Question

The monetarists criticized (LO5) a) the stop-and-go policies of the Federal Reserve b) the ineffectiveness of monetary policy at fighting inflation c) the importance given to money by the Keynesians d) the Fed for keeping a heavy foot on the monetary brake and allowing the money supply to rise by only 3 percent a year

Short answer

The main criticism made by monetarists is the stop-and-go policies of the Federal Reserve, as they believe in a consistent and predictable monetary policy with a constant growth in the money supply. Thus, the correct answer is: a) the stop-and-go policies of the Federal Reserve.

Step-by-step solution

Statement a: The stop-and-go policies of the Federal Reserve

Monetarists criticize inconsistent and unpredictable policies. They believe in a consistent and predictable monetary policy with a constant growth in the money supply. The stop-and-go policies refer to situations where the Federal Reserve increases the money supply for a period of time and then restricts it unexpectedly, leading to fluctuations in the economy. Therefore, this statement could represent the monetarists' criticism.

Statement b: The ineffectiveness of monetary policy at fighting inflation

Monetarists emphasize the importance of controlling the money supply to reduce inflation. They consider monetary policy to be an effective tool in controlling inflation. On the other hand, statement b suggests that monetarists criticize the ineffectiveness of monetary policy at fighting inflation, which is contrary to their belief. So, this statement doesn't represent the monetarists' view.

Statement c: The importance given to money by the Keynesians

Monetarists criticize the Keynesians' approach for emphasizing more on fiscal policy and less on monetary policy. Monetarists believe that money plays a crucial role in economic stability. Since statement c reflects the monetarists' disagreement with the Keynesians' approach, this statement can also represent monetarists' criticism.

Statement d: The Fed for keeping a heavy foot on the monetary brake and allowing the money supply to rise by only 3 percent a year

Monetarists argue for a steady and predictable growth in the money supply to maintain economic stability. This statement suggests that monetarists criticize the Federal Reserve for not allowing a significant increase in the money supply. Since monetarists advocate for a consistent growth rate in the money supply, this statement could also represent their criticism. Now, we need to choose the one that represents the main criticism made by monetarists. Out of the three relevant statements (a, c, and d), statement a is the closest to the main criticism, as it specifically addresses the inconsistency in Federal Reserve policies. Thus, the correct answer is: a) the stop-and-go policies of the Federal Reserve

Key concepts

Federal Reserve Policies

Understanding the Federal Reserve's policies is crucial as they play a pivotal role in the US economy. The Fed regulates the country's money supply and interest rates, with the goal of managing inflation, maximizing employment, and stabilizing the financial system. Monetarists, in particular, have critiqued the Fed for what they see as 'stop-and-go' policies, which involve alternating between expanding and contracting the money supply.

This inconsistency can lead to uncertainty in the market, as businesses and consumers are unable to predict economic conditions. Monetarists advocate for a more consistent approach with a steady growth rate of the money supply to maintain economic stability. They suggest that predictable policies could help avoid the economic fluctuations that are often the result of unanticipated changes in monetary policy.

In order to improve understanding of this concept, let's consider the Federal Reserve's dual mandate—to foster economic conditions that achieve both stable prices and maximum sustainable employment. An erratic monetary policy, altering between easing and tightening, could jeopardize these goals as it would likely cause volatility in interest rates and investment decisions.

Money Supply and Inflation

The relationship between the money supply and inflation is a cornerstone of monetarist theory. Monetarists posit that there is a direct link between the amount of money in circulation and the level of prices in the economy. Essentially, if the Federal Reserve increases the money supply too rapidly, it leads to inflation, which means that each dollar has less purchasing power.

To remedy and prevent inflation, monetarists argue that controlling the growth of the money supply is key. They often reference the quantity theory of money, which in simplified terms, states that too much money chasing too few goods leads to price increases. A steady and moderate growth in the money supply, aligned with economic growth, is advocated to avoid both rampant inflation and deflation.

Improving this topic's clarity could involve illustrating the concept with a tangible example, such as the hyperinflation experienced in countries where the money supply was increased excessively. It's also important to explain the tools the Fed uses to control money supply, like open market operations, reserve requirements, and the discount rate.

Keynesian Economics

Keynesian economics, named after the British economist John Maynard Keynes, emphasizes the role government and fiscal policy play in managing the economy, particularly during recessions. Keynesians believe that during economic downturns, consumer demand typically decreases, leading to less production and higher unemployment. To counter this, they advocate for increased government spending and lower taxes to boost demand.

Monetarists, however, often critique Keynesian economics for placing too much emphasis on fiscal policy and not enough on the role of the money supply. They argue that irresponsible fiscal policy can lead to budget deficits and may not effectively tackle inflation. According to monetarists, managing the money supply is crucial for economic stability.

For those seeking an improved understanding of Keynesian economics, it's beneficial to delve into the concepts of the multiplier effect, where an initial increase in spending leads to further increases in income and consumption, and the paradox of thrift, which suggests that increased saving can lead to a decrease in aggregate demand and thus lower economic growth in the short term.