MONETARISM: ORIGIN, CHARACTERISTICS, REPRESENTATIVES, ADVANTAGES - ECONOMY - 2025

The monetarism or monetarist theory is a school of thought in the cash economy which emphasizes the role of governments in controlling the amount of money in circulation.

It is based on considering that the total amount of money in an economy is the main determinant of economic growth. It states that variations in the money supply have a great short-term influence on national production and long-term on price levels.

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As the availability of money in the system increases, the demand for goods and services increases, fostering job creation. However, in the long run, growing demand will outweigh supply, causing an imbalance in the market. The shortage caused by a demand greater than supply will force prices to rise, generating inflation.

Monetarism and Keynesian economics

For monetarists, the best thing for the economy is to keep an eye on the money supply and let the market take care of itself. According to this theory, the market is more efficient in dealing with inflation and unemployment.

The government must maintain a stable money supply, extending it slightly each year, in order to allow the economy to grow naturally.

It differs significantly from Keynesian economics, which emphasizes the role of government in the economy through spending, rather than monetary policy.

Keynesian economics supports any effort by a central bank to introduce more money into the economy, in order to increase demand.

Origin

Monetarism was born out of criticism of Keynesian economics. It was named for its focus on the role of money in the economy. Its heyday came from the reformulation of the quantity theory of money by Milton Friedman in 1956.

By expanding the money supply, people would not want to keep that extra money tied up, since they would have more money saved than they required. Therefore, they would spend this excess money, increasing demand.

Similarly, if the money supply were reduced, people would want to replenish their holdings of money, reducing their expenses. Thus, Friedman questioned the resolution attributed to Keynes, which suggested that money did not matter.

In his 1967 speech to the American Economic Association, Friedman created the theory of monetarism. He said the antidote to inflation was to raise interest rates. That would reduce the money supply and prices would fall, because people would have less money to spend.

1970s

Monetarism rose to prominence in the 1970s, especially in the United States. During this period, both inflation and unemployment increased and the economy did not grow.

This occurred as a consequence of the increase in oil prices and, mainly, due to the disappearance of the Bretton Woods system of fixed exchange rates, caused in large part by the United States not continuing to maintain the value of the dollar in gold.

The Federal Reserve was not successful in trying to control inflation. However, in 1979 he put into practice a new attempt that involved procedures with monetarist characteristics, limiting the growth of the money supply.

Although the change helped the inflation rate fall, it had the side effect of sending the economy into a recession.

characteristics

Long-term monetary neutrality

An increase in the quantity of existing money causes in the long run an increase in the general level of prices, with no real effects on factors such as consumption or production.

Short-term monetary neutrality

An increase in the quantity of existing money has short-term effects on production and employment, because wages and prices take time to adjust.

Rule of constant money growth

Friedman proposed that the central bank should set a money growth rate that equals the growth rate of GDP, so as not to change the price level.

Interest rate flexibility

Monetary policy is used to adjust interest rates, thus controlling the money supply.

When interest rates rise, people have more incentive to save than to spend, contracting the money supply in this way.

On the other hand, when interest rates are lowered, people can borrow and spend more, stimulating the economy.

Theory of the quantity of money

This theory is fundamental to monetarism, establishing that the money supply multiplied by the rate at which money is spent annually is equal to the nominal expenses in the economy. The formula is: O * V = P * C, where:

O = Offer of money.

V = Speed ​​at which money changes hands.

P = Average price of a good or service.

C = Quantity of goods and services sold.

Monetarist theorists consider V to be constant and predictable, which implies that the money supply is the main driver of economic growth. An increase or decrease in O will lead to an increase or decrease in P or C.

Main managers

It is particularly associated with the writings of Milton Friedman, Anna Schwartz, Karl Brunner, and Allan Meltzer.

Milton friedman

Nobel Prize-winning economist, he was one of the first to break with the commonly accepted principles of Keynesian economics.

Friedman argued that monetary policy should be done by focusing on the growth rate of the money supply, in order to maintain economic and price stability.

