Macroeconomic Equilibrium - Monetarists vs Keynesians: The Final Showdown

Macroeconomic Equilibrium – Monetarists vs Keynesians: The Final Showdown

Imagine you’re at a music festival. The crowd’s buzzing (aggregate demand), the performers are ready (aggregate supply), and everything's flowing just right - that’s macroeconomic equilibrium. But what if too many people show up and the sound system can’t cope? Or worse, no one shows up and the headline act plays to a field of sheep? Welcome to the wild world of macroeconomic imbalance.

What is Macroeconomic Equilibrium?

At its core, macroeconomic equilibrium happens when aggregate demand (AD) = aggregate supply (AS) - like two perfectly matched dance partners. This can occur in the short run or the long run, and how it happens depends on whether you follow the Monetarist or the Keynesian school of thought.

Short-Run Macroeconomic Equilibrium: SRAS Meets AD

In the short run, equilibrium is reached when SRAS intersects AD. This determines:

• The average price level (think: general ticket prices for the economy)

• The real GDP / output (how many people actually show up to the gig)

But here’s where things get more interesting: depending on the price elasticity of supply, changes in demand could cause:

• A massive spike in prices (if AS is inelastic)

• A big jump in output (if AS is elastic)

The Monetarist View: The Economy Always Finds Its Way (Eventually)

Monetarists believe the economy is a bit like a GPS - it recalculates route and eventually brings you back to full employment, no matter what detour you take.

So what do they believe in?

• The LRAS is vertical at full employment output (YF).

• Wages and prices are flexible, so the economy self-corrects.

• If there’s an inflationary gap (too much demand), the SRAS will shift left due to higher costs - bringing you back to YF.

• No need for government intervention. Let the market do its thing.

Real-world check: Think Germany - often praised for long-term fiscal discipline and structural reform, sticking close to monetarist ideals.

The Keynesian View: Sometimes You’ve Got to Step In

Keynesians see the economy more like a moody teenager. Left alone, it might spiral into a long sulk (a recession) and not bounce back on its own.

Here’s their take:

• The AS curve has three zones: flat, sloped, and vertical.

• In deep recessions (like the 2008 Global Financial Crisis or Japan in the '90s), the economy can get stuck in a deflationary gap.

• Wages are sticky downwards - people don’t accept pay cuts easily, especially with strong unions or long-term contracts.

• Government intervention is essential: fiscal and monetary policies are needed to nudge the economy out of trouble.

Real-world throwback: Think of how governments injected billions during COVID-19 just to keep economies alive.

Inflationary & Deflationary Gaps: When Things Get Wobbly

• An inflationary gap (YE > YF) = the economy’s overheating. Too much money chasing too few goods = rising prices. Hello, inflation.

• A deflationary (or recessionary) gap (YE < YF) = economy underperforms. Output and employment fall. Hello, Netflix binges and CV updating.

Each model offers its own fix:

• Monetarists: “Patience, young padawan. The market itself will fix it.”

• Keynesians: “Intervene before this turns into a full-blown crisis.”

Why It Matters for IB Students

Knowing the difference between these models can win you major points on Paper 3 and provide the economic street smarts to debate fiscal policy over dinner (or more realistically, argue about inflation with your mate who just bought crypto).

Real-Life Example Showdown

1. USA during the Great Depression: Keynesian policies under FDR’s New Deal helped boost government spending to pull the economy out of a slump.

2. Post-COVID EU response: massive stimulus packages used Keynesian logic to avoid economic collapse.

3. Brazil’s monetary tightening in 2023: Monetarist in tone, raising interest rates to tame inflation despite high unemployment risk.

Key Takeaways

• Monetarist Model: Self-correcting, vertical LRAS, flexible prices/wages, focus on long-term.

• Keynesian Model: Economy can stay in recession, sticky wages, three-zoned AS curve, active gov intervention needed.

• Both models agree that long-term growth depends on increasing productive capacity - but they strongly disagree on how to handle the bumps along the way.

Stay well