Anda di halaman 1dari 22

A Comparison of Keynesian,

Austrian, and Monetarist theories


on Inflation and the Business Cycle
Elizabeth Dalzen
University of Wisconsin
Superior

Outline

Keynesian Theories
Money Illusion/Animal spirits
Keynes on Says Law
Liquidity Trap

Non-keynesian
Austrian economics
Austrian Business Cycle Theory
Classical
Classical vs. Keynes

Monetarism
Quantity Theory of Money
Inflation and Side Effects
Government Spending

Money Illusion and animal spirits

People think in nominal terms, not real terms


Deflation
price level, nominal wages, real wages
price level, nominal wages, real wages surplus
Involuntary unemployment

Animal spirits:
A spontaneous urge to action rather than inaction*

Decisions are made in the short-run,

In the long run, we are all

dead.**
Confidence
*Keynes, The General Theory of Employment, Interest, and Money
**Keynes, A Tract on Monetary Reform

Keynes and Says Law

Says Law: People produce in order to


consume
No general gluts

What if suppliers dont spend?


Hoarding (saving without investing)
AD unemployment AD

Recession

Liquidity Trap

As the interest rate approaches zero,


stronger liquidity preference
Individuals dont save (invest), banks dont

lend

Flat LM curve
Impotent monetary policy

Confidence

Keynesian Econ

If
Money illusion
Glut of unemployment
Low interest rates
Deflation
Low consumer and business confidence
Hoarding/Liquidity Trap
Dearth of investment

Then
Increase national income by shifting IS curve,

increasing AD
Govt. should spend, spend, SPEND!

Austrian Business Cycle Theory

Expansion of credit by banks


A central bank is necessary for banks to expand
credit
if banks were truly competitive, any expansion of credit

by one bank would quickly pile up the debts of that bank


in its competitors, and its competitors would quickly call
upon the expanding bank for redemption in cash*

*Rothbard, Economic Depressions: Their Cause and Cure

A.B.C. Theory

Credit expansion Inflationary Boom


Domestic prices bid up imports
Gold flows out of the country as
payment for imports
As banks gold stores dwindle, panic!
Fractional reserve banking

Banks call in loans, Money supply


(deflation)
Economy contracts
Balance of payments reverses

A.B.C. Theory

Interest rate artificially depressed


Malinvestment
Low i rate is only temporary

Overinvestment in capital goods


Not enough savings to buy all producers

goods

Capital is heterogeneous

A.B.C. Theory

Gold Standard
Money supply shouldnt increase,
even if the population or supply of
goods increases
Deflation problems

Government sanctioned M
counterfeiting

Classical Economics

Smallest decision making unit: the


individual
Homo economicus
Rational
Self-interested
Utility maximizing

Assume perfect information

Classical
vs.
Keynes
Why Keynes is wrong if people are rational, self-interested and
utility maximizing.

Money illusion/stickiness
Example: Deflation
Workers resist nominal wages
Businesses have 2 options:
Raise prices cost-push inflation
Lay off wokers
Workers seek new jobs
Businesses offer wages that reflect workers real worth (if
no minimum wage laws, labor unions, etc.)

Stickiness due to:


Time lags with change in price level
Contract length
Labor unions

Keynes refutation of
Says Law

Misrepresentation of Says Law


Say never said that depressions and

unemployment are impossible

Says Law: supply creates its own


demand, so no general gluts
requires flexible, self-correcting markets
A temporary glut in the labor market is not a

general glut

Hoarding: why?

Puzzling Paradox

Keynesian economic man:


Ruled by animal spirits
Doesnt make decisions for the long-run
Incapable of thinking in real terms
But somehow responds rationally to lower

interest rates by investing less of his


money?

Monetarist Economics

Also has roots in classical economics


Disagree with both Keynesians and
Austrians on inflation and the
business cycle
Milton Friedman

Quantity Theory of Money

Quantity theory of money:


M*V=P*Q
M=quantity of money in circulation
V=velocity of money
P=price level
Q=index of the real value of final expenditures

Keynes: V is inherently unstable


M, V move in opposite directions

Friedman: M, V move in the same


direction

How to Avoid Inflation

Inflation is always a monetary


phenomenon
M and P are not independent
MP

Since M*V=P*Q, we have


M+V=P+Q
Assume velocity is stable (V=0)
P=0 if and only if M=Q
To avoid inflation, the growth rate of the

money supply should be set equal to the


growth rate of output

Inflation and Side Effects

Monetarists want monetary policy


that creates a stable framework
Reducing inflation is not technically
difficult, but there are political
barriers
Possible side effects of reducing
inflation:
Recession
Unemployment

Stimulus

In a liquidity trap:
Even if the Fed increases M, banks hesitate

to lend (low interest rates)


Bypass the banks, give money directly to
consumers
Aggregate Demand boosted without
increasing government spending

Government Spending

Where does the money come from?


