What Is Monetarism? - Back to Basics - Finance & Development, March
Monetarists postulate that the economic health of an economy can be While this makes sense, monetarists say velocity is generally stable. Monetarism is an economic theory that says the money supply drives growth in in his address to the American Economic Association. theory of money. The Monetarists claim that a change in the money supply causes a lish in a theoretical way whether there is a causal relationship between.
This theory draws its roots from two historically antagonistic schools of thought: The result was summarised in a historical analysis of monetary policy, Monetary History of the United States —, which Friedman coauthored with Anna Schwartz. The book attributed inflation to excess money supply generated by a central bank. It attributed deflationary spirals to the reverse effect of a failure of a central bank to support the money supply during a liquidity crunch.
Under this rule, there would be no leeway for the central reserve bank, as money supply increases could be determined "by a computer", and business could anticipate all money supply changes.
Monetarism - Wikipedia
Opposition to the gold standard[ edit ] Most monetarists oppose the gold standard. Friedman, for example, viewed a pure gold standard as impractical. Rise[ edit ] Clark Warburton is credited with making the first solid empirical case for the monetarist interpretation of business fluctuations in a series of papers from Friedman argued that the demand for money could be described as depending on a small number of economic variables.
These excess money balances would therefore be spent and hence aggregate demand would rise. Similarly, if the money supply were reduced people would want to replenish their holdings of money by reducing their spending. In this, Friedman challenged a simplification attributed to Keynes suggesting that "money does not matter. The rise of the popularity of monetarism also picked up in political circles when Keynesian economics seemed unable to explain or cure the seemingly contradictory problems of rising unemployment and inflation in response to the collapse of the Bretton Woods system in and the oil shocks of On the one hand, higher unemployment seemed to call for Keynesian reflationbut on the other hand rising inflation seemed to call for Keynesian disinflation.
Differences Between Monetarist & Keynesian Theories of Money | Pocket Sense
InUnited States President Jimmy Carter appointed as Federal Reserve chief Paul Volckerwho made fighting inflation his primary objective, and who restricted the money supply in accordance with the Friedman rule to tame inflation in the economy.
The result was a major rise in interest rates, not only in the United States; but worldwide.
The "Volcker shock" continued from to the summer ofdramatically both decreasing inflation and increasing unemployment. Monetarist economists never recognized that the policy implemented by the Federal Reserve from was a monetarist policy.
Monetarist Theory of Inflation
Nevertheless, the influence of monetarism on the Federal Reserve was twofold: However, unemployment in the United Kingdom dramatically increased from 5. In his seminal work A Monetary History of the United States, —, which he wrote with fellow economist Anna Schwartz inFriedman argued that poor monetary policy by the U.
In their view, the failure of the Fed as it is usually called to offset forces that were putting downward pressure on the money supply and its actions to reduce the stock of money were the opposite of what should have been done.
They also argued that because markets naturally move toward a stable center, an incorrectly set money supply caused markets to behave erratically. Inwith U. But monetarism faded in the following decades as its ability to explain the U. Nevertheless, some of the insights monetarists brought to economic analysis have been adopted by nonmonetarist economists. At its most basic The foundation of monetarism is the Quantity Theory of Money.
The theory is an accounting identity—that is, it must be true. It says that the money supply multiplied by velocity the rate at which money changes hands equals nominal expenditures in the economy the number of goods and services sold multiplied by the average price paid for them.
As an accounting identity, this equation is uncontroversial. What is controversial is velocity.
Monetarist theory views velocity as generally stable, which implies that nominal income is largely a function of the money supply. Variations in nominal income reflect changes in real economic activity the number of goods and services sold and inflation the average price paid for them. The quantity theory is the basis for several key tenets and prescriptions of monetarism: An increase in the money stock would be followed by an increase in the general price level in the long run, with no effects on real factors such as consumption or output.
An increase in the stock of money has temporary effects on real output GDP and employment in the short run because wages and prices take time to adjust they are sticky, in economic parlance. Friedman, who died inproposed a fixed monetary rule, which states that the Fed should be required to target the growth rate of money to equal the growth rate of real GDP, leaving the price level unchanged.
If the economy is expected to grow at 2 percent in a given year, the Fed should allow the money supply to increase by 2 percent. The Fed should be bound to fixed rules in conducting monetary policy because discretionary power can destabilize the economy. The money growth rule was intended to allow interest rates, which affect the cost of credit, to be flexible to enable borrowers and lenders to take account of expected inflation as well as the variations in real interest rates.
They also assert that government intervention can often destabilize the economy more than help it.
Differences Between Monetarist & Keynesian Theories of Money
Keynesians, who took their inspiration from the great British economist John Maynard Keynes, believe that demand for goods and services is the key to economic output. They contend that monetarism falters as an adequate explanation of the economy because velocity is inherently unstable and attach little or no significance to the quantity theory of money and the monetarist call for rules. Keynesians also do not believe that markets adjust to disruptions and quickly return to a full employment level of output.
But the monetarist challenge to the traditional Keynesian theory strengthened during the s, a decade characterized by high and rising inflation and slow economic growth.