What is Monetarism?

There are many different economic theories that have, at some point, dominated the economic discussion during the 20th century. The economic institutions that run the economy of industrialized nations have toyed around with several methods of practice and theory in order to yield a stronger, more sustainable economy. While Keynesian economics has certainly been the most prominent of these ideas, there are many others that have been tested and had their time in the Sun. Today, we’re going to look at the era of monetarism and the effect that it had on our country…

Basic idea

Monetarism was brought to the mainstream during the 1970’s by famed economist and Nobel-prize winner Milton Friedman. This idea was built upon the Quantity Theory of Money, which had been popular nearly 100 years ago. Monetarism purports that money supply is what will have the greatest effect on GDP and the eventual price level. Monetarists believe that the core objective of monetary policy is to stabilize the growth rate of the money supply. Velocity is viewed as a stable phenomenon in Monetarism, which is unique. The foundation of monetarism thought is the equation that money supply multiplied by velocity equals nominal expenditures in an economy. This can be used to measure the number of goods and services, as well as the price paid for them.

Rise of Monetarism

In the 1970’s the United States was suffering from high rates of inflation. Milton Friedman, an American economist, criticized the monetary policy of the central bank and Federal Reserve. He argued that their actions had led to both the Great Depression, as well as the high rate of inflation that was occurring at the time. As levels of inflation began to reach 20%, the Federal Reserve began to embrace Milton Friedman’s monetarist theory. At the same time in Great Britain, Prime Minister Margaret Thatcher also began to utilize monetarist theory. Because of this, inflation dropped dramatically in both countries.

Criticism and eventual decline

Although Monetarism reached great prominence in the 1970’s, it’s support began to wane through the 80’s and 90’s. Many economists criticized monetarism, due to the fact that it treated the velocity of currency as a stable, constant factor. Indeed, during the 70’s, velocity was an easy factor to predict, and thus it was simple to control the money supply to reflect the economy. However, velocity eventually was shown to be not so predictable, because it is rooted in human behavior, which is sometimes erratic. Because of this, the link between money supply and GDP became lost in the monetarist equation. This caused many economists to abandon the theory, despite having previously supported it. Today, there are still certain groups that are beckoning for a return to monetarism, but it is certainly far from the mainstream.