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While the monetarists' and non-monetarists' views about the transmission process of monetary policy do not appear to differ significantly with respect either to relative price or wealth effects of monetary policy on the real sector of the economy, their empirical examinations suggest two entirely different results. Specifically, the non-monetarists use large scale economic models which provide some evidence that fiscal variables are more effective than monetary variables. On the other hand, monetarists start from a reduced form function derived from the monetary and real sector. This function, that approximates the aggregate demand curve and also determines nominal income, provides evidence indicated that monetary variables are far more significant than fiscal variables.

The purpose of this study is to provide a structural model based on the IS-LM framework, in order to examine the reasonableness of monetarist assumptions underlying their reduced form function. These assumptions are: (1) the demand for money is stable over time; (2) the factors determining the demand for and supply of money are independent of each other; and (3) the price elasticity of aggregate demand is minus one.