INTRODUCTION

Keynesian views on the role of money in the economy

are primarily derived from the work of John Maynard Keynes, especially as presented in his
seminal work, "The General Theory of Employment, Interest, and Money," published in 1936.
Keynesian economics places a strong emphasis on the role of money in influencing aggregate
demand and, consequently, determining overall economic activity (Keynes, 1936). Here are
some key aspects of Keynesian views on the role of money:
Medium of Exchange and Store of Value: Keynes acknowledged the traditional functions of
money as a medium of exchange and a store of value. Money facilitates transactions and helps
individuals store wealth in a convenient form.

Liquidity Preference: Keynes introduced the concept of liquidity preference, suggesting that
individuals have a preference for holding liquid assets (cash or near-cash assets) rather than less
liquid forms of wealth. The demand for money, therefore, is related to people's desire to hold
liquid assets for transactional purposes and as a precaution against uncertainty.

Interest Rates and Investment: Keynes argued that the interest rate plays a crucial role in
influencing investment decisions. He introduced the liquidity trap concept, where, during
economic downturns, interest rates may become so low that holding cash is preferred over other
assets. In such a scenario, traditional monetary policy measures may be less effective, and fiscal
policy becomes more important in stimulating demand.

Role in Aggregate Demand: Keynesian economics sees money as a key determinant of

aggregate demand. Changes in the money supply can influence interest rates, investment, and
consumption, which collectively impact overall spending in the economy.

Government Intervention: Keynesians advocate for active government intervention in the

economy, particularly through fiscal policy, to manage aggregate demand. In times of economic
recession, governments should increase spending or cut taxes to stimulate demand and reduce
unemployment. Conversely, during periods of inflation, fiscal measures can be used to cool
down the economy.
MONETARISM
Associated with economists like Milton Friedman, places a strong emphasis on the role of money
in the economy, particularly in determining the overall level of prices and inflation. Here are key
aspects of Monetarist views on the role of money,
Quantity Theory of Money: Monetarists adhere to the Quantity Theory of Money, which posits
a direct relationship between the money supply and the price level. The equation of exchange,
MV= PY, reflects the Quantity Theory, where M is the money supply, V is the velocity of money,
P is the price level, and Y is real output (Friedman, 1956).
Monetary Policy and Inflation: Monetarists argue that changes in the money supply directly
influence inflation rates. Controlling the growth rate of the money supply is seen as a key tool for
achieving price stability (Friedman & Schwartz, 1963).
Velocity of Money: Monetarists emphasize the importance of the velocity of money in
determining the overall level of economic activity. They contend that changes in velocity can
have significant effects on nominal GDP (Friedman, 1970).

Role of Central Banks: Monetarists advocate for a rule-based approach to monetary policy,
where the central bank should target a specific growth rate for the money supply. This is believed
to provide a stable economic environment (Friedman, 1968).

COMPARE AND CONTRAST

Keynesian and Monetarist views on the role of money in the economy represent two distinct
schools of thought in economics. While both theories acknowledge the importance of money in
the economic system, they differ in their explanations of how it influences economic activity and
the appropriate role of government in managing the money supply.

COMPARISON
Acknowledgment of Money's Importance: Both Keynesians and Monetarists acknowledge the
pivotal role of money in the economy. Keynesians, following John Maynard Keynes, recognize
money as a medium of exchange and a store of value. Monetarists, such as Milton Friedman,
similarly recognize money's significance and its influence on economic outcomes (Keynes,
1936;Friedman & Schwartz, 1963).
Impact of Money on Economic Activity: Both schools of thought agree that changes in the
money supply can affect economic activity. Keynesians and Monetarists emphasize the
importance of managing the money supply to achieve macroeconomic stability and address
fluctuations in output and employment (Keynes, 1936; Friedman, 1960).

CONTRAST:
Emphasis on Demand vs. Supply: Keynesians primarily focus on the demand side of the
economy. They assert that managing aggregate demand through fiscal policy is crucial for
economic stability, with a particular emphasis on influencing consumption and investment
(Keynes, 1936). Monetarists, on the other hand, emphasize the supply side, particularly the
money supply. They argue that controlling the growth rate of the money supply is vital for
maintaining stable prices and fostering long-term economic growth (Friedman, 1960).

Policy Recommendations: Keynesians advocate for active fiscal policy, recommending

government intervention through changes in spending and taxation to manage demand and
stabilize the economy (Keynes, 1936). On the other hand Monetarists favor a rule-based
approach to monetary policy, arguing for a stable growth rate of the money supply as a means of
achieving economic stability and avoiding the negative consequences of discretionary policy
(Friedman, 1960).
2. compare the monetary authority actions to address commodity and money markets shocks by
using IS-LM models.

The IS-LM model is a macroeconomic tool that shows how the equilibrium in the market for
goods (IS) interacts with the equilibrium in the money market (LM) at different levels of output
and interest rate. The model can be used to analyze how monetary actions affect the economy in
response to commodity and money markets shocks (Hicks,1937).

A commodity market shock is a sudden change in the price or availability of a commodity, such
as oil, gold, or wheat. A commodity market shock can affect the aggregate demand and supply of
goods and services, as well as the inflation rate and the exchange rate. For example, an increase
in the price of oil can reduce the demand for oil-dependent goods and services, increase the cost
of production, and raise the inflation rate. This can shift the IS curve to the left, reducing the
output and increasing the interest rate. Alternatively, a decrease in the price of oil can have the
opposite effects, shifting the IS curve to the right, increasing the output and reducing the interest
rate (Investopedia).

