Monetarism

The School of Monetarism Economics

Introduction

Monetarism is an economic school of thought that emerged in the mid-20th century as a response to Keynesian economics. It emphasizes the role of governments in controlling the amount of money in circulation. The primary proponent of monetarism, Milton Friedman, argued that variations in the money supply have significant effects on national output in the short run and the price level over longer periods. This article explores the historical context, key concepts, prominent figures, critiques, and lasting impact of monetarism.

Historical Context

1. Response to Keynesian Economics

In the post-World War II era, Keynesian economics dominated economic policy-making, particularly in Western countries. Keynesians advocated for active government intervention to manage economic cycles, primarily through fiscal policy. However, during the 1970s, many countries experienced stagflation—simultaneous high inflation and unemployment—which traditional Keynesian models struggled to explain.

2. Milton Friedman and the Chicago School

Milton Friedman, a leading economist of the Chicago School, emerged as a critical voice against Keynesianism. He argued that inflation was primarily a monetary phenomenon caused by excessive growth in the money supply, rather than a consequence of rising demand or supply constraints. His work laid the foundation for monetarist theory and significantly influenced economic policy in the late 20th century.

Key Concepts of Monetarism

1. The Quantity Theory of Money

At the heart of monetarism is the quantity theory of money, which posits that changes in the money supply directly affect price levels and economic output. The theory is often expressed through the equation:

MV=PY

Where:

• M = Money supply

• V = Velocity of money (the rate at which money circulates in the economy)

• P = Price level

• Y = Real output (GDP)

Monetarists argue that if the money supply grows faster than the economy’s capacity to produce goods and services, inflation will result.

2. Role of Money Supply in Economic Stability

Monetarists contend that controlling the money supply is crucial for achieving economic stability. They argue that a stable growth rate of the money supply, typically aligned with the growth of real output, leads to sustainable economic growth and helps maintain low inflation.

3. Monetary Policy vs. Fiscal Policy

While Keynesians emphasize fiscal policy (government spending and taxation) as a primary tool for managing economic fluctuations, monetarists prioritize monetary policy (control of the money supply) as the more effective means of influencing economic activity. Monetarists argue that fiscal policy can often lead to unintended consequences and should be used cautiously.

4. Natural Rate of Unemployment

Monetarism introduces the concept of the natural rate of unemployment, which suggests that there is a level of unemployment that the economy naturally gravitates toward in the long run, regardless of monetary or fiscal interventions. This perspective challenges the idea that government can reduce unemployment below this natural rate without leading to inflation.

5. Long-Term vs. Short-Term Effects

Monetarists argue that while changes in the money supply can have short-term effects on output and employment, the long-term effects primarily relate to price levels. They believe that attempts to stimulate the economy through increased money supply will ultimately lead to inflation without producing sustained increases in real output.

Prominent Figures in Monetarism

1. Milton Friedman (1912-2006)

Milton Friedman is the most prominent figure associated with monetarism. His research on the relationship between money supply and economic activity fundamentally changed the way economists and policymakers think about monetary policy. Friedman’s influential works, including A Monetary History of the United States (with Anna Schwartz), provided empirical evidence supporting the monetarist perspective.

2. Anna Schwartz (1910-2012)

Anna Schwartz was a co-author with Friedman on several key works, including A Monetary History of the United States. Her research and contributions to understanding the historical impact of monetary policy significantly shaped monetarist theory and its applications.

3. Friedrich Hayek (1899-1992)

Although primarily associated with the Austrian School of economics, Friedrich Hayek’s ideas about the importance of monetary policy and the role of information in economic decision-making align with some monetarist principles. His critique of central planning and support for free-market policies influenced monetarist thought.

Critiques of Monetarism

While monetarism has significantly impacted economic theory and policy, it has also faced various critiques:

1. Neglect of Fiscal Policy

Critics argue that monetarism underestimates the role of fiscal policy in managing economic cycles. They contend that government spending can be an essential tool for addressing economic downturns and stimulating growth, particularly during recessions.

