Monetarism

A macroeconomic theory concerned with the sources of national income and the causes of inflation. The theory, proposed by and closely associated with Milton Friedman, states that the amount of money issued by a government should be kept steady, only allowing increases in the supply of money to allow for natural economic growth. Â Monetarism also states that the rate of inflation is directly determined by the supply of money available in an economy. Â Friedman believed that the government should be less focused on controlling the supply of money and more focused on maintaining price stability, a balance between monetary supply and demand. See: Economic growth rate, Monetarist

Monetarism

In economics, a theory stating that inflation results directly and exclusively from the expansion of a country's money supply. That is, if a government prints money, inflation will result. Monetarists believe that a government ought to set target interest rates to encourage or slow growth in the supply. For example, when an economy is growing rapidly, monetarists recommend raising interest rates. On the other hand, they recommend lowering interest rates in a recession. In general, however, monetarists recommend that a government maintain a relatively steady money supply, with an allowance for growth to keep up with GDP expansion. Many of its beliefs, notably the one on interest rates, are still commonly held, though many economists believe the relationship between money supply and inflation is more complex than monetarism theorizes. Milton Friedman is considered the father of modern monetarism.

monetarism

An economic theory, the proponents of which argue that economic variations, such as changes in prices and output, are primarily the result of changes in the money supply. (Thus, the Federal Reserve Board is the most important economic policymaker in the country.) Proponents of monetarism believe that changes in the money supply precede changes in other economic variables, including stock prices, and that a rational policy calls for moderate, steady increases in the money supply.

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monetarism

a body of economic ideas concerning the role of MONEY, in particular the MONEY SUPPLY, in the functioning of the economy The historical roots of modern monetarism lie in the quantity theory of money: MV = PT, where M = money supply V = velocity of circulation of money, P = general price level, T = the number of goods and services produced by the economy. In simple terms, assuming V to be constant and T to be fixed in the short run, then an increase in M results in an increase in P. i.e. the quantity theory provides an explanation of INFLATION in the economy The theory thus emphasizes the importance of the need for a long-term balanced relationship between the amount of money available to finance purchases of goods and services, on the one hand, and the ability of the economy to produce such goods and services, on the other. Thus, in order to avoid inflation the growth of the money supply must not exceed the supply capacity (i.e. growth rate) of the economy over time. See MONETARY POLICY, ECONOMIC POLICY.

monetarism

a body of analysis relating to the influence of MONEY in the functioning of the economy. The theory emphasizes the importance of the need for a ‘balanced’ relationship between the amount of money available to finance purchases of goods and services, on the one hand, and the ability of the economy to produce such goods and services, on the other.

The theory provides an explanation of INFLATION centred on excessive increases in the MONEY SUPPLY. Specifically, the monetarists argue that if the government spends more than it receives in taxes, increasing the PUBLIC-SECTOR BORROWING REQUIREMENT to finance the shortfall, then the increase in the money supply that results from financing the increase in the public-sector borrowing requirement will increase the rate of inflation. The ‘pure’ QUANTITY THEORY OF MONEY (MV = PT) suggests that the ultimate cause of inflation is excessive monetary creation (that is, ‘too much money chasing too little output’) - thus it is seen as a source of DEMAND-PULL INFLATION.

Monetarists suggest that ‘cost-push’ is not a truly independent theory of inflation - it has to be ‘financed’ by money supply increases. Suppose, initially, a given stock of money and given levels of output and prices. Assume now that costs increase (for example, higher wage rates) and this causes suppliers to put up prices. Monetarists argue that this increase in prices will not turn into an inflationary process (that is, a persistent tendency for prices to rise) unless the money supply is increased. The given stock of money will buy fewer goods at the higher price level and real demand will fall; but if the government increases the money supply then this enables the same volume of goods to be purchased at the higher price level. If this process continues, COST-PUSH INFLATION is validated. See also MONEY SUPPLY/SPENDING LINKAGES, MONETARY POLICY, MEDIUM-TERM FINANCIAL STRATEGY, CHICAGO SCHOOL.