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monetarisma 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.
monetarisma 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.