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What structural evidence lead early Keynesians to believe that monetary policy does not
matter?
Answer:
a. Interest rates during the Great Depression fell to extremely low levels. Early Keynesians
believed monetary policy affected aggregate demand solely through its effect on nominal interest
rates, which in turn affected investment spending. They believed that low interest rates during
the Depression indicated that monetary policy was easy since it encouraged investment spending
and so could not have played a contractionary role during this period.
b. Early empirical studies found no linkage between movements in nominal interest rates and
investment spending. Since early Keynesians believed that this is the only channel through which
money supply affects aggregate demand, finding this link weak, led them to believe that money
has no effect on output.
c. Surveys of businesspeople revealed that their decisions on how much to invest in new physical
capital were not influenced by market interest rates.
Diff: 2 Type: SA Page Ref: 27.1A- 4
Skill: Recall
Objective List: Appendix: Evaluating Empirical Evidence
What is the statistical evidence of early monetarists on the importance of money?
Answer: Monetarist statistical evidence conducted in a paper by Friedman and Meiselman in
1963 and examined the correlations between money M and autonomous expenditure A to
aggregate spending Y. They characterized the Keynesian model as saying that A should be
highly correlated with aggregate spending Y, while money supply M should not. In the
monetarist model, the money supply is the source of fluctuations in aggregate spending, and M
should be highly correlated with Y, while A should not. A logical way to find out which model is
better would be to see which is more highly correlated with Y: M or A. When they conducted
this test for many different periods of U.S. data, they discovered that the monetarist model wins.
They concluded that monetarist analysis gives a better description than Keynesian analysis of
how aggregate spending is determined.
Diff: 2 Type: SA Page Ref: 27.1A- 7
Skill: Recall
Objective List: Appendix: Evaluating Empirical Evidence