The Monetarist and Keynesian theories present alternative views on how the money supply affects the economy

Question

On some issues they agree but on others they disagree. This question tests your knowledge of these areas of agreement and disagreement.

Select the multiple choice option that best describes the statement below.

"High nominal interest rates are an indication of excessive monetary stimulus, not monetary restraint."

A. Monetarists and Keynesians agree with this statement.

B. Neither Monetarists nor Keynesians agree with this statement.

C. Monetarists agree with this statement but Keynesians do not.

D. Keynesians agree with this statement but Monetarists do not.

Answer 1

Monetarists

Monetarists do not believe that the government should intervene by trying to manage the level of aggregate demand. They argue that this type of interventionist policy will be destabilising in the long run and should therefore be avoided. A key problem with discretionary demand management policies is the time lags, which monetarists believe make fiscal policy too difficult to use to manage the economy effectively. The best thing therefore, is to take a long-run view of price stability and use monetary policy to achieve this.

Keynesians

Keynesians traditionally see fiscal policy as the key tool of economic management. They see the role of government as maintaining the economy at full employment. The way to do this was to manage the level of aggregate demand until the economy was at or close to full employment. If the economy was growing too fast, then fiscal policy should be essentially deflationary, and vice-versa when below full employment. Monetary policy should, in their view, simply be used as a backup to fiscal policy. However, they would argue that direct interest rate changes could be used to control aggregate demand. Their main objection to monetary policy has always been that there is a weak link between the money supply and aggregate demand, and that the money supply is difficult to control anyway.

The information provided is too vague to make a judgement on the best answer. I'm thinking A or B but its a very badly worded question.

Answer 2

D. Keynesian's agree with this statement but Monetarists do not.

Keynesian's would agree with it only partially (because of equilibrium between fiscal policy and monetary, IS-LM), but monetarists were concerned primary about inflation rather than on nominal interest rates (thus lower inflation - lower interest rates).