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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. [1]

A school of thought, or intellectual tradition, is the perspective of a group of people who share common characteristics of opinion or outlook of a philosophy, discipline, belief, social movement, economics, cultural movement, or art movement.

Monetary economics is the branch of economics that studies the different competing theories of money: it provides a framework for analyzing money and considers its functions, and it considers how money, for example fiat currency, can gain acceptance purely because of its convenience as a public good. The discipline has historically prefigured, and remains integrally linked to, macroeconomics. This branch also examines the effects of monetary systems, including regulation of money and associated financial institutions and international aspects.

Money supply total amount of monetary assets available in an economy at a specific time

The money supply is the total value of money available in an economy at a point of time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits. Each country’s central bank may use its own definitions of what constitutes money for its purposes.


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". [2]

Milton Friedman American economist, statistician, and writer

Milton Friedman was an American economist who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the complexity of stabilization policy. With George Stigler and others, Friedman was among the intellectual leaders of the second generation of Chicago school of economics, a methodological movement at the University of Chicago's Department of Economics, Law School and Graduate School of Business from the 1940s onward. Several students and young professors who were recruited or mentored by Friedman at Chicago went on to become leading economists, including Gary Becker, Robert Fogel, Thomas Sowell and Robert Lucas Jr.

Keynesian economics is a group of various macroeconomic theories about how in the short run – and especially during recessions – economic output is strongly influenced by aggregate demand. In the Keynesian view, named for British economist John Maynard Keynes, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation.

Anna Schwartz American economist

Anna Jacobson Schwartz was an American economist who worked at the National Bureau of Economic Research in New York City and a writer for the New York Times. Paul Krugman once said that Schwartz is, "one of the world's greatest monetary scholars."[1] Schwartz is most notably recognized for her collaborative work with Milton Friedman on A Monetary History of the United States, 1867–1960, which was published in 1963.[2] This book placed the blame for the Great Depression at the door of the Federal Reserve System. She was also president of the Western Economic Association International in 1988.[3] Schwartz was inducted into the National Women's Hall of Fame in 2013.

Though he opposed the existence of the Federal Reserve, [3] 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.

Central bank public institution that manages a states currency, money supply, and interest rates

A central bank, reserve bank, or monetary authority is an institution that manages the currency, money supply, and interest rates of a state or formal monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and also generally controls the printing/coining of the national currency, which serves as the state's legal tender. A central bank also acts as a lender of last resort to the banking sector during times of financial crisis. Most central banks also have supervisory and regulatory powers to ensure the solvency of member institutions, to prevent bank runs, and to discourage reckless or fraudulent behavior by member banks.

In macroeconomics, Aggregate Demand (AD) or Domestic Final Demand (DFD) is the total demand for final goods and services in an economy at a given time. It is often called effective demand, though at other times this term is distinguished. This is the demand for the gross domestic product of a country. It specifies the amounts of goods and services that will be purchased at all possible price levels.


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.

Macroeconomics branch of economics that studies aggregated indicators

Macroeconomics is a branch of economics dealing with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies.

Inflation increase in the general price level of goods and services in an economy over a period of time

In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The opposite of inflation is deflation, a sustained decrease in the general price level of goods and services. The common measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time.

Price stability is a goal of monetary and fiscal policy aiming to support sustainable rates of economic activity. Policy is set to maintain a very low rate of inflation or deflation. For example, the European Central Bank (ECB) describes price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the Euro area of below 2%. However, by referring to “an increase in the HICP of below 2%” the ECB makes clear that not only persistent inflation above 2% but also deflation are inconsistent with the goal of 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. [4] 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.

John Maynard Keynes English economist

John Maynard Keynes, 1st Baron Keynes, was a British economist, trained mathematician, whose ideas fundamentally changed the theory and practice of macroeconomics and the economic policies of governments. He built on and greatly refined earlier work on the causes of business cycles, and was one of the most influential economists of the 20th century. Widely considered the founder of modern macroeconomics, his ideas are the basis for the school of thought known as Keynesian economics, and its various offshoots.

