Monetarism

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Monetarism is a school of thought in

monetary economics that emphasizes the
role of governments in controlling the
amount of money in circulation.
Monetarist theory asserts that variations
in the money supply have major influences
on national output in the short run and on
price levels over longer periods.
Monetarists assert that the objectives of
monetary policy are best met by targeting
the growth rate of the money supply rather
than by engaging in discretionary
monetary policy.[1]

Monetarism today is mainly associated

with the work of Milton Friedman, who was
among the generation of economists to
accept Keynesian economics and then
criticise Keynes's theory of fighting
economic downturns using fiscal policy
(government spending). Friedman and
Anna Schwartz wrote an influential book, A
Monetary History of the United States,
1867–1960, and argued "inflation is always
and everywhere a monetary
phenomenon".[2]

Though he opposed the existence of the

Federal Reserve,[3] Friedman advocated,
given its existence, a central bank policy
aimed at keeping the growth of the money
supply at a rate commensurate with the
growth in productivity and demand for
goods.

Description
Monetarism is an economic theory that
focuses on the macroeconomic effects of
the supply of money and central banking.
Formulated by Milton Friedman, it argues
that excessive expansion of the money
supply is inherently inflationary, and that
monetary authorities should focus solely
on maintaining price stability.

This theory draws its roots from two

historically antagonistic schools of
thought: the hard money policies that
dominated monetary thinking in the late
19th century, and the monetary theories of
John Maynard Keynes, who, working in the
inter-war period during the failure of the
restored gold standard, proposed a
demand-driven model for money.[4] While
Keynes had focused on the stability of a
currency’s value, with panics based on an
insufficient money supply leading to the
use of an alternate currency and collapse
of the monetary system, Friedman
focused on price stability.

The result was summarised in a historical

analysis of monetary policy, Monetary
History of the United States 1867–1960,
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.[5]
Friedman originally proposed a fixed
monetary rule, called Friedman's k-percent
rule, where the money supply would be
automatically increased by a fixed
percentage per year. 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.[6][7] With other monetarists he
believed that the active manipulation of
the money supply or its growth rate is
more likely to destabilise than stabilise the
economy.
Opposition to the gold standard E…

Most monetarists oppose the gold

standard. Friedman, for example, viewed a
pure gold standard as impractical.[8] For
example, whereas one of the benefits of
the gold standard is that the intrinsic
limitations to the growth of the money
supply by the use of gold would prevent
inflation, if the growth of population or
increase in trade outpaces the money
supply, there would be no way to
counteract deflation and reduced liquidity
(and any attendant recession) except for
the mining of more gold.

Rise
Rise
Clark Warburton is credited with making
the first solid empirical case for the
monetarist interpretation of business
fluctuations in a series of papers from
1945.[1]p. 493 Within mainstream
economics, the rise of monetarism
accelerated from Milton Friedman's 1956
restatement of the quantity theory of
money. Friedman argued that the demand
for money could be described as
depending on a small number of economic
variables.[9]

Thus, where the money supply expanded,

people would not simply wish to hold the
extra money in idle money balances; i.e., if
they were in equilibrium before the
increase, they were already holding money
balances to suit their requirements, and
thus after the increase they would have
money balances surplus to their
requirements. 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."[9] Thus the word 'monetarist' was
coined.

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 1972 and the oil shocks of 1973. On the
one hand, higher unemployment seemed
to call for Keynesian reflation, but on the
other hand rising inflation seemed to call
for Keynesian disinflation.
In 1979, United States President Jimmy
Carter appointed as Federal Reserve chief
Paul Volcker, who 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 1979 to the summer of
1982, dramatically both decreasing
inflation and increasing unemployment.
Monetarist economists never recognized
that the policy implemented by the Federal
Reserve from 1979 was a monetarist
policy. Nevertheless, the influence of
monetarism on the Federal Reserve was
twofold: a direct influence, by the
adherence of some members of the
Federal Open Market Committee to
monetarist ideas; and an indirect
influence, because monetarist views were
taken into account in the determination of
US monetary policy: even the members of
the FOMC who were not monetarists took
monetarist influence into strong
consideration.[10]

By the time Margaret Thatcher, Leader of

the Conservative Party in the United
Kingdom, won the 1979 general election
defeating the sitting Labour Government
led by James Callaghan, the UK had
endured several years of severe inflation,
which was rarely below the 10% mark and
by the time of the May 1979 general
election, stood at 15.4%.[11] Thatcher
implemented monetarism as the weapon
in her battle against inflation, and
succeeded at reducing it to 4.6% by 1983.
However, unemployment in the United
Kingdom dramatically increased from
5.7% in 1979 to 12.2% in 1983, reaching
13.0% in 1982; and starting with the first
quarter of 1980, the UK economy
contracted in terms of real gross domestic
product for six straight quarters.[12]
 

Money supply decreased significantly between Black

Tuesday and the Bank Holiday in March 1933 in the
wake of massive bank runs across the United States.

