Keynesian Views On Money Price Relationship Essay

1617 WordsAug 25, 20157 Pages
2.4 Keynesian Views on Money-Price Relationship Keynes accepted the classical view that increase in money supply causes rising prices or inflation only when the aggregate output corresponds to full employment and aggregate supply curve is vertical. Keynes published an article entitled ‘How to Pay for the War’ in 1940, in which he developed a demand side model incorporating inflation process with temporarily rigid prices in the labor market. The primary concern of Keynes was to provide space for the necessary increase in output during war where the economy had already reached the full employment level. At full employment level, as aggregate demand increases it results in inflationary gap. This inflationary gap can be removed either by taxation or by saving in such a way that aggregate demand equals existing output (Skidelsky 2000, 84). Snowdon and Vane (2005) write “Keynes, in his ‘How to Pay for the War’ (1940), advocated wartime fiscal restraint. This pamphlet is described by Vines (2003, p. 343) as a ‘marvelous piece of applied economics’ even if his plan was only partially adopted (Keynes believed that an alternative system of universal rationing amounted to ‘Bolshevism’; see Skidelsky, 2000, p. 68). Keynes’s analysis involved comparing aggregate demand, including war expenditures, with potential aggregate supply. Keynes (see Skidelsky, 2000, p. 84) defined the ‘inflationary gap’ as ‘the amount of purchasing power which has to be withdrawn control as the most efficient

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