Question

During a recession, if the money supply were increased \((\mathrm{LO4}, 5)\) a) the Keynesians and the monetarists agree that people would probably just hold on to these funds b) the Keynesians and the monetarists agree that people would spend this money on assets of one kind or another c) the Keynesians believe people would probably just hold on to these funds, while the monetarists believe people would spend this money on assets of one kind or another

Short answer

c) The Keynesians believe people would probably just hold on to these funds, while the monetarists believe people would spend this money on assets of one kind or another.

Step-by-step solution

Understand Keynesian Economics

Keynesian economists advocate for an increase in government spending and a decrease in taxes to stimulate demand in the economy. When the money supply is increased during a recession, Keynesians usually believe that people would prefer to hold onto their money instead of spending because they are uncertain about the future economic conditions. This is called the liquidity preference. 2.

Understand Monetarist Economics

Monetarist economists believe that the money supply is the primary determinant of economic activity. They emphasize the importance of controlling the money supply to manage inflation and stabilize the economy. According to monetarists, an increase in money supply during recession would encourage people to spend more, as they would prefer to invest in assets rather than holding on to cash that is losing value due to inflation. 3.

Analyze the given choices

Now we need to analyze the given choices to determine which one correctly represents the views of both Keynesians and Monetarists. a) Both Keynesians and Monetarists agree that people will hold on to the funds - This statement does not correctly represent Monetarist's view. b) Both Keynesians and Monetarists agree that people will spend the money on assets - This statement does not correctly represent Keynesian's view. c) Keynesians believe people would hold on to the funds, while Monetarists believe people would spend on assets - This statement correctly represents the viewpoints of both Keynesians and Monetarists.

Conclusion

Based on our understanding of Keynesian and Monetarist economic theories and their views on increasing the money supply during a recession, we can conclude that the correct answer is: c) The Keynesians believe people would probably just hold on to these funds, while the monetarists believe people would spend this money on assets of one kind or another.

Key concepts

Keynesian Economics

Keynesian Economics is a theory developed by John Maynard Keynes during the Great Depression, emphasizing the role of government intervention during economic downturns. This approach supports the idea that active government policies can help stabilize the economy. Keynesians advocate for increasing government spending and decreasing taxes to boost aggregate demand. During a recession, they argue that consumption decreases due to economic uncertainties. Thus, even if the money supply increases, individuals might still prefer to hold onto their money. This is explained by the concept of liquidity preference, where people choose to keep money in hand due to fear of future financial instability.

In essence, Keynesians focus on stimulating demand to kickstart the economy. They believe that without government intervention, the economy could spiral deeper into recession. Their approach is mainly demand-driven, aiming to increase employment levels and economic output through fiscal policies, such as government expenditures and tax cuts.

Monetarist Economics

Monetarist Economics, championed by economists like Milton Friedman, places significant importance on the control of the money supply to manage economic stability. Monetarists assert that economic fluctuations are often the result of inappropriate adjustments in the money supply. Unlike Keynesians, monetarists believe that fiscal policy has limited impact, preferring instead to use monetary policy. By controlling money supply, they aim to influence inflation and overall economic output effectively.

Monetarists think that in times of recession, increasing the money supply can lead to higher spending. They argue that people will invest in assets since holding onto money could lead to losing value due to inflation. This philosophy is supply-side oriented, focusing on managing inflation and fostering long-term growth through regulated money supply. The fundamental belief is that a stable and predictable monetary environment will naturally correct economic imbalances over time.

Money Supply

The money supply plays a crucial role in both Keynesian and Monetarist economics. It refers to the total amount of money available in an economy at a given time. Adjustments to the money supply are often utilized as a tool to influence economic activity.

In Keynesian economics, an increase in money supply during a recession is intended to encourage spending by increasing liquidity, although Keynesians believe its impact may be limited without corresponding fiscal measures. Meanwhile, monetarists believe that careful management of the money supply is crucial. They argue that changing the money supply can influence inflation rates and overall economic performance.

Thus, while both theories acknowledge the importance of money supply, they diverge on methods and expectations of its impact. It is a pivotal element in shaping monetary policy, serving as an instrument for both stimulating growth and containing inflation.

Liquidity Preference

Liquidity preference is a key concept in Keynesian economics that describes individuals' desire to hold cash or easily liquidated assets instead of spending or investing them. It is especially significant during periods of economic uncertainty, such as recessions, when people are more cautious about their financial decisions.

John Maynard Keynes introduced this concept, suggesting that individuals have a preference for liquidity based on their expectations of future economic conditions. This preference is influenced by factors such as interest rates, inflation expectations, and overall economic stability.

The notion of liquidity preference supports the Keynesian view that during a recession, individuals are less likely to spend, even if the money supply increases. Instead, they hold onto their funds until they are more confident about the future. Understanding liquidity preference is crucial for developing policies aimed at stimulating demand in an economy during downturns.