Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. Developed primarily by economist Milton Friedman in the 1950s, it argues that variations in the money supply have major influences on national output in the short run and the price level 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 fiscal policies. According to this view, stable economic growth and low inflation are best achieved by controlling the expansion of the money supply to match the growth in productivity and demand.
The core mechanism of monetarism is the Quantity Theory of Money, represented by the equation MV = PQ, where M stands for money supply, V for velocity of money, P for price level, and Q for output. Monetarists believe that V and Q are relatively stable in the short term. Thus, any change in M directly affects P, leading to inflation if the money supply grows too quickly. This relationship lays the foundation for monetarist policies that aim for a steady, moderate expansion of the money supply, which, according to this theory, should help stabilize the economy without triggering rapid inflation.
The implementation of monetarist policies can be observed during the late 20th century, particularly in the United States and the United Kingdom. The most notable period was during the early 1980s when the Federal Reserve, under Chairman Paul Volcker, dramatically increased interest rates to combat the high inflation of the 1970s. This policy shift was aligned with monetarist principles and led to a severe recession in the short term but was successful in lowering inflation, demonstrating the influence of monetary policy over the economy's health.
Critics of monetarism argue that its focus on the money supply as the primary driver of economic activity is too narrow. They contend that it disregards other crucial factors such as investment, technology changes, and consumer behavior. Additionally, the assumption that the velocity of money and output are stable has been challenged, particularly in light of economic crises such as the 2008 financial meltdown, where these variables exhibited significant fluctuation. Despite these criticisms, monetarism has contributed significantly to our understanding of the relationship between money supply and economic activity, and it continues to influence monetary policy in various forms around the world.
EconomicTheory MiltonFriedman QuantityTheory FederalReserve VelocityOfMoney