Monetarists not only sought to explain

present problems; they also interpreted
historical ones. Milton Friedman and Anna
Schwartz in their book A Monetary History
of the United States, 1867–1960 argued
that the Great Depression of the 1930s
was caused by a massive contraction of
the money supply (they deemed it "the
Great Contraction"[13]), and not by the lack
of investment Keynes had argued. They
also maintained that post-war inflation
was caused by an over-expansion of the
money supply.

They made famous the assertion of

monetarism that "inflation is always and
everywhere a monetary phenomenon".
Many Keynesian economists initially
believed that the Keynesian vs. monetarist
debate was solely about whether fiscal or
monetary policy was the more effective
tool of demand management. By the mid-
1970s, however, the debate had moved on
to other issues as monetarists began
presenting a fundamental challenge to
Keynesianism.

Many monetarists sought to resurrect the

pre-Keynesian view that market
economies are inherently stable in the
absence of major unexpected fluctuations
in the money supply. Because of this belief
in the stability of free-market economies
they asserted that active demand
management (e.g. by the means of
increasing government spending) is
unnecessary and indeed likely to be
harmful. The basis of this argument is a
relationship between "stimulus" fiscal
spending and future interest rates. In
effect, Friedman's model argues that
current fiscal spending creates as much of
a drag on the economy by increased
interest rates as it creates present
consumption: that it has no real effect on
total demand, merely that of shifting
demand from the investment sector to the
consumer sector.

Current state
Since 1990, the classical form of
monetarism has been questioned. This is
because of events that many economists
interpreted as being inexplicable in
monetarist terms: the disconnection of the
money supply growth from inflation in the
1990s and the failure of pure monetary
policy to stimulate the economy in the
2001–2003 period. Greenspan argued that
the 1990s decoupling was explained by a
virtuous cycle of productivity and
investment on one hand, and a certain
degree of "irrational exuberance" in the
investment sector on the other.

There are also arguments that monetarism

is a special case of Keynesian theory. The
central test case over the validity of these
theories would be the possibility of a
liquidity trap, like that experienced by
Japan. Ben Bernanke, Princeton professor
and another former chairman of the U.S.
Federal Reserve, argued that monetary
policy could respond to zero interest rate
conditions by direct expansion of the
money supply. In his words, "We have the
keys to the printing press, and we are not
afraid to use them."

These disagreements—along with the role

of monetary policies in trade liberalisation,
international investment, and central bank
policy—remain lively topics of
investigation and argument.

Notable proponents
Karl Brunner
 Phillip D. Cagan
Milton Friedman
Alan Greenspan
David Laidler
Allan Meltzer
Anna Schwartz
Margaret Thatcher
Paul Volcker
Clark Warburton

See also
Austrian School of economics
Chicago school of economics
Demurrage (currency)
 Fiscalism (usually contrasted to
monetarism)
Inflation targeting
Market monetarism
Modern Monetary Theory

General:

Macroeconomics
Political economy

References
1. Phillip Cagan, 1987. "Monetarism", The
New Palgrave: A Dictionary of
Economics, v. 3, Reprinted in John
 Eatwell et al. (1989), Money: The New
Palgrave, pp. 195–205, 492–97.
2. Friedman, Milton (2008). Monetary
History of the United States, 1867-
1960. Princeton University Press.
ISBN 0691003548. OCLC 994352014 .
3. Doherty, Brian (June 1995). "Best of
Both Worlds" . Reason. Retrieved
July 28, 2010.
4. Mankiw, N. Gregory. "Real Business
Cycles: A New Keynesian Perspective".
Journal of Economic Perspectives 3.3
(1989): 79–90. Web.|date=October
2013
5. Bordo, Michael D. (1989). "The
Contribution of A Monetury History" .
Money, History, & International
Finance: Essays in Honor of Anna J.
Schwartz . The Increase in Reserve
Requirements, 1936-37. University of
Chicago Press. p. 46 . ISBN 0-226-
06593-6. Retrieved 2019-07-25.
6. Thomas Palley (November 27, 2006).
"Milton Friedman: The Great
Conservative Partisan" . Retrieved
June 20, 2013.
7. Ip, Greg; Whitehouse, Mark (2006-11-
17). "How Milton Friedman Changed
Economics, Policy and Markets" . The
Wall Street Journal.
8. "Monetary Central Planning and the
State, Part 27: Milton Friedman's
Second Thoughts on the Costs of
Paper Money" . Archived from the
original on November 14, 2012.
9. Friedman, Milton (1970). "A
Theoretical Framework for Monetary
Analysis". Journal of Political
Economy. 78 (2): 193–238 [p. 210].
doi:10.1086/259623 .
JSTOR 1830684 .
10. Reichart Alexandre & Abdelkader Slifi
(2016). 'The Influence of Monetarism
on Federal Reserve Policy during the
1980s.' Cahiers d'économie
Politique/Papers in Political Economy,
(1), pp. 107–50.
https://www.cairn.info/revue-cahiers-
d-economie-politique-2016-1-page-
107.htm
11. "Economy tables: GDP, interest rates
and inflation history, unemployment" .
This Is Money. Retrieved June 20,
2013.
12. "Real Gross Domestic Product for
United Kingdom, Federal Reserve Bank
of St. Louis" . Retrieved December 16,
2018.
13. Milton Friedman; Anna Schwartz
(2008). The Great Contraction, 1929–
1933 (New Edition) . Princeton
University Press. ISBN 0-691-13794-3.

