5. How does an increase of money supply affect the macro economylin the short-ru

Question

5. How does an increase of money supply affect the macro economylin the short-run and in the long-run? Compare the views of different school of thought b) Compare general equilibrium macro models that are based on classical principles to Keynesian macro models. In particular tell what are the important differences in basic assumptions and how the effects of monetary and fiscal policy differ across the models. c)Explain what Ricardian equivalence theorem means. Also tell how realistic do you find the theorem. In particular, explain what features of the real world seem to violate the assumptions of the theorem

Explanation / Answer

1.An increase in the money supply reduces the interest rate ,which increases investment spending,which leads to a further rise in consumer spending and so on.

In the long run, a monetary expansion raises the aggregate price level,but has no effect on real GDP

2.General equilibrium models that are based on classical models to keynesian macro models like

DSGE-Dynamic Stochastic General Euilibrium  attempts to explain aggregate economic phenomena, such as economic growth, business cycles, and the effects of monetary and fiscal policy, on the basis of macroeconomic models derived from microeconomic principles.

3.The Ricardian equivalence theorem states that government bonds and lump-sum taxes are equivalent means to finance government spending. Thus, a lump-sum tax cut financed by the issuance of government bonds would not affect consumption.

Different assumptions that this model make

1)consumers have operative altruistic bequest motives so that they care about taxes after their death

2)there is a complete set of competitive markets

3)only lump sum taxes are changed

Violations of these assumptions is that consumers may not a bequest motive,either because they do not care about welfare of anyone else except their children. Even if the bequest motive,it is not appropriate form for the theorem to hold.

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