Keynesian vs Quantity Theory A sketch of the differences

How will an injection of $5 billion of reserves work into the economy from a Keynesian point of view? Fed Banking System as a Whole A L A L + $5 billion T- bonds + $5 billion Reserves + 5 billion deposits of bond dealers + $5 billion Reserves + $45 billion loans + $45 billion in checkable deposits + 50 billion in bank system assets + $50 billion in bank system checkable deposit liabilities Loanable funds supply has increased by $45 billion. This will lower interest rates for corporations and other borrowers, which will increase aggregate demand and the economy will speed up.

Impact of a $45 billion increase in the supply of loanable funds: Prime rate S1- lenders S2- when banks lend to the max, the loanable funds supply shifts $45 to the right $45 billion r1 r2 Demand- borrowers Q of loanable funds Note: when the Fed injects $5 billion reserves into the system, banks lend to the max and everyone re-deposits in commercial banks, the supply of loanable funds rises a huge amount, and there is a noticeable effect on the prime rate, a benchmark for all sorts of traditional loans. When the prime falls, what happens to the macroeconomy from a Keynesian perspective?

Effect of a decline in interest rates on the macroeconomy Effect of a decline in interest rates on the macroeconomy. Keynesian View Agg. Supply Price Level P1=P2 D before D after y1 y2

The amount of account money has risen by $50 billion How will an injection of $5 billion of reserves work into the economy from a Quantity Theory of Money perspective? Fed Banking System as a Whole A L A L + $5 billion T- bonds + $5 billion Reserves + 5 billion deposits of bond dealers + $5 billion Reserves + $45 billion loans + $45 billion in checkable deposits + 50 billion in bank system assets + $50 billion in bank system checkable deposit liabilities The amount of account money has risen by $50 billion

Write out the Quantity Equation MV=Py M is the quantity of money in the hands of the public V is the average rate of turnover for goods and services of money P is price level y is real GDP

Write out the Quantity Equation

Write out the Quantity Equation MV=Py

Write out the Quantity Equation MV=Py What do each of these letters stand for?

Write out the Quantity Equation MV=Py M is the quantity of money in the hands of the public

Write out the Quantity Equation MV=Py M is the quantity of money in the hands of the public V is velocity money; or the average rate of turnover of money spent on goods and services

Write out the Quantity Equation MV=Py M is the quantity of money in the hands of the public V is velocity money; or the average rate of turnover of money spent on goods and services P is price level

Write out the Quantity Equation MV=Py M is the quantity of money in the hands of the public V is velocity money; or the average rate of turnover of money spent on goods and services P is price level y is real GDP

The Quantity Theory Believes: Who controls the amount of money?

The Quantity Theory Believes: The Fed exogenously controls the amount of money. (M) Who controls V, the rate of turnover of money?

The Quantity Theory Believes: The Fed exogenously controls the amount of money. (M) The non-bank public controls V. It has a stable desire to hold money, so velocity will also be relatively stable When the Fed creates more money than the public wishes to hold, what will they do with their excess cash?

The Quantity Theory Believes: They’ll spend their excess cash. Which side of the macro-economy will this spending move?

The Quantity Theory Believes: Excess money creation over what people want to hold will be spent on goods and services. Aggregate demand will shift to the right when this spending occurs. What law of markets is behind the aggregate supply curve?

The Quantity Theory Believes: Say’s Law When companies see excess demand for their goods, how will they respond?

The Quantity Theory Believes: When companies see excess demand for their goods, they’ll raise prices. The Fed by pumping up the money supply has not significantly increased real economic activity, it has just caused _________________. (fill in the blank)

The Quantity Theory Believes: When companies see excess demand for their goods, they’ll raise prices. The Fed by pumping up the money supply has not significantly increased real economic activity, it has just caused inflation!

Effect of $50 billion increase in M1 Step 1. The Fed has been responsible for increasing the quantity of money by $50 billion (exogenously created M rises)

Effect of $50 billion increase in M1 The Fed has been responsible for increasing the quantity of money by $50 billion The non-bank public, who owns the money, has more than it wishes to hold. It spends the excess cash balances. Which side of the macroeconomy will move? Which way? Show this.

Effect of $50 billion increase in M1 The Fed has been responsible for increasing the quantity of money by $50 billion The non-bank public, who owns the money, has more than it wishes to hold. It spends the excess cash balances. Which side of the macroeconomy will move? Which way?

Effect of $50 billion increase in M1 Aggregate Demand will move to the right

What theory of markets is behind the Quantity Theory?

What theory of markets is behind the Quantity Theory? Say’s Law How do you draw a Say’s Law aggregate supply curve?

What theory of markets is behind the Quantity Theory? Say’s Law How do you draw a Say’s Law aggregate supply curve? Show the impact of the $50 billion increase in the money supply on the macroeconomy.

Impact of a $50 billion increase in M1 on the macroeconomy: Q theory perspective S Say’s Law shape P2 P1 D after D before increase in M1 y1 y2 MV=Py If the Fed injects too much money into the system, people spend their excess cash. Companies raise prices faster than quantities. The effect: inflation with very little increase in real GDP.