How did the monetary theories of Milton Friedman and John Keynes differ and what is the significanceof their difference in opinion? 20 points Keynes and Friedman are usually perceived as opposing, rather than supporting each other’s ideas. According to Keynes, money held by people served the purpose of protecting them from unexpected occurrences. Therefore, demand for money reduces with increase in interest rates leading to increased money supply in the capital markets. This reduction in demand for money causes the establishment of a financial foundation that result to extra cumulative demand.
The extra demand is prone to fluctuations even when the central bank and commercial banks make the money supply available. Friedman, on the other hand, argues that the need for money is minimally affected by the available interest rates. He notes that effects of interest rates can force the financial investors to leave the capital markets and invest in equities, durable goods and other profitable assets apart from money. His theory states that increase in interest rates does not necessarily result to increase in aggregate demand and, therefore, only the central bank changes fluctuates the total market. 2.
What is the difference between adaptive expectations and rational expectations? 20 points Adaptive expectations refer to the changes in behavior of people when they learn over a certain period as a result of their own experiences. For example, a wage cut during depression may not be welcomed by many but when unemployment rate persists for a longer time, people eventually adjust to the demands. Additionally, rational expectations take place after considering all the available information such as past events, government history and the how the business reacts and evaluates changes in economic conditions.
Precisely, rational expectations predict events and respond more rapidly to changing events rather than reacting to the economic changes. 3. Both Hayek and Keynes thought that uncertainty was the cause of business cycles, yet they came to different conclusions about what this meant. Briefly compare their perspectives and explain the significance of their differences. 20 points According to Keynes and Frank Knight, uncertainty refers to the unknown future in the same way as the probability. In this environment, people come up with strategies that are accompanied with mistakes leading to a reduction in economic activity and calls for correction by the state but Hayek alleged that no one possesses above a small fraction of the entire information and, therefore, data can be revealed by interpersonal exchange and networking.
He believed that the market prices were major means for information on revealing economic conditions but the state as well as the people was ignorant on the means of gauging particular and true economic conditions. In his conclusion, Hayek found out that intervention by the state in economic activity frustrated the market mechanism and price changes that were better indicators of economic conditions. Work cited Garrison, John.
Is Milton Friedman a Keynesian? in Mark Skousen, ed., Dissent on Keynes: A Critical Appraisal of Keynesian Economics, New York: Praeger Publishers, 1992: 131-147.