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Chapter 16 :green_cross: Neoclassical school-Monetary Economics (Who Pay…
Chapter 16 :green_cross: Neoclassical school-Monetary Economics
Monetary Economics
Monetary policies of central banks and governments
became increasingly important
Money in economics became more important with the
growth of banking,credit and economic fluctuations
There is
no separate school
of monetary economics
Who Pay Attention?
Marshall devoted some attention to monetary analysis
He stated the equation of exchange called the Cambridge Equation- M=kPT
M =
stock of money
k = fraction of income people collectively wish to hold in form of cah balance
P = general price level
i
s either volume of trade or real income
Marshall's k is reciprocal of the velocity of circulation V,MV = PT
Wicksell, Fisher and Hawtery are within the Marshallian neoclassical tradition
The trio contribution to economics
They explored
monetary analysis
which had been neglected but was growing in importance
They helped integrate monetary analysis into
general economic theory
John Gustav Knut Wicksell
Greatly influenced by
Bawerk's book
on capital theory
One of the earliest economist to suggest that the
typical firm will experience increasing returns, then constant return and finally decreasing returns
as it expand it size
He anticipated the
theory of monopolistic competition
, and later was worked out by Chamberlin and Robinson in 1930
His overall objective was to
synthesize monetary theory, business cycle theory, public finance and price theory
into one system
Contribution to Monetary Economics
An analysis of the role of interest rates in achieving an equilibrium price level or generating cumulative
inflationary or deflationary
movements
Recognizing the potential contribution of government and central bank in
retarding or promoting price stability
Savings-Investment approach to macroeconomics equilibrium - this established Wicksell as the so-called father of Stockholm school of economics
Price level Changes
He distinguihed between the
normal or natural rate
of interest rate of interest and the bank rate
Normal or natural rate of interest
- depends on supply and demand for real capital that is not yet invested
Interaction of supply and demand determines the natural interest rate
Pricel level change
Case 1 : bank rate < Natural rate
If bank lend money at lower rate than natural rate,
S will be discouraged, and demand for C goods and services will rise
. As
cost of borrowing lower, I will rise
, thus rise in income. the price of C goods begins to rise and continue to rise as long as
bank rate < natural rate
Case 2 : Bank rate > Natural rate
If bank rate > natural rate prices will fall. This is because
S will rise and I will lower.
Decline in I will
reduce national income,
which in turn will cause
the price of consumer goods to decline.
The general price level will decline and deflation will occur