Chapter 16
Monetarist Theory
The asserts that fluctuations in the growth rate
of the money supply are the impulse that creates business cycles.
More specifically, a slowdown in the growth rate of the money
supply decreases aggregate demand and hence creates a recession
with its decrease in real GDP and increase in unemployment.
The figure to the right shows the start of a recession. In the figure, the slowdown in the monetary growth rate decreases aggregate demand from AD0 to AD1. The economy moves along its short-run aggregate supply curve SAS0 and real GDP decreases from $7.0 trillion to $6.5 trillion.
However, the economy does not stay in the recession
permanently. Instead, there is an automatic change that
leads the economy out of the recession. In particular, when real
GDP has decreased to $6.5 trillion, unemployment has increased.
The higher unemployment rate means that eventually the money wage
rate will decrease because the large number of unemployed workers
puts downward pressure on the money wage rate. In turn, as the
money wage rate falls, the short-run aggregate supply increases.
You can see the increase in short-run aggregate supply in the
second figure as the rightward shift from SAS0
to SAS1. As short-run aggregate supply
increases the economy moves back to its long-run equilibrium on
the long-run aggregate supply curve (LAS). Real GDP
returns to $7.0 trillion ( potential GDP). To review the other
business cycle theories, click on the appropriate figure. To see
the summary, click on the summary figure.
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