Monetarism

Definition

Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. This theory suggests that variations in the money supply have major influences on national output in the short run and the price level over longer periods. Monetarism connects with various economic aspects, such as the importance of money supply management for economic stability and growth, influencing banking practices and monetary policy decisions.

5 Must Know Facts For Your Next Test

1. Milton Friedman is the most recognized advocate of monetarism, arguing that controlling the money supply is key to managing inflation and economic stability.
2. Monetarists believe that an excessive increase in money supply can lead to inflation, while too little can result in unemployment and reduced economic growth.
3. Monetarism stresses the importance of long-term monetary policy over short-term fiscal interventions, suggesting that stable growth in money supply leads to predictable economic outcomes.
4. The quantity theory of money, which states that money supply times velocity equals price level times output, is foundational to monetarist thought.
5. In practice, central banks like the Federal Reserve use monetarist principles to guide their monetary policy decisions, focusing on maintaining a stable growth rate of the money supply.

Review Questions

• How does monetarism view the relationship between money supply and economic indicators like inflation and unemployment?
  • Monetarism posits that there is a direct link between the money supply and key economic indicators such as inflation and unemployment. It suggests that an increase in money supply can lead to inflation if it outpaces economic growth, while a controlled money supply helps maintain price stability. Conversely, if the money supply is too tight, it could result in higher unemployment due to insufficient demand for goods and services. Therefore, understanding this relationship is crucial for effective monetary policy.
• Analyze how monetarist principles influence central bank functions and their approach to achieving monetary policy objectives.
  • Monetarist principles greatly influence central bank functions by prioritizing the control of money supply as a primary tool for achieving monetary policy objectives. Central banks adopt policies aimed at regulating the growth of money supply to manage inflation rates and stabilize the economy. By adhering to monetarist views, they often focus on long-term strategies rather than short-term fiscal policies, ensuring predictable economic conditions. This shift towards monetary control has led central banks to develop frameworks emphasizing transparency and accountability in their monetary policy decisions.
• Evaluate the implications of monetarism on banking practices and the broader economy during periods of economic instability.
  • During periods of economic instability, monetarism has significant implications on banking practices and broader economic conditions. Banks are encouraged to adjust their lending practices based on anticipated changes in money supply dictated by central bank policies. This can lead to tighter credit conditions if the central bank aims to curb inflation or looser conditions if attempting to stimulate growth. The adherence to monetarist principles implies that banks must be responsive not only to market demands but also to monetary policy shifts, affecting their risk assessments and financial strategies, ultimately shaping overall economic resilience or vulnerability.

Related terms

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

Inflation:

The rate at which the general level of prices for goods and services rises, eroding purchasing power.

Friedman Rule: A monetary policy guideline proposed by economist Milton Friedman advocating for a steady increase in the money supply to match economic growth.