Monetary Policy within the IS-LM Framework

Chapter 6

Friedman and Modern Quantity Theory

Keynes’ General Theory1 introduced new ways of analyzing economics and providing explanations for business cycles. An important contribution is that it demonstrates the possibility that unemployment cannot be resolved automatically. In short, it shows that a market economy need not necessarily succeed in creating and maintaining full employment equilibrium in all markets, at all times. For example, the ­IS-­LM analysis of Chapter 3 reveals the possibility of equilibrium in the goods and money market without equilibrium in the labor market.

After 1936, it seemed that the Walrasian instantaneous auctioneer was dead, and Smith’s invisible hand crippled. The idea of discretionary fiscal and monetary ...