The Basics of Keynes's Monetary Theory Essay Example | Topics and Well Written Essays - 1000 words

The Basics of Keynes's Monetary Theory - Essay Example Keynes cautioned against free market systems as he pointed it out to be the cause of an unexpected rampant increase in unemployment rates. As Keynes differed with the classical perspective of economists on employment he keenly explained that employees were interested in the nominal wage rather than a real wage. Keynes further describes how employees respond to the levels of unemployment based on prices of wages in terms of frictional, seasonal and voluntary unemployment. Keynes biggest contribution is based on the money illusion by workers that lead to involuntary unemployment. In addition, Keynes came up with the liquidity preference theory of interest rates that focuses on the uses of money in differences classes. This is because money could be held for transaction motive as an individual wish to make normal purchases besides money for a precautionary motive that is for unforeseen incidences and money for a speculative motive of investments to get returns. In addition, the governme nt can control the amount of money borrowed from financial institutions by increasing the interest rate during periods of high inflation. Both the New Keynesian economists and New Classical economists have made contributions to the field of economics in the twentieth century. As a group opposed to the Keynes theory perspective, the new classical group of differs as they point out that Keynes did underestimate the impact of the quantity of money on aggregate demand and prices in the economy. In addition, the new classical economists argue a different notion on unemployment and inflation (Meltzer, 2005). This is because they advocate for a stable inflation-unemployment trade-off through the Phillips curve that involves the assumption of changes in the price level in the private sector freely. In addition, this class of economists conceptualized that the expectations-augmented in the Phillips curve could reduce the unemployment rate to a further extent below its natural level leading t o higher levels inflation in the long run (Meltzer, 2005). The new classical economists differ with the Keynes economists as they believe both monetary and fiscal policy lead to increased inflation rates because of the response of suppliers to the economic market. Based on the classical assumption on flexible prices a consecutive increase in aggregate demand automatically leads to higher prices; that cause unexpected shift as suppliers will increase production to take advantage of increased relative prices. The New Keynesian economists are based on the theory contributions made by Keynes as they believe that in the economy the nominal variables can affect real variables and understanding of market imperfections in the economy. This new group of Keynes economists believes that imperfect competition will solve several problems that deal with wages and prices levels thus, reducing the possibility of involuntary unemployment (Meltzer, 2005). This new class of Keynes economists believes that the welfare of the citizen is in increasing output and employment. Therefore, this class of economists believes that both monetary and fiscal policy allows for changes in price levels as it affects both the demand and supply.