Monetarism

Definition

Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. This theory argues that variations in the money supply have major influences on national output in the short run and the price level over longer periods. Monetarists believe that managing the money supply is essential for controlling inflation and maintaining economic stability.

5 Must Know Facts For Your Next Test

1. Monetarism was popularized by economist Milton Friedman, who argued that inflation is always a monetary phenomenon caused by excessive growth in the money supply.
2. Monetarists advocate for a fixed annual increase in the money supply, typically aligning it with the growth rate of real GDP to avoid inflation.
3. In contrast to Keynesian economics, monetarism stresses long-term policies rather than short-term fixes, emphasizing the importance of stable money supply growth.
4. Monetarism gained prominence during the 1970s as policymakers struggled to control stagflation—a combination of high inflation and unemployment.
5. Central banks, influenced by monetarist principles, often focus on metrics like M1 or M2 money supply to guide monetary policy decisions.

Review Questions

• How does monetarism differentiate itself from Keynesian economics in terms of monetary policy approach?
  • Monetarism differs from Keynesian economics by placing greater emphasis on the long-term control of the money supply rather than short-term government intervention. While Keynesians advocate for fiscal policies to manage economic fluctuations, monetarists argue that stable and predictable changes in the money supply are essential for economic stability. They believe that too much government involvement can lead to inflationary pressures, thus highlighting the importance of controlling money growth.
• Discuss how monetarist theory addresses the relationship between money supply and inflation.
  • Monetarist theory posits a direct relationship between changes in the money supply and inflation rates. According to monetarists, when the money supply increases too rapidly relative to economic output, it leads to higher prices as more money chases the same amount of goods and services. This perspective suggests that controlling inflation requires careful management of the money supply, and thus advocates for policies aimed at maintaining stable growth in monetary aggregates.
• Evaluate the impact of monetarist ideas on central banking practices since their introduction.
  • Since monetarist ideas emerged, they have significantly influenced central banking practices, leading many banks to adopt a more rule-based approach to monetary policy. For instance, central banks increasingly monitor money supply measures like M1 and M2 as indicators for policy adjustments. The lessons learned from monetarism have also encouraged a focus on long-term price stability rather than merely addressing cyclical economic fluctuations, shaping how central banks respond to inflation and economic crises.

Related terms

Money Supply: The total amount of monetary assets available in an economy at a specific time, which can influence inflation and economic activity.

Phillips Curve: A concept that illustrates the inverse relationship between inflation and unemployment, suggesting that lower unemployment comes with higher inflation.

Quantitative Easing: A monetary policy tool used by central banks to stimulate the economy by increasing the money supply through the purchase of financial assets.