Further references
Andersen, Leonall C., and Jerry L.
Jordan, 1968. "Monetary and Fiscal
Actions: A Test of Their Relative
Importance in Economic Stabilisation",
Federal Reserve Bank of St. Louis
Review (November), pp. 11–24. PDF
(30 sec. load: press +) and HTML.
_____, 1969. "Monetary and Fiscal
Actions: A Test of Their Relative
Importance in Economic Stabilisation —
Reply", Federal Reserve Bank of St.
Louis Review (April), pp. 12–16. PDF
(15 sec. load; press +) and HTML.
Brunner, Karl, and Allan H. Meltzer, 1993.
Money and the Economy: Issues in
Monetary Analysis, Cambridge.
Description and chapter previews, pp.
ix –x.
Cagan, Phillip, 1965. Determinants and
Effects of Changes in the Stock of Money,
1875–1960. NBER. Foreword by Milton
Friedman, pp. xiii–xxviii. Table of
Contents.
Friedman, Milton, ed. 1956. Studies in
the Quantity Theory of Money, Chicago.
Chapter 1 is previewed at Friedman,
2005, ch. 2 link.
_____, 1960. A Program for Monetary
Stability. Fordham University Press.
_____, 1968. "The Role of Monetary
Policy", American Economic Review,
58(1), pp. 1–17 (press +).
_____, [1969] 2005. The Optimum
Quantity of Money. Description and
table of contents , with previews of 3
chapters.
Friedman, Milton, and David Meiselman,
1963. "The Relative Stability of Monetary
Velocity and the Investment Multiplier in
the United States, 1897–1958", in
Stabilization Policies, pp. 165–268.
Prentice-Hall/Commission on Money
and Credit, 1963.
Friedman, Milton, and Anna Jacobson
Schwartz, 1963a. "Money and Business
Cycles", Review of Economics and
Statistics, 45(1), Part 2, Supplement, p.
p. 32 –64. Reprinted in Schwartz, 1987,
Money in Historical Perspective, ch. 2.
_____. 1963b. A Monetary History of the
United States, 1867–1960. Princeton.
Page-searchable links to chapters on
1929-41 and 1948–60
Johnson, Harry G., 1971. "The Keynesian
Revolutions and the Monetarist Counter-
Revolution", American Economic Review,
61(2), p. p. 1 –14. Reprinted in John
Cunningham Wood and Ronald N.
Woods, ed., 1990, Milton Friedman:
Critical Assessments, v. 2, p. p. 72 –
88. Routledge,
Laidler, David E.W., 1993. The Demand
for Money: Theories, Evidence, and
Problems, 4th ed. Description.
 Schwartz, Anna J., 1987. Money in
Historical Perspective, University of
Chicago Press. Description and
Chapter-preview links, pp. vii -viii.
Warburton, Clark, 1966. Depression,
Inflation, and Monetary Policy; Selected
Papers, 1945–1953 Johns Hopkins
Press. Amazon Summary in Anna J.
Schwartz, Money in Historical
Perspective, 1987.

External links
"Monetarism" at The New School's
Economics Department's History of
Economic Thought website.
 McCallum, Bennett T. (2008).
"Monetarism" . In David R. Henderson
(ed.). Concise Encyclopedia of
Economics (2nd ed.). Indianapolis:
Library of Economics and Liberty.
ISBN 978-0865976658.
OCLC 237794267 .
Monetarism from the Economics A–Z
of The Economist

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