Gold standard monetary system in which the standard economic unit of account is based on a fixed quantity of gold

A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was widely used in the 19th and early part of the 20th century. Most nations abandoned the gold standard as the basis of their monetary systems at some point in the 20th century, although many still hold substantial gold reserves.

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 failure of a central bank to support the money supply during a liquidity crunch. [5]

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. [6] [7] 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.

Opposition to the gold standard

Most monetarists oppose the gold standard. Friedman, for example, viewed a pure gold standard as impractical. [8] 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. [1] p. 493 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. [9]

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." [9] 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, dramatically both decreasing inflation and increasing unemployment. Monetarist economists never recognized that the policy implemented by the Federal Reserve from 1979 was a monetarist policy. Nevertheless, the influence of monetarism on the Federal Reserve was twofold: a direct influence, by the adherence of some members of the Federal Open Market Committee to monetarist ideas; and an indirect influence, because monetarist views were taken into account in the determination of US monetary policy: even the members of the FOMC who were not monetarists took monetarist influence into strong consideration. [10]

By the time Margaret Thatcher, Leader of the Conservative Party in the United Kingdom, won the 1979 general election defeating the sitting Labour Government led by James Callaghan, the UK had endured several years of severe inflation, which was rarely below the 10% mark and by the time of the May 1979 general election, stood at 15.4%. [11] Thatcher implemented monetarism as the weapon in her battle against inflation, and succeeded at reducing it to 4.6% by 1983. However, unemployment in the United Kingdom dramatically increased from 5.7% in 1979 to 12.2% in 1983, reaching 13.0% in 1982; and starting with the first quarter of 1980, the UK economy contracted in terms of real gross domestic product for six straight quarters. [12]

Money supply decreased significantly between Black Tuesday and the Bank Holiday in March 1933 in the wake of massive bank runs across the United States. Money supply during the great depression era.png
Money supply decreased significantly between Black Tuesday and the Bank Holiday in March 1933 in the wake of massive bank runs across the United States.

Monetarists not only sought to explain present problems; they also interpreted historical ones. 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" [13] ), 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.

Many monetarists sought to resurrect the pre-Keynesian view that market economies are inherently stable in the absence of major unexpected fluctuations in the money supply. Because of this belief in the stability of free-market economies they asserted that active demand management (e.g. by the means of increasing government spending) is unnecessary and indeed likely to be harmful. The basis of this argument is a relationship between "stimulus" fiscal spending and future interest rates. In effect, Friedman's model argues that current fiscal spending creates as much of a drag on the economy by increased interest rates as it creates present consumption: that it has no real effect on total demand, merely that of shifting demand from the investment sector to the consumer sector.

Current state

Since 1990, the classical form of monetarism has been questioned. This is because of events that many economists interpreted as being inexplicable in monetarist terms: the disconnection of the money supply growth from inflation in the 1990s and the failure of pure monetary policy to stimulate the economy in the 2001–2003 period. 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.

Notable proponents

See also


Related Research Articles

In economics, stagflation, or recession-inflation, is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high. It presents a dilemma for economic policy, since actions intended to lower inflation may exacerbate unemployment

Fiscal policy use of government revenue collection and spending to influence the economy

In economics and political science, fiscal policy is the use of government revenue collection and expenditure (spending) to influence a country's economy. The use of government revenues and expenditures to influence macroeconomic variables developed as a result of the Great Depression, when the previous laissez-faire approach to economic management became discredited. Fiscal policy is based on the theories of the British economist John Maynard Keynes, whose Keynesian economics indicated that government changes in the levels of taxation and government spending influences aggregate demand and the level of economic activity. Fiscal and monetary policy are the key strategies used by a country's government and central bank to advance its economic objectives. The combination of these policies enables these authorities to target the inflation and to increase employment. Additionally, it is designed to try to keep GDP growth at 2%–3% and the unemployment rate near the natural unemployment rate of 4%–5%. This implies that fiscal policy is used to stabilize the economy over the course of the business cycle.

