Question

Discuss whether expansionary monetary policy lower the rate of unemployement temporarily or parmanently according to the monetarist view.

Answer 1

Under the theory of monetarism, central banks should take steps to reduce the interest rate and/or increase the money supply. In doing so, more money will be injected into the economy through investment and consumer spending.

Effects of expansion of monetary policy:

· Increase in money supply – M_s will increase

· Increase in spending by consumer – C_s will increase

· Increase in nominal output – Y will increase

· GDP will increase

Monetarists do not believe that expansionary monetary policy can permanently reduce the unemployment rate and stimulate the pace of economic growth. Monetary expansion may result in a reduction in unemployment and acceleration in the growth rate in the short run. However, as markets adjust, output and employment will eventually return to their previous levels, and inflation will be the long-run side effect of the expansionary monetary policy.