2. Assumption of Stable Money Velocity

Monetarists assume that the velocity of money is relatively stable over time. However, critics point out that changes in payment technologies, consumer behavior, and economic conditions can lead to fluctuations in velocity, complicating the relationship between money supply and economic outcomes.

3. Challenges in Policy Implementation

Critics argue that implementing monetarist policies can be challenging, particularly when central banks face uncertainty regarding the correct amount of money supply needed for economic stability. Delays in policy implementation and responses to changing economic conditions can lead to unintended consequences.

4. Impact of Globalization

In an increasingly globalized economy, critics argue that monetarism may not adequately account for the influence of international capital flows and exchange rates on domestic monetary policy. Globalization can complicate the relationship between national money supply and domestic economic outcomes.

The Legacy of Monetarism

1. Shift in Monetary Policy

Monetarism had a profound impact on monetary policy in the late 20th century. Central banks, particularly the Federal Reserve in the United States, began to focus more on controlling money supply growth and inflation. The 1980s saw a shift toward monetarist policies under the leadership of Fed Chairman Paul Volcker, who implemented aggressive interest rate hikes to combat high inflation.

2. Influence on Central Banking

Monetarist principles have influenced the frameworks and practices of central banking worldwide. Many central banks now prioritize inflation targeting and maintaining stable monetary conditions as key objectives of their policies.

3. Ongoing Relevance

Monetarism continues to play a role in contemporary economic discussions, especially during times of economic uncertainty. The recent financial crises and the response of central banks have reignited debates about the effectiveness of various monetary policy approaches, including monetarism.

4. Integration with Other Theories

Monetarism has also contributed to the development of new economic theories that integrate elements of both Keynesian and monetarist thought. The evolution of economic discourse continues to reflect the complex interplay between various schools of thought, as economists seek to address the multifaceted challenges of modern economies.

Conclusion

The School of Monetarism has significantly influenced economic theory and policy, emphasizing the critical role of money supply in determining economic activity and inflation. Milton Friedman’s insights reshaped how economists and policymakers approach monetary policy, advocating for a focus on controlling the money supply to ensure economic stability. Despite facing critiques and evolving in response to changing economic conditions, monetarism remains a vital part of the economic landscape, influencing contemporary debates on monetary policy and the appropriate role of government in managing the economy. Its legacy continues to resonate in discussions about the effectiveness of monetary policy, inflation control, and the ongoing quest for economic stability and growth.

Here is a list of influential and notable economists from the School of Monetarism, along with their key contributions:

1. Milton Friedman (1912–2006)

• Key Works: A Monetary History of the United States (1963, with Anna Schwartz), Capitalism and Freedom (1962)

• Contribution: The most prominent figure in monetarism, Friedman argued that changes in the money supply are the primary driver of economic cycles. His work showed that inflation is always and everywhere a monetary phenomenon. He advocated for a monetary policy rule that targets a constant growth rate of money supply rather than discretionary fiscal and monetary intervention.

2. Anna J. Schwartz (1915–2012)

• Key Works: A Monetary History of the United States (1963, with Milton Friedman)

• Contribution: Schwartz collaborated extensively with Milton Friedman and co-authored key works on monetary history and policy. Their work emphasized the role of monetary policy in causing and exacerbating economic cycles, particularly the Great Depression, highlighting the dangers of poor central bank management.

3. Karl Brunner (1916–1989)

• Key Works: Money and the Economy (1968), The Great Depression Revisited (1981)

• Contribution: Brunner was a key contributor to the development of monetarist theory. He focused on the relationship between money, credit, and interest rates, and argued that central banks should focus on controlling the growth of the money supply to achieve stable economic conditions.

4. Allan H. Meltzer (1928–2017)

• Key Works: A History of the Federal Reserve (2003), Money, Credit, and Policy (1995)

• Contribution: Meltzer contributed extensively to monetarist thought and was a leading historian of the Federal Reserve. He argued for the importance of monetary rules and criticized the discretionary policies of central banks. Meltzer’s work also emphasized the role of monetary policy in causing the inflation of the 1970s.

