‬‭the‬‭quantity‬‭theory‬‭of‬‭money‬ ‭(MV‬ ‭=‬ ‭PQ)‬ ‭and‬ ‭assuming‬ ‭constant‬ ‭output‬ ‭and‬ ‭velocity,‬ ‭a‬ ‭doubling‬ ‭of‬ ‭the‬ ‭money‬ ‭supply,‬ ‭for‬ ‭instance,‬ ‭explains‬ ‭a‬ ‭doubling‬‭in‬‭the‬‭price‬‭level.‬‭Consequently,‬‭F.A.‬‭Hayek‬‭and‬‭Classical‬‭economists‬‭contend‬‭that‬ ‭the‬‭economy‬‭will‬‭naturally‬‭adjust‬‭towards‬‭equilibrium‬‭without‬‭the‬‭need‬‭for‬‭monetary‬‭policy‬‭tools.‬ ‭This‬‭is‬ ‭because‬‭changes‬‭in‬‭the‬‭money‬‭supply,‬‭according‬‭to‬‭their‬‭view,‬‭do‬‭not‬‭cause‬‭shifts‬‭in‬‭unemployment‬ ‭or output levels but rather only influence the price level‬ ‭.‬ ‭For‬‭example,‬‭if‬‭the‬‭Fed‬‭implements‬‭an‬‭expansionary‬‭monetary‬‭policy‬‭that‬‭increases‬‭money‬‭supply‬‭when‬ ‭the‬‭economy‬‭is‬‭at‬‭potential‬‭output,‬‭the‬‭nominal‬‭interest‬‭rate‬‭decreases.‬‭The‬‭chain‬‭of‬‭effects‬‭will‬‭lead‬‭to‬ ‭higher‬‭aggregate‬‭demand‬‭(from‬‭AD₁‬‭to‬‭AD₂)‬‭which‬‭also‬‭raises‬‭the‬‭price‬‭level‬‭from‬‭PL₁‬‭to‬‭PL₂‬‭(inflation).‬ ‭As‬‭a‬‭result‬‭of‬‭inflation,‬‭nominal‬‭wages‬‭increase‬‭which‬‭raises‬‭suppliers’‬‭costs‬‭of‬‭production‬‭and‬‭shifts‬‭the‬ ‭SRAS‬ ‭curve‬ ‭to‬ ‭the‬ ‭left‬ ‭from‬ ‭SRAS₁‬ ‭to‬ ‭SRAS₂‬ ‭(SRAS‬ ‭decreases).‬ ‭The‬ ‭long-term‬ ‭net‬ ‭effect‬ ‭of‬ ‭this‬ ‭expansionary‬‭monetary‬‭policy‬‭would‬‭be‬‭a‬‭new‬‭equilibrium‬‭at‬‭the‬‭potential‬‭level‬‭(Y₃)‬‭but‬‭at‬‭a‬‭higher‬ ‭price‬ ‭level‬ ‭(PL₃‬ ‭)‬ ‭.‬ ‭This‬ ‭implies‬ ‭inflation‬ ‭without‬ ‭an‬ ‭increase‬‭in‬‭real‬‭GDP.‬ ‭Most‬‭economists‬‭attribute‬ ‭this phenomenon to the theory of money neutrality, except for Keynes.‬

‭165‬

‭© 2024 ACHIEVE ULTIMATE CREDIT-BY-EXAM GUIDE‬‭|‬‭MACROECONOMICS‬