What Are The Flaws Of Money Theory
The study of macro economics entails the behaviour of modern economy as a complete system. The following paper centers specifically on the money theory postulated by Keynes. We focus on the flaws in the classical money theory and then move on to explain the Keynes money model, then work on the criticisms on it. Since it is believed in the 1960's 70's and even now that
"Never trust any theory of money older than thirty years"
The Classical Theory:
The fundamental principle of the classical theory is that the economy is self regulating. Classical economists maintain that the economy is always capable of achieving the natural level of real GDP or output, which is the level of real GDP that is obtained when the economy's resources …show more content…
Thus, the basic need is for a theory which will diagnose the ills of the modern economic system and furnish a guide for the solution of problems like unemployment, business cycles, inflation and other economic ills.
Keynesian Theory of Money:
Keynes reformulated the old Quantity theory of Money that failed to integrate the value theory with the monetary theory. He argues that there exists a rather non-proportional and indirect relationship between quantity theory of money and prices. He formulates the missing link between the in the old theory old money that failed to exert the influence quantity of money on the interest rate, which in turn reacts upon the output and employment.
Keynes’ theory of money revolves around the fundamentals of how money affects income via the interest rate. For example, an increase in the money supply lowers the interest rate, and the lower interest rate in turn, increases aggregate demand and income.
Keynes’ Reformulated Theory on …show more content…
The assumption of classical quantity theory of money is very unrealistic due to full employment of resources. According to the assumptions, the increase in the quantity of money will always result to a proportionate increase in the level of price. But Keynes views were different; he believes that full employment is an exception.
So, if there is an unemployment, both output and employment will change in the same proportion as the quantity of money changes, but the price will not be affected; and when there is full employment, prices will also change in the same proportion as the quantity of money. Therefore, the Keynesian analysis of theory of money is more advanced than the classical analysis of money for establishing its relationship between the quantity of money and prices both under unemployment and full employment conditions. Keynesian theory of money emphasizes more on important policy implications but the traditional theory of money believes that every increase in the quantity of money leads to