Causes of the Great Depression

The causes of the Great Depression in the early 20th century have been extensively discussed by economists and remain a matter of active debate. They are part of the larger debate about economic crises. The specific economic events that took place during the Great Depression are well established. There was an initial stock market crash that triggered a "panic sell-off" of assets. This was followed by a deflation in asset and commodity prices, dramatic drops in demand and credit, and disruption of trade, ultimately resulting in widespread unemployment and impoverishment. However, economists and historians have not reached a consensus on the causal relationships between various events and government economic policies in causing or ameliorating the Depression.

In monetary economics, the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply. The theory was originally formulated by Polish mathematician Nicolaus Copernicus in 1517, and was influentially restated by philosophers John Locke and David Hume, and by economists Milton Friedman and Anna Schwartz in A Monetary History of the United States published in 1963.

Neo-Keynesian economics is a school of macroeconomic thought that was developed in the post-war period from the writings of John Maynard Keynes. A group of economists, attempted to interpret and formalize Keynes' writings and to synthesize it with the neo-classical models of economics. Their work has become known as the neo-classical synthesis and created the models that formed the core ideas of neo-Keynesian economics. These ideas dominated mainstream economics in the post-war period and formed the mainstream of macroeconomic thought in the 1950s, 1960s and 1970s.

Fiscalism is a term sometimes used to refer the economic theory that the government should rely on fiscal policy as the main instrument of macroeconomic policy. Fiscalism in this sense is contrasted with monetarism, which is associated with reliance on monetary policy. Fiscalists reject monetarism in a non-convertible floating rate system as inefficient if not also ineffective

David Ernest William Laidler is an economist who has been one of the foremost scholars of monetarism. He published major economics journal articles on the topic in the late 1960s and early 1970s. His book, The Demand for Money, was published in four editions from 1969 through 1993, initially setting forth the stability of the relationship between income and the demand for money and later taking into consideration the effects of legal, technological, and institutional changes on the demand for money. The book has been translated into French, Spanish, Italian, Japanese, and Chinese.

Friedman's k-percent rule is a monetary policy rule that the money supply should be increased by the central bank by a constant percentage rate every year, irrespective of business cycles. In A Monetary History of the United States, 1867–1960, monetarist economists Milton Friedman and Anna Schwartz attributed inflation to excess money supply generated by a central bank. It attributed deflationary spirals to the reverse effect of a failure of a central bank to support the money supply during a liquidity crunch. Friedman proposed a fixed monetary rule, called Friedman's k-percent rule, where the money supply would be calculated by known macroeconomic and financial factors, targeting a specific level or range of inflation.

The following is a list of works by the prominent American economist Milton Friedman.

The Shadow Open Market Committee (SOMC) is an independent group of economists, first organized in 1973 by Professors Karl Brunner, from the University of Rochester, and Allan Meltzer, from Carnegie Mellon University, to provide a monetarist alternative to the views on monetary policy and its inflation effects then prevailing at the Federal Reserve and within the economics profession.

<i>A Monetary History of the United States</i> 1963 book by Milton Friedman and Anna Schwartz

A Monetary History of the United States, 1867–1960 is a book written in 1963 by Nobel Prize–winning economist Milton Friedman and Anna J. Schwartz. It uses historical time series and economic analysis to argue the then-novel proposition that changes in the money supply profoundly influenced the U.S. economy, especially the behavior of economic fluctuations. The implication they draw is that changes in the money supply had unintended adverse effects, and that sound monetary policy is necessary for economic stability. Economic historians see it as one of the most influential economics books of the century. The chapter dealing with the causes of the Great Depression was published as a stand-alone book titled The Great Contraction, 1929–1933.

Outline of economics Overview of and topical guide to economics

The following outline is provided as an overview of and topical guide to economics:

In macroeconomics, particularly in the history of economic thought, the Treasury view is the assertion that fiscal policy has no effect on the total amount of economic activity and unemployment, even during times of economic recession. This view was most famously advanced in the 1930s by the staff of the British Chancellor of the Exchequer. The position can be characterized as:

Any increase in government spending necessarily crowds out an equal amount of private spending or investment, and thus has no net impact on economic activity.

