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Q. When Milton Friedman and Anna Schwartz in a book titled: A Monetary History of the United States, 1867-1960 uncovered the empirical reality that money is 'pro-cyclical' and 'leading,' the classical economists "went to the drawing board." We discussed how the RBC theorists explained this phenomenon through reverse causation. We also discussed how the New Classical school explained this phenomenon via the Lucas Island Model.
a) Provide the RBC explanation as to why money is leading and pro-cyclical. Be sure to include a money market diagram, an IS-LM diagram, and an AS/AD diagram in your answer being sure to refer to your graphs in your essay. Finish your essay by discussing whether or not money is neutral in the RBC model and why.
b) Use the "Lucas Island Model" to provide an explanation as to why money is leading and pro-cyclical according to the New Classical Economists. Be sure to include a completely labeled AS/AD diagram and an explanation of what we mean exactly by a Lucas Aggregate supply curve (along with the intuition underlying it). Finish your essay by discussing whether or not money is neutral in this New Classical model and why.
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