Money, Income, and Causality: Some Evidence from Pakistan

Publication Year : 1991

The role of money in determining the level of economicactivity has long been debated among economists. The classicaleconomists were of the view that the changes in the money supply canonly affect the monetary variables like the price level and nominal wagerates but cannot influence real output. J. M. Keynes and his followersasserted that changes in money supply do influence the level of realoutput through their effect on the rate of interest and thereby changinginvestment expenditure. However, by introducing the idea of a liquiditytrap and by making investment as highly interest inelastic, Keynes didnot assign any active role to money. Milton Friedman and his followers,known as the Monetarists, raised the slogan that “money does matter” andthus tried to assign a dominant role to money supply in determining thelevel of economic activity. They assert that changes in money supplyhave a dominant influence on changes in nominal income. They are of theview that in the short run money does influence real output andemployment and thus money is the dominant factor causing cyclicalmovements in output and employment. However, they believe like theclassical economists, that in the long run the changes in moneyprimarily influence the price level and other nominalmagnitudes.

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