Monetarism

Definition

Monetarism is an economic theory that emphasizes the role of the money supply in influencing economic activity, inflation, and the business cycle. It focuses on the central bank's ability to manage the money supply as the primary tool for stabilizing the economy and controlling inflation.

5 Must Know Facts For Your Next Test

1. Monetarists believe that changes in the money supply are the primary determinant of changes in nominal GDP and the price level.
2. Monetarists advocate for the central bank to focus on controlling the growth rate of the money supply rather than directly targeting inflation or other economic variables.
3. Monetarists argue that discretionary fiscal policy is less effective than monetary policy in stabilizing the economy.
4. Monetarists believe that the economy tends towards full employment equilibrium in the long run, and that the primary role of the central bank is to maintain price stability.
5. Monetarism gained prominence in the 1970s and 1980s as a response to the perceived failures of Keynesian economic policies.

Review Questions

• Explain how monetarists view the relationship between the money supply and economic activity.
  • Monetarists believe that changes in the money supply are the primary determinant of changes in nominal GDP and the price level. They argue that the central bank can stabilize the economy by controlling the growth rate of the money supply, which in turn influences inflation and real economic output. Monetarists emphasize the importance of the central bank's role in managing the money supply as the primary tool for achieving economic objectives such as price stability and full employment.
• Describe the monetarist perspective on the effectiveness of fiscal policy compared to monetary policy.
  • Monetarists argue that discretionary fiscal policy is less effective than monetary policy in stabilizing the economy. They believe that the economy tends towards full employment equilibrium in the long run, and that the primary role of the central bank should be to maintain price stability by controlling the growth rate of the money supply. Monetarists contend that changes in the money supply have a more direct and predictable impact on economic activity than changes in government spending or taxation.
• Analyze the historical context and significance of the rise of monetarism as an economic theory.
  • Monetarism gained prominence in the 1970s and 1980s as a response to the perceived failures of Keynesian economic policies, which were seen as contributing to the problem of stagflation (high inflation and high unemployment). Monetarists argued that the central bank's focus on targeting inflation or other economic variables was less effective than a strategy of controlling the growth rate of the money supply. The rise of monetarism challenged the Keynesian consensus and influenced the adoption of more restrictive monetary policies by central banks in many countries, which helped to bring down high rates of inflation during this period.

Related terms

Money Supply: The total amount of money available in an economy, including currency, deposits, and other liquid assets.

Quantity Theory of Money: The economic theory that the general price level is directly proportional to the money supply, assuming velocity of money and real output remain constant.

Monetary Policy:

The actions taken by a central bank to influence the money supply and interest rates in order to achieve economic objectives such as price stability and full employment.