Chapter 17, Problem 21AA

To determine

To show:The comparison and contrast between the goals, methods and outcomes of the Keynesian theory and monetarism.

Explanation of Solution

Monetarism: Monetarism is the theory that explains the relationship between the amount of money introduced by the Federal Reserve to be circulated in the economy and the level of activities in the economy. People who are running this theory are termed as monetarists.

The diagram below represents the goals, methods and outcomes of monetarism and Keynesian theory:

  

The Keynesian theory and monetarism theory both have focused on eradicating unemployment from an economy and leading the economy to achieve better growth. Though both of these theories focus on similar goals, there lies the difference between the applications and they can be explained below:

1. Keynesian theory focuses on the application of fiscal policy at times of recession to activate economic growth. However, monetarism theory focuses on the application of monetary policy, and monetarists believe that fiscal policy cannot cause an increase in real output.

2. Keynesian theory causes a sticky downwards flow in wages which can lead to unemployment while in absence of minimum wages or trade unions, wages become flexible.

3. In the Keynesian view, there is a trade-off between the situation of unemployment and inflation while in the monetarism view, this trade-off is for the very short term.

4. Keynesian view supports that government should borrow more to offset the private spending in a situation of recession. However, monetarists are of the opinion that the government should move in direction of a balanced budget.

5. Keynesian view says that there is no crowding out in a situation of recessions while monetarists are of the view that government borrowing can cause more crowding out.