Monetarism ..
"There are
conditions under which governments can create money—or debt—without fear of inflation or excessive debt burdens. There are other conditions under which debt or money creation can lead to inflation and balance sheet problems." Michael Pettis
Monetarism is a
school of thought in
monetary economics that emphasizes the
role of governments in controlling the amount of money in circulation. Monetarist theory asserts that
variations in the money supply have major influences on national output in the short run and on price levels over longer periods. Monetarists assert that the objectives of
monetary policy are best met by targeting the growth rate of the
money supply rather than by engaging in
discretionary monetary policy.
Monetarism today is mainly associated with the work of
Milton Friedman, who was among the generation of economists to
accept Keynesian economics and then
criticise Keynes's theory of fighting economic downturns using
fiscal policy (
government spending).
Friedman and Anna Schwartz wrote an influential book,
A Monetary History of the United States, 1867–1960, and argued "
inflation is always and everywhere a monetary phenomenon".
Though he opposed the existence of the
Federal Reserve, Friedman advocated, given its existence, a
central bank policy aimed at
keeping the growth of the money supply at a rate commensurate with the growth in productivity and demand for goods.
Monetarism is an economic theory that focuses on the
macroeconomic effects of the supply of money and central banking. Formulated by
Milton Friedman, it argues that
excessive expansion of the money supply is inherently inflationary, and that
monetary authorities should focus solely on maintaining price stability.
This theory draws its roots from two historically antagonistic schools of thought: the
hard money policies that dominated monetary thinking in the
late 19th century, and the
monetary theories of John Maynard Keynes, who, working in the inter-war period during the
failure of the restored gold standard, proposed a
demand-driven model for money. While
Keynes had focused on the stability of a currency's value, with
panics based on an insufficient money supply leading to the use of an
alternate currency and
collapse of the monetary system, Friedman focused on price stability.
The result was summarised in a historical analysis of monetary policy,
Monetary History of the United States 1867–1960, which Friedman coauthored with
Anna Schwartz. The book
attributed inflation to excess money supply generated by a central bank. It attributed
deflationary spirals to the
reverse effect of a f
ailure of a central bank to support the
money supply during a
liquidity crunch.
Friedman originally proposed a
fixed monetary rule, called
Friedman's k-percent rule, where the money supply would be automatically increased by a fixed percentage per year. Under this rule, there would be no leeway for the central reserve bank, as money supply increases could be determined "by a computer", and business could anticipate all money supply changes. With other monetarists he believed that the active manipulation of the money supply or its growth rate is more likely to destabilise than stabilise the economy.
Most monetarists
oppose the gold standard.
Friedman, for example, viewed a pure gold standard as
impractical. For example, whereas one of the benefits of the
gold standard is that the
intrinsic limitations to the growth of the money supply by the use of gold would prevent inflation,
if the
growth of population or increase in trade outpaces the money supply, there would be
no way to counteract deflation and reduced liquidity (and any
attendant recession) except for the mining of more gold.
Clark Warburton is credited with making the
first solid empirical case for the monetarist interpretation of
business fluctuations in a series of papers from
1945. Within mainstream economics, the rise of monetarism accelerated from
Milton Friedman's
1956 restatement of the
quantity theory of money. Friedman argued that the
demand for money could be described as depending on a
small number of economic variables.
Thus, where the
money supply expanded, people would not simply wish to hold the extra money in idle money balances; i.e., if they were in equilibrium before the increase, they were already holding money balances to suit their requirements, and thus after the increase they would have
money balances surplus to their requirements. These excess money balances would therefore be
spent and hence
aggregate demand would rise. Similarly,
if the money supply were reduced people would want to replenish their holdings of money by
reducing their spending. In this, Friedman challenged a simplification attributed to Keynes suggesting that "money does not matter." Thus the word 'monetarist' was coined.
The rise of the popularity of monetarism also picked up in political circles when Keynesian economics seemed unable to explain or cure the
seemingly contradictory problems of rising unemployment and inflation in response to the
collapse of the Bretton Woods system in 1972 and the
oil shocks of 1973. On the one hand, higher unemployment seemed to call for Keynesian
reflation, but on the other hand rising inflation seemed to call for Keynesian
disinflation.
In
1979, United States President
Jimmy Carter appointed as Federal Reserve chief
Paul Volcker, who made
fighting inflation his primary objective, and who
restricted the money supply (in accordance with the
Friedman rule) to tame inflation in the economy. The result was a
major rise in interest rates, not only in the United States; but worldwide. The
"Volcker shock" continued from
1979 to the summer of
1982,
decreasing inflation and increasing unemployment.
Former Federal Reserve chairman
Alan Greenspan argued that the
1990s decoupling was explained by a
virtuous cycle of productivity and investment on one hand, and a certain
degree of "irrational exuberance" in the investment sector on the other.
There are also
arguments that monetarism is a special case of Keynesian theory. The central test case over the validity of these theories would be the possibility of a
liquidity trap, like that experienced by Japan.
Ben Bernanke, Princeton professor and another former chairman of the U.S. Federal Reserve, argued that monetary policy could respond to
zero interest rate conditions by
direct expansion of the money supply. In his words, "We have the keys to the printing press, and we are not afraid to use them."
These
disagreements—along with the
role of monetary policies in trade liberalisation, international investment, and central bank policy—remain lively topics of investigation and argument.
Monetarists not only sought to explain present problems; they also
interpreted historical problems. Milton Friedman and
Anna Schwartz in their book
A Monetary History of the United States, 1867–1960 argued that the
Great Depression of the 1930s was caused by a
massive contraction of the money supply (they deemed it "the
Great Contraction"), and not by the lack of investment Keynes had argued. They also maintained that
post-war inflation was caused by an
over-expansion of the money supply.
They made famous the assertion of monetarism that
"inflation is always and everywhere a monetary phenomenon." Many Keynesian economists initially believed that the Keynesian vs. monetarist debate was solely about whether fiscal or
monetary policy was the more effective tool of demand management. By the
mid-1970s, however, the debate had moved on to other issues as monetarists began presenting a
fundamental challenge to Keynesianism.
Monetarists argued that
central banks sometimes caused major unexpected fluctuations in the money supply. They
asserted that actively increasing demand through the central bank can have negative unintended consequences.
Notable Proponents of Monetarism
Karl Brunner .
Phillip D. Cagan .
Milton Friedman .Alan Greenspan .
David Laidler .
Allan Meltzer .
Anna Schwartz .Margaret Thatcher .
Paul Volcker .
Clark Warburton .
