Monetarism

Monetarism is a set of views concerning the determination of national income and monetary economics. These are areas of economics over which there are fundamental and often passionate theoretical disagreements. One has to keep in mind that there are as many views on economics as there are economists.

Table of contents
1 What are monetarists?
2 The rise of monetarism
3 Monetarism in practice
4 Monetarism and Monetary Theory

What are monetarists?

One thing that monetarists are not is new; they are simply a modern variation of the neoclassical school of economics which dominated the field from the 1870s to the Keynesian revolution of the 1930s and 1940s. Monetarists share the same essential view as the neoclassical school, that is, they reject theories of macro demand deficiencies and emphasize the efficiency of free markets; for instance, they believe that market forces act quickly to eliminate unemployment. Monetarists are new only in the sense that their theory is more sophisticated than that of their ancestors and that their doctrine has reasserted itself after a long period following 1945 in which Keynesians dominated both economics and economic policy.

The modern term 'monetarist' derives from the debate of the 1960s and 1970s concerning the role of money in determining aggregate demand. It is seen by many as a relatively narrow argument to motivate specific monetary reform, in particular, a "fine-turning" of measures to deal with inflation — while, its critics say, ignoring everything else, well being in particular.

The rise of monetarism

The rise of monetarism within mainstream economics dates mostly from Milton Friedman's 1956 restatement of the quantity theory of money. Friedman argued that the demand for money depended in a stable and predictable manner on several major economic variables. Thus, if the money supply was 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. Thus Friedman challenged the Keynesian assertion that 'money does not matter'; he argued that the supply of money does affect the amount of spending in an economy. Thus the word 'monetarist' was coined.

The rise of the popularity of monetarism in political circles accelerated as Keynesian economics seemed unable to explain or cure the seemingly contradictory problems of rising unemployment and inflation. On the one hand higher unemployment seemed to call for Keynesian reflation, but on the other hand rising inflation seemed to call for Keynesian deflation. The result was a significant disillusionment with Keynesian demand management.

Monetarists not only sought to explain contemporary 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 1930 was caused by a massive contraction of the money supply and not by the lack of investment as Keynes had argued. They also maintained that post-war inflation was caused by an over-expansion of the money supply. They coined the famous assertion of monetarism that 'inflation is always and everywhere a monetary phenomenon'. At first, to many economists whose perceptions had been set by Keynesian ideas, it seem that the Keynesian v. monetarist debate was merely 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 more profound matters as monetarists presented a more fundamental challenge to Keynesian orthodoxy.

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 (eg. by the means of increasing government spending) is unnecessary and indeed likely to be harmful.

Monetarism in practice

The political right adopted the outward rationale of monetarism as an intellectual underpinning of their wish to return to a laissez-faire approach to economic policy in which economic outcomes are left to be determined by the free play of market forces, and free trade to ensure competition. This was especially attractive to those on the right, such as Margaret Thatcher and Ronald Reagan, who interpreted the expansion of the role of government as back door socialism.

However, monetarists are very skeptical that fiscal policy in the form of tax cuts serve as an economic stimulus. They are often concerned over the long term damage that large budget deficits can do to the economy. There is often conflict between monetarists and supply-side economics. This occurred during the administrations of Ronald Reagan and George W. Bush, when monetarists disagreed over the wisdom of large tax cuts which were supposed to produce a stimulus effect on the economy despite unabated government spending on agricultural subsidies and the military.

Monetarism and Monetary Theory

Monetarists of the Milton Friedman school of thought believed in the 1970s and 1980s that the growth of the money supply should be based on certain formulations related to economic growth. As such they can be regarded as adovcates of a monetary policy based on a "quantity of money" target. This can be contrasted with the monetary policy advocated by supply side economics or Austrian economics which are based on a "value of money" target or concept.

In 2003 Milton Friedman renounced many of the policies from the 1980s that were based on quantity targets. In doing so he basically conceded that the demand for money is not easily predicted. However he stands by his basic formulations.

See also macroeconomics, political economy, list of finance topics




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