Increased tax revenue

Borrowing from the private sector


Government spends money that otherwise
would have been spent in the private sector

Printing money
Implicit tax on holders of dollar denominated
assets
No legislation involved

Review

Keynesian Theories
Money Illusion/Animal spirits
Keynes on Says Law
Liquidity Trap

Non-keynesian
Austrian economics
Austrian Business Cycle Theory
Classical
Classical vs. Keynes

Monetarism
Quantity Theory of Money
Inflation and Side Effects
Government Spending

Questions?

References
Blinder, Alan S. "Keynesian Economics." The Concise Encyclopedia of Economics. David R. Henderson, ed. Liberty Fund, Inc. 2008. Library

of Economics and Liberty [Online] available from http://www.econlib.org/library/Enc/KeynesianEconomics.html; accessed 8 May 2009;
Internet.
Caplan, Bryan. Why I am not an austrian economist. Bryan Caplan [cited 04/09 2009]. Available from
http://www.gmu.edu/departments/economics/bcaplan/whyaust.htm (accessed 04/09).
Friedman, Milton. 2006. The optimum quantity of money. With a new introduction by Michael D. Bordo; New Brunswick, N.J. and London:;
Transaction, AldineTransaction.
. 2004. Reflections on A monetary history. Cato Journal 23, (3) (Winter): 349-51.
. 2002. Capitalism and freedom. Fortieth anniversary edition; With a new preface by the author. With the assistance of Rose D.
Friedman; Chicago and London:; University of Chicago Press.
. 1991. Monetarist economics. IEA Masters of Modern Economics series; Oxford and Cambridge, Mass.:; Blackwell.
Friedman, Milton, and Anna J. Schwartz. 1999. Money and business cycles. In The foundations of monetary economics. volume 2., ed.
David Laidler, 384-416 Elgar Reference Collection; Cheltenham, U.K. and Northampton, Mass.:; Elgar; distributed by American
International Distribution Corporation, Williston, Vt.
Hazlitt, Henry. 1959. The failure of the new economics. Princeton, New Jersey: D. Van Nostrand Company, INC.
Nobel Web. The sveriges riksbank prize in economic sciences in memory of alfred nobel 1974. in Nobel Web [database online]. Sweden,
2009 [cited 6/30 2009]. Available from http://nobelprize.org/nobel_prizes/economics/laureates/1974/press.html (accessed 6/30/09).
Reisman, George. 1998. Capitalism: A treatise on economics. Ottawa, Illinois: Jameson Books.
Rothbard, Murray N. 2000. America's great depression. 5th ed. The Ludwig von Mises Institute.
. 1997. The Austrian theory of money. In The logic of action one: Method, money, and the Austrian school. 297-320. Cheltenham,
UK: Edward Elgar Publishing Ltd.
. 1997. The present state of Austrian economics. In The logic of action one: Method, money, and the Austrian school. p. 111-172.
Cheltenham, UK: Edward Elgar Publishing Ltd.
. Economic depressions: Their cause and Cure. In http://mises.org [cited 6/30 2009]. Available from
http://mises.org/tradcycl/econdepr.asp; accessed 6/30/09).
Smiley, Gene. "Great Depression." The Concise Encyclopedia of Economics. David R. Henderson, ed. Liberty Fund, Inc. 2008. Library of
Economics and Liberty [Online] available from http://www.econlib.org/library/Enc/GreatDepression.html; accessed 8 May 2009.
Tullock, Gordon. 1988. Why the austrians are wrong about depressions. In The review of austrian economics. volume 2., eds. Murray N.
Rothbard, Walter Block, 73-78Washington, D.C.:; Ludwig von Mises Institute.
Wikipedia contributors. Rational choice theory. Wikipedia, The Free Encyclopedia. http://en.wikipedia.org/w/index.php?
title=Rational_choice_theory&oldid=285627674 (accessed 05/08, 2009).