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Changing Role of Money in Economics
The assessment of the role of money in economic activities has been attempted by the classical, Keynesian and modern economists. They do not agree with the question of the role of money and monetary policy. Different views regarding the importance of money are explained below –
The Classical Views on Money
The classical economists believed that money was only a medium of exchange. People keep money as a medium of exchange. People require money for carrying out transactions or for buying and selling of goods and services.
The classical economists also believed that the role of money was neutral. It means changes in money supply affect money variables and not real variables.
Thus, money was supposed to have only a passive role in the economy. It gives a fully employed economics system in which money was neutral and the real balance effect was not present.
The classical economists advocated a stabilizing monetary policy in order to maintain price stability and reduce frictional unemployment in the economy.
Keynesian View on Money
According to Keynes, money is demanded not only for the transaction and precautionary motives, but also for speculative motive. He considered the money as the medium of exchange and also a store of value.
In Keynesian system, money was regarded as non-neutral in which monetary variations could have affect upon the real variables. Keynes strongly criticized the classical concept of a self regulating economy and advocated an active role for government policies for achieving full employment.
According to him, a properly designed fiscal policy combined with monetary expansion is the most effective way to recover or combat unemployment and depression.
He maintained that expansionary monetary policy is ineffective in the period of depression. However, he favoured a tight-money policy to tackle the problem of inflation.
The Modern view on money
The modern economists particularly Friedmen and Phelps postulate or said that monetary policy can affect the real variables only in the short period. The Friedmen-Phelps model explains, the situation of stagnation through the concept of neutral rate of unemployment to which an economy returns in the long run.
According to modern economists or monetarists, money is neutral in the long run. But they believed that changes in money supply can alter the relative prices and therefore can change the real variable in the short run.
The neo-classical writers explained that the real economic activity is not likely to get affected by the changes in money supply.
Again the neo-classical economists believed that both monetary and fiscal operation can have stabilising affect upon the economic system. Thus, the role of money has been changing regarding the views of different economists.
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