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.
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