Friedman proposed in his book, "A Monetary History of the United States, 1867-1960," a fixed growth rate, called Friedman's k-percent rule.

This rule indicated that the money supply should rise at a constant annual rate, contingent on the growth of nominal GDP and expressed as a fixed annual percentage.

In this way, the money supply was expected to grow moderately, with companies being able to anticipate changes in the money supply each year, the economy growing at a constant rate and keeping inflation low.

Karl Brunner

In 1968 he introduced the term monetarism into the general vocabulary of economics. Fundamentally, Brunner conceived of monetarism as the application of the theory of prices relative to the analysis of aggregate phenomena.

He affirmed that the basic principle of monetarism is to reaffirm the relevance of the theory of prices to understand what happens in the aggregate economy.

Brunner considered that the main propositions that characterize the monetarist vision can be organized into four groups.

These groups refer to descriptions of the transfer mechanism, the dynamic properties of the private sector, the dominance and nature of monetary drives, and the separation of aggregate and distributive forces.

Advantage

Most of the changes in Keynesian thinking that the early monetarists proposed are accepted today as part of standard macro-monetary analysis.

The main changes proposed were to carefully distinguish between real and nominal variables, to distinguish between real and nominal interest rates, and to deny the existence of a long-term trade-off between inflation and unemployment.

Monetarists look at real interest rates instead of nominal rates. Most of the published rates are nominal rates. Real rates eliminate the effects of inflation. They give a truer picture of the cost of money.

Controlling the money supply is key to setting business expectations and fighting the effects of inflation. A change in the money supply will directly set production, prices, and employment.

Furthermore, most of today's research economists accept the proposition that monetary policy is more powerful and useful than fiscal policy in stabilizing the economy.

Inflation control

Current thinking clearly favors the policy of rules, in contrast to "discretion", highlighting the central importance of keeping inflation fairly low.

Most importantly, inflation cannot continue indefinitely without increases in the money supply, and controlling it must be a primary responsibility of the central bank.

It is only in its emphasis on monetary aggregates that monetarism is not being widely adopted and practiced today.

Disadvantages

The promotion of monetarism was brief. As a policy objective, the cash supply is useful only when the relationship between money and nominal GDP is stable and predictable.

That is, if the money supply increases, so must nominal GDP, and vice versa. However, to achieve that direct effect, the velocity of money must be predictable.

Economists who followed the Keynesian approach were some of the most critical opponents of monetarism, especially after the anti-inflationary policies of the early 1980s led to a recession.

Economic policies and the theories behind why they should or shouldn't work are constantly changing. A school of thought can explain a certain period of time very well, then fail in future comparisons.

Monetarism has a strong track record, but it is still a relatively new school of thought and one that will likely be further refined over time.

Unhelpful liquidity measure

Today, monetarism has fallen out of favor. This is because the money supply is a less useful liquidity measure than in the past. Liquidity includes cash, credit, and money market mutual funds.

However, the money supply does not measure other assets, such as stocks, commodities, and home equity. People are more likely to save money in the stock market than in the money markets, by receiving a better return.

The money supply does not measure these assets. If the stock market goes up, people feel rich and will be more willing to spend. This increases demand and boosts the economy.

References

1. Brent Radcliffe (2019). Monetarism: Printing Money To Curb Inflation. Taken from: investopedia.com.
2. Will Kenton (2017). Monetarism. Investopedia. Taken from: investopedia.com.
3. Bennett T. McCallum (2019). Monetarism. The Library of Economics and Liberty. Taken from: econlib.org.
4. Wikipedia, the free encyclopedia (2019). Monetarism. Taken from: en.wikipedia.org.
5. Kimberly Amadeo (2018). Monetarism Explained with Examples, Role of Milton Friedman. The Balance. Taken from: thebalance.com.
6. Sarwat Jahan and Chris Papageorgiou (2014). What is Monetarism? International Monetary Fund. Taken from: imf.org.
7. Wikipedia, the free encyclopedia (2019). Karl Brunner (economist). Taken from: en.wikipedia.org.