An increase in the money supply will increase real GDP growth in the long run inA) the Real Business Cycle model.B) the New Keynesian model.C) Neither the Real Business Cycle model nor the New Keynesian model.D) Both the Real Business Cycle model and the New Keynesian model.

Asked Jun 11, 2019

An increase in the money supply will increase real GDP growth in the long run in

A) the Real Business Cycle model.

B) the New Keynesian model.

C) Neither the Real Business Cycle model nor the New Keynesian model.

D) Both the Real Business Cycle model and the New Keynesian model.


Expert Answer

Step 1

GDP (Gross Domestic Product)/ output of a country is the market value of all finished (final) goods and services produced in an economy during a particular year. It represents the economic well-being of a country as it is the aggregate income of that economy.

Money supply represents the stock of money that is in circulation in the economy.

Step 2

New Keynesian is the school of economics with following features:

  1. Rational expectations
  2. Short term non-neutrality of money
  3. Price rigidities
  4. Labor market rigidities (wage rigidities because of wage contracts)

Real business cycle (RBC) model explains short term economic fluctuations based on the assumptions of classical theory. It says that output can be away from natural level only in short tun and business cycles are the result of real (and not nominal) shocks. Real shocks are the shocks to the economy that affect real variables like real output, employment, etc. Examples of real shocks are productivity shocks, technology advancement, capital formation, etc.

Step 3

According to New Keynesians, an increase in money supply would result in increase in output only in short term. That is, money is non-neutral in short run due to existence of nominal rigidities. However, in long run, money is neutral. It means that, in the long run, increase in money supply would not affect real variables like real output and ...

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