Monetarism

Definition

Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. It suggests 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 argues that managing the money supply is crucial for controlling inflation and stabilizing the economy.

5 Must Know Facts For Your Next Test

1. Milton Friedman is one of the most well-known advocates of monetarism, arguing that changes in the money supply are directly linked to economic stability.
2. Monetarists believe that excessive growth in the money supply can lead to inflation, while too little growth can cause unemployment and stagnation.
3. The theory posits that fiscal policy is less effective than monetary policy in influencing economic activity due to time lags associated with government spending decisions.
4. Monetarism led to a shift in how central banks operate, focusing more on controlling the money supply rather than adjusting interest rates as the primary tool of monetary policy.
5. In practice, monetarist principles influenced central bank policies during the 1980s, particularly in combating high inflation rates through strict control of money supply growth.

Review Questions

• How does monetarism propose to manage inflation compared to traditional fiscal policies?
  • Monetarism suggests that managing inflation should primarily focus on controlling the money supply rather than relying heavily on fiscal policies like government spending. By regulating how much money is circulating in the economy, monetarists believe that it can effectively address inflationary pressures. This approach contrasts with traditional fiscal methods that may not react as swiftly or effectively due to bureaucratic delays.
• What are the implications of monetarism on the functions of a central bank in implementing monetary policy?
  • Monetarism has significant implications for how central banks implement monetary policy. It emphasizes a systematic approach to controlling the money supply as a primary tool for achieving economic stability. Central banks are encouraged to focus on consistent growth rates of money supply rather than frequently changing interest rates based on fluctuating economic conditions. This leads to a more predictable and stable monetary environment, aiding long-term economic planning.
• Evaluate the effectiveness of monetarist principles during economic crises compared to other economic theories.
  • Evaluating monetarist principles during economic crises reveals both strengths and weaknesses compared to other economic theories like Keynesianism. While monetarism effectively addressed high inflation in the 1980s through strict control of money supply, it sometimes struggled during recessions when demand-side interventions were necessary. In contrast, Keynesian approaches emphasize government spending to stimulate demand during downturns. Therefore, while monetarism offers valuable insights on inflation control, its effectiveness can vary depending on the specific economic challenges faced.

Related terms

Money Supply: The total amount of monetary assets available in an economy at a specific time, which includes cash, coins, and balances held in bank accounts.

Inflation Targeting: A monetary policy strategy used by central banks to control inflation by setting an explicit target for the inflation rate and adjusting monetary policy accordingly.

Central Bank: An institution that manages a country’s currency, money supply, and interest rates, often overseeing the banking system and implementing monetary policy.