¶ … Modifications That Were Made to Keynes' Approach by the Neo-Keynesians and the Implications for the Scope of Fiscal and Monetary Policies
The objective of this work is to examine the key modifications that were made to Keynes' Approach by the Neo-Keynesians and the Implications for the Scope of Fiscal and Monetary Policies. Keynesian economics is reported in the work of Chick (1983) to be understood as a certain set of policy prescriptions, yet in the General Theory; very little space is devoted to the implications of the theory for government policy." (p.316) The Keynesian doctrine held that the economy "could be stabilized and growth encouraged by policies -- mostly variations of government expenditure and taxation -- designed to alter the level of aggregate demand, while monetary policy was dismissed as impotent, not just in the particular circumstances of the 1930s and later 1940s but generally 'money did not matter'." (Chick, 1983, p.316) The alleviation of unemployment was also a primary aspect of Keynesian policy as Keyes was attempting to solve a futuristic problem and specifically that of "unemployment high for over a decade and showing no sign of improvement, entrepreneurs discouraged, great excess capacity yet the economy generally undercapitalized: a condition where there is a shortage of houses, but where nevertheless no one can afford to live in the houses there are." (Chick, 1983, p.317) Modigliani states that money, in the free capitalistic economy serves two purposes: (1) it is a medium of exchange; and (2) it is a form of holding assets. (p.49) Two sources of demand for money exist: (1) the transaction demand for money; and (2) the demand for money as an asset. (p.48) Keynes argues that classical theory is only applicable to special rather that general cases and that the assumption is made in the situation "which is assumes being a limiting point of the possible positions of equilibrium." (p.3) In addition Keynes holds that the characteristics of the special case assumed by the classical theory happen not to be those of the economic society in which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience." (Keynes, 1964, p.3)
Pasinetti states that the principle of effective demand "may appear very simple; so simple in fact as to make one wonder why it has taken so long to emerge." (p.33) Keynes is stated to have been forced "by the very logic of his system, to look for a new theory of the rate of interest. He claims that, for a series of reasons including transactions, precautionary and speculative motives that there is certain quantity of money that people are willing to hold at each level of the rate of interest. This quantity of money -- the demand for money is inversely related to the rate of interest and tends to infinity before the rate of interest reaches zero." (Pasinetti, 1974, p.37) This means that the rate of interest is determined by the money quantity that the Central Authority issues. The IS-LM model holds that monetary policy is not as strong as fiscal policy "because it shifts the aggregate demand curve directly. Monetary policy influences aggregate demand through adjusting interest rates and money supply." (CLIENT'S REFERENCE) This is reported to take place through government bond sale or purchase with the money supply being fixed by the central bank and demand on money determination "through the liquidity preference and thus, the interest rate." (CLIENT'S REFERENCE) Depending on the balance and demand and the money supply the interest rate is adjusted affecting the money market and the quantity of goods as well as services and the price level of those services. A larger money supply decreases rates of interest and results in the stimulation of investment expenditure resulting in an increase in aggregate demand. (CLIENT'S REFERENCE)
In the classical system it is reported that the "suppliers of labor are supposed to behave rationally." (Modigliani, 1994, p.47) The supply of any commodity is stated to be dependent "on the relative price of the commodity so the supply of labor is taken to depend not on the money wage rate, but on the real wage rate." (Modigliani, 1974, p.47) However, the assumptions made by Keynes are different on the supply-of-labor schedule as the supply of labor "is assumed to be perfectly elastic at the historically ruling wage rate." (Modigliani, 1974, p. 47) The classical system was such that when there was no work for workers that the services of the workers could...
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