A money market shock is a sudden change in the demand or supply of money, such as an
increase or decrease in the money supply by the central bank, or a change in the preference for
holding money by the public. A money market shock can affect the liquidity and interest rate in
the economy, as well as the investment and consumption decisions. For example, an increase in
the money supply by the central bank can increase the liquidity and reduce the interest rate in the
money market, shifting the LM curve to the right. This can stimulate the investment and
consumption spending, increasing the output and reducing the interest rate further. Alternatively,
a decrease in the money supply by the central bank can have the opposite effects, shifting the LM
curve to the left, reducing the output and increasing the interest rate (Investopedia).

The following graph illustrates how the IS-LM model can be used to compare the effects of
different monetary actions in response to commodity and money markets shocks.( tafuta michoro
na uichole+ cover page)
In this graph, the initial equilibrium is at point E0, where the IS and LM curves intersect, and the
output and interest rate are Y0 and r0, respectively. Suppose there is a positive commodity
market shock, such as a decrease in the price of oil, that shifts the IS curve to the right, from IS0
to IS1. This increases the output and reduces the interest rate, moving the equilibrium to point E1
, where the new IS curve and the old LM curve intersect, and the output and interest rate are Y1
and r1, respectively. Now, suppose the central bank wants to counteract the effects of the
commodity market shock by decreasing the money supply, shifting the LM curve to the left,
from LM0 to LM1. This reduces the output and increases the interest rate, moving the
equilibrium back to point E0, where the new IS and LM curves intersect, and the output and
interest rate are Y0 and r0, respectively. Thus, the monetary action of decreasing the money
supply can offset the effects of the positive commodity market shock on the output and interest
rate.
3. Transmission mechanism of monetary

The transmission mechanism of monetary is the process by which monetary policy decisions
affect the economy and the price level. Monetary policy can influence the economy through
various channels, such as interest rates, expectations, asset prices, exchange rates, and credit
supply. The transmission mechanism is complex, nonlinear, and uncertain, and it may vary
across countries, time periods, and policy regimes.
One of the key channels of monetary transmission is the interest rate channel. This channel
works by affecting the cost and availability of credit for households and firms, as well as their
saving and investment decisions. For example, if the central bank lowers the policy interest rate,
this can reduce the market interest rates for loans and deposits, making borrowing cheaper and
saving less attractive. This can stimulate consumption and investment spending, and increase the
aggregate demand and output in the economy. Conversely, if the central bank raises the policy
interest rate, this can increase the market interest rates for loans and deposits, making borrowing
more expensive and saving more attractive. This can dampen consumption and investment
spending, and decrease the aggregate demand and output in the economy(Bernanke,2000;
Goodfriend, 2005).

Another important channel of monetary transmission is the expectations channel. This channel
works by affecting the beliefs and anticipations of economic agents about the future course of
monetary policy, inflation, and economic activity. For example, if the central bank lowers the
policy interest rate, this can signal its commitment to support the economy and maintain price
stability. This can boost the confidence and optimism of households and firms, and increase their
spending and investment plans. Conversely, if the central bank raises the policy interest rate, this
can signal its concern about inflationary pressures and economic overheating. This can reduce
the confidence and optimism of households and firms, and decrease their spending and
investment plans (Woodford, 2003; Orphanides, 2003).

Other channels of monetary transmission include the asset price channel, which works by
affecting the value and returns of financial and real assets, such as stocks, bonds, and housing
(Cochrane ,2011; Mishkin ,2007).The exchange rate channel, which works by affecting the
competitiveness and profitability of domestic and foreign producers, as well as the purchasing
power of domestic and foreign consumers( Obstfeld & Rogoff, 2006; Rey,2015) ; and the credit
channel, which works by affecting the availability and conditions of credit for borrowers and
lenders, especially in the presence of financial frictions and imperfections.

In summary, the transmission mechanism of monetary is the process by which monetary policy
affects the economy and the price level through various channels and mechanisms. The
transmission mechanism is not a simple or direct one, but rather a complex and dynamic one,
that depends on many factors and circumstances.
 REFERENCES.

Bernanke, B. S. (2000). Monetary policy and asset prices (No. w7973). National Bureau of
Economic Research.
Goodfriend, M. (2005). Interest rate policy and the conduct of monetary policy. Routledge.

Cochrane, J. H. (2011). Finance and growth. Princeton University Press.

Mishkin, F. S. (2007). The economics of money, banking, and financial markets. Addison-
Wesley.
Obstfeld, M., & Rogoff, K. (2006). Fundamentals of international economics. W.W. Norton &
Company.

Rey, H. (2015). Dilemma not trilemma: The conflict among stabilization, sterilization, and
internationalization. Journal of Monetary Economics, 77, 1-47.

Woodford, M. (2003). Interest and prices: Foundations of a theory of monetary policy. Princeton
University Press.
Orphanides, A. (2003). The expectations channel for monetary policy (No. w9600). National
Bureau of Economic Research.

Friedman, M. (1956). “The Quantity Theory of Money: A Restatement.” In Studies in the

Quantity Theory of Money. University of Chicago Press.

Friedman, M. (1960). A Program for Monetary Stability.

Friedman, M. (1968). “The Role of Monetary Policy.” American Economic Review, 58(1), 1-17.

Friedman, M. (1970). ''The Counter-Revolution in Monetary Theory." In The Optimum Quantity

of Money and Other Essays. Aldine Publishing Company.

Friedman, M., & Schwartz, A. J. (1963). “A Monetary History of the United States, 1867-1960.”
Princeton University Press.

Keynes, J. M. (1936). ''The General Theory of Employment, Interest, and Money.".

 Investopedia: The IS-LM model is described in detail, including its components,
characteristics, and historical context1.
 Hicks, J. R. (1937): Original work introducing the IS-LM model