Stimulus (economics) attempts to use monetary or fiscal policy to stimulate the economy

In economics, stimulus refers to attempts to use monetary or fiscal policy to stimulate the economy. Stimulus can also refer to monetary policies like lowering interest rates and quantitative easing.

History of macroeconomic thought

Macroeconomic theory has its origins in the study of business cycles and monetary theory. In general, early theorists believed monetary factors could not affect real factors such as real output. John Maynard Keynes attacked some of these "classical" theories and produced a general theory that described the whole economy in terms of aggregates rather than individual, microeconomic parts. Attempting to explain unemployment and recessions, he noticed the tendency for people and businesses to hoard cash and avoid investment during a recession. He argued that this invalidated the assumptions of classical economists who thought that markets always clear, leaving no surplus of goods and no willing labor left idle.

Market monetarism is a school of macroeconomic thought that advocates that central banks target the level of nominal income instead of inflation, unemployment, or other measures of economic activity, including in times of shocks such as the bursting of the real estate bubble in 2006, and in the financial crisis that followed. In contrast to traditional monetarists, market monetarists do not believe monetary aggregates or commodity prices such as gold are the optimal guide to intervention. Market monetarists also reject the New Keynesian focus on interest rates as the primary instrument of monetary policy. Market monetarists prefer a nominal income target due to their twin beliefs that rational expectations are crucial to policy, and that markets react instantly to changes in their expectations about future policy, without the "long and variable lags" postulated by Milton Friedman.


  1. 1 2 Phillip Cagan, 1987. "Monetarism", The New Palgrave: A Dictionary of Economics , v. 3, Reprinted in John Eatwell et al. (1989), Money: The New Palgrave, pp. 195–205, 492–97.
  2. Friedman, Milton (2008). Monetary History of the United States, 1867-1960. Princeton University Press. ISBN   0691003548. OCLC   994352014.
  3. Doherty, Brian (June 1995). "Best of Both Worlds". Reason. Retrieved July 28, 2010.
  4. Mankiw, N. Gregory. "Real Business Cycles: A New Keynesian Perspective". Journal of Economic Perspectives 3.3 (1989): 79–90. Web.|date=October 2013
  5. Bordo, Michael D. (1989). "The Contribution of A Monetury History". Money, History, & International Finance: Essays in Honor of Anna J. Schwartz. The Increase in Reserve Requirements, 1936-37. University of Chicago Press. p. 46. ISBN   0-226-06593-6 . Retrieved 2019-07-25.
  6. Thomas Palley (November 27, 2006). "Milton Friedman: The Great Conservative Partisan" . Retrieved June 20, 2013.[ unreliable source? ]
  7. Ip, Greg; Whitehouse, Mark (2006-11-17). "How Milton Friedman Changed Economics, Policy and Markets". The Wall Street Journal.
  8. "Monetary Central Planning and the State, Part 27: Milton Friedman's Second Thoughts on the Costs of Paper Money". Archived from the original on November 14, 2012.Cite uses deprecated parameter |deadurl= (help)
  9. 1 2 Friedman, Milton (1970). "A Theoretical Framework for Monetary Analysis". Journal of Political Economy . 78 (2): 193–238 [p. 210]. doi:10.1086/259623. JSTOR   1830684.
  10. Reichart Alexandre & Abdelkader Slifi (2016). 'The Influence of Monetarism on Federal Reserve Policy during the 1980s.' Cahiers d'économie Politique/Papers in Political Economy, (1), pp. 107–50.
  11. "Economy tables: GDP, interest rates and inflation history, unemployment". This Is Money. Retrieved June 20, 2013.
  12. "Real Gross Domestic Product for United Kingdom, Federal Reserve Bank of St. Louis" . Retrieved December 16, 2018.
  13. Milton Friedman; Anna Schwartz (2008). The Great Contraction, 1929–1933 (New Edition). Princeton University Press. ISBN   0-691-13794-3.

Further references