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The General Theory of Employment Interest and Money - Research Paper Example

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This paper “The General Theory of Employment Interest and Money” is meant to work upon the relationship between the systematic money supply actions and the inflation rate in the context of the United States. For that purpose, a simple linear model has been chosen…
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The General Theory of Employment Interest and Money
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Download file to see previous pages After the Great Depression, 1929 the idea of Classical Dichotomy which states that the real and the nominal macroeconomic variables are determined in the separate markets, i.e. none of them can affect each other, got a severe jolt. In 1933, John Maynard Keynes in his revolutionary book, The General Theory of Employment Interest and Money, claimed that the Classical Dichotomy does not hold in the short run, i.e. the nominal variables can influence the real variables in the short run and vice versa—the economy is no more dichotomized between the real and the nominal sectors. Later on, in 1960s Prof Milton Friedman postulated his famous ‘Quantity Theory of Money’, in a simple form which says that: MV= PY. M=Money supply, P=Price index, Y=Gross Output and V=Velocity of money (how frequently money changes hands). From this equation, we may write % change in M= % change in P, for a given output and velocity of money. Thus for a given output and velocity of money (which usually remains constant for a long period of time) the rate of change of money supply exactly matches the rate of inflation. Prof Friedman proved this more empirically than theoretically in the U.S. context. According to him, “Inflation is always and everywhere a monetary phenomenon”. Though, the link between the money supply and changes in inflation is not instantaneous. In Dec 1971 Milton Friedman presented a work at American Economic Association meetings, regarding the lagged effect of money supply on the inflation rate. His estimates showed the highest correlation with 20 months’ lagged money supply (M1). Since then for many countries that have been able to arrest inflation to a moderate level. ...Download file to see next pagesRead More
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