5. David Laidler (1938–present)

• Key Works: The Demand for Money (1969), Monetarist Perspectives (1982)

• Contribution: Laidler is known for his work on the demand for money and its relationship to economic stability. He expanded on Friedman’s monetarist ideas, contributing to the development of theories on how changes in the money supply affect inflation, interest rates, and economic activity.

6. Robert E. Lucas Jr. (1937–2023)

• Key Works: Expectations and the Neutrality of Money (1972), Studies in Business-Cycle Theory (1981)

• Contribution: Lucas introduced the concept of rational expectations into macroeconomic theory, which had a major influence on monetarist thinking. He argued that individuals form expectations about future inflation and policy, meaning that systematic monetary policy cannot influence output and employment in the long run, aligning with monetarist ideas about the limits of government intervention.

7. Bennett T. McCallum (1941–present)

• Key Works: Monetary Economics (1989), The Role of Monetary Policy (2000)

• Contribution: McCallum is known for his work on monetary policy rules, particularly the McCallum rule, which suggests that central banks should follow a rule based on nominal GDP targeting to control inflation and stabilize the economy. His research built on monetarist insights into how monetary policy affects economic activity.

8. Tim Congdon (1951–present)

• Key Works: Money in a Free Society (2011), Central Banking in a Free Society (2009)

• Contribution: Congdon is a British economist and a leading advocate of monetarism in the UK. He has written extensively on the role of monetary policy in managing inflation and has been a critic of discretionary fiscal policies. His work focuses on monetary aggregates as a tool for controlling inflation and promoting economic stability.

9. Michael D. Bordo (1942–present)

• Key Works: The Gold Standard and Related Regimes (1999), A Retrospective on the Classical Gold Standard (1984)

• Contribution: Bordo is an economic historian whose work focuses on monetary policy, the gold standard, and financial crises. He has contributed to monetarist thought by analyzing historical episodes of monetary policy, particularly the role of central banks in economic cycles.

10. Charles Goodhart (1936–present)

• Key Works: The Evolution of Central Banks (1988), Money, Information, and Uncertainty (1975)

• Contribution: Though not exclusively a monetarist, Goodhart’s work on central banks and monetary policy has been influential within monetarist circles. Goodhart’s Law, which states that ‘when a measure becomes a target, it ceases to be a good measure,’ critiques overreliance on monetary aggregates, but his work still intersects with key monetarist concerns about the role of money in the economy.

11. James Tobin (1918–2002)

• Key Works: Tobin’s q (1969), Asset Accumulation and Economic Activity (1980)

• Contribution: Although not strictly a monetarist, Tobin’s work influenced monetarist ideas through his analysis of asset markets and their relationship with monetary policy. Tobin was a key figure in the debate between Keynesian and monetarist approaches to monetary policy, advocating for the importance of financial markets in influencing the real economy.

12. Friedrich Hayek (1899–1992)

• Key Works: Prices and Production (1931), The Road to Serfdom (1944)

• Contribution: While Hayek is more commonly associated with Austrian economics, his opposition to discretionary monetary policy and belief in the self-regulating nature of markets align with certain monetarist ideas. He argued that economic cycles are caused by excessive credit expansion and that monetary stability can only be achieved through rules-based policies.

13. Ludwig von Mises (1881–1973)

• Key Works: The Theory of Money and Credit (1912), Human Action (1949)

• Contribution: Like Hayek, von Mises is an Austrian economist, but his views on monetary policy have influenced monetarists, especially regarding the dangers of inflationary monetary policies. He argued for the importance of a sound money system and warned about the destabilizing effects of central bank interventions.

Conclusion

The economists listed here have each contributed significantly to the development of monetarist thought, emphasizing the importance of controlling the money supply to manage inflation and maintain economic stability. Monetarism, particularly as popularized by Milton Friedman, remains influential in shaping modern monetary policy, especially in the context of central banking and inflation targeting. These economists advanced theories that challenge the efficacy of discretionary fiscal and monetary policies, advocating for rule-based approaches that focus on maintaining stable growth in the money supply.