Monetarism

Definition

Monetarism is an economic theory that emphasizes the role of government in controlling the amount of money in circulation. 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. This theory is particularly connected to how central banking systems manage monetary policy, the nature of fiat currency, and the functioning of international monetary systems.

5 Must Know Facts For Your Next Test

1. Milton Friedman is one of the most prominent economists associated with monetarism, advocating for a steady growth rate of money supply.
2. Monetarists believe that controlling inflation is primarily a matter of controlling the money supply rather than adjusting fiscal policies.
3. The velocity of money, or how quickly money circulates in the economy, is a key concept in monetarism; it can affect economic stability.
4. Monetarism gained prominence in the 1970s as a response to stagflation, where high inflation and unemployment coexisted.
5. Critics argue that monetarism oversimplifies the complexities of economic variables and downplays the importance of fiscal policy.

Review Questions

• How does monetarism connect with the strategies employed by central banks to manage inflation?
  • Monetarism directly connects with central bank strategies as it emphasizes controlling the money supply to manage inflation effectively. Central banks, like the Federal Reserve, implement monetary policies that adjust interest rates or utilize tools such as open market operations to influence how much money is circulating. By maintaining a targeted growth rate of money supply, these institutions aim to stabilize prices and curb inflation, reflecting core monetarist principles.
• Discuss how monetarism challenges traditional Keynesian economic theories regarding fiscal policy.
  • Monetarism challenges traditional Keynesian economics by arguing that fiscal policy is less effective than controlling the money supply for managing economic fluctuations. While Keynesians advocate for government spending and intervention during downturns, monetarists believe that changes in the money supply are more significant drivers of inflation and economic activity. This shift in focus emphasizes monetary stability over fiscal stimulus, reshaping discussions about effective economic governance.
• Evaluate the implications of monetarism on international monetary systems and how it influences global economic relations.
  • The implications of monetarism on international monetary systems are profound as it influences how countries manage their currencies and interact economically. By promoting policies aimed at stabilizing national money supplies, countries adopting monetarist principles can impact exchange rates and global trade dynamics. This framework encourages nations to be mindful of their monetary policies' effects on inflation and international competitiveness, influencing decisions on trade agreements and financial cooperation across borders.

Related terms

Inflation:

A sustained increase in the general price level of goods and services in an economy over a period of time.

Interest Rates: The amount charged by lenders to borrowers for the use of money, usually expressed as a percentage of the principal.

Quantitative Easing: A non-traditional monetary policy tool used by central banks to stimulate the economy by increasing the money supply through the purchase of government securities.