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Encyclopedia > Monetarism

Monetarism is a set of views concerning the determination of national income and monetary economics. It focuses on the supply and demand for money as the primary means by which economic activity is regulated. Monetary theory focuses on money supply and on inflation as an effect of the supply of money being larger than the demand for money. GNP redirects here. ... Face-to-face trading interactions on the New York Stock Exchange trading floor Economics is the social science that studies the production, distribution, and consumption of commodities. ... The examples and perspective in this article or section may not represent a worldwide view. ...


Monetarism today is mainly associated with the work of Milton Friedman, who was among the generation of liberal economists to accept Keynesian economics and then critique it on its own terms. Friedman and Anna Schwartz wrote an influential book, Monetary History of the United States 1867-1960, and argued that "inflation is always and everywhere a monetary phenomenon." Friedman advocated a central bank policy aimed at keeping the supply and demand for money at equilibrium, as measured by growth in productivity and demand. The monetarist argument that the demand for money is a stable function gained considerable support during the late 1960s and 1970s from the work of David Laidler. While most monetarists believe that government action is at the root of inflation, very few advocate a return to the gold standard. Friedman, for example, viewed the gold standard as highly impractical. The former head of the United States Federal Reserve, Alan Greenspan, is generally regarded as monetarist in his policy orientation. Milton Friedman (July 31, 1912 – November 16, 2006) was an American economist and public intellectual who made major contributions to the fields of macroeconomics, microeconomics, economic history and statistics while advocating laissez-faire capitalism. ... Keynesian economics (pronounced ), also called Keynesianism, or Keynesian Theory, is an economic theory based on the ideas of 20th century British economist John Maynard Keynes. ... Anna Schwartz is an economist who has changed our understanding of how the world works. ... David E.W. Laidler (b. ... The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... Alan Greenspan (born March 6, 1926) is an American economist and was Chairman of the Board of Governors of the Federal Reserve of the United States from 1987 to 2006. ...


Critics of monetarism include both neo-Keynesians who argue that demand for money is intrinsic to supply, and some conservative economists who argue that demand for money cannot be predicted. Supply-sider Jude Wanniski declared monetarism a failure because it assumed that the velocity of money is roughly constant [1]. Joseph Stiglitz has argued that the relationship between inflation and money supply growth is weak for ordinary inflation, as opposed to hyperinflation (meaning perhaps more than 10% year-over-year) which is almost universally regarded as an effect of government spending at a time when output growth can not absorb it (See inflation by government spending). In an interview with the Financial Times from June 6, 2003, Milton Friedman even seemed to repudiate the monetary policy of monetarism and was quoted as saying "The use of quantity of money as a target has not been a success," ... "I'm not sure I would as of today push it as hard as I once did." John Maynard Keynes provided the framework for synthesizing a host of economic ideas present between 1900 and 1940, and that synthesis bears his name. ... Supply-side economics is a school of macroeconomic thought which emphasizes the supply part of supply and demand. ... It has been suggested that Two Santa Claus Theory be merged into this article or section. ... Velocity of money In economics, the velocity of money refers to a key term in the quantity theory of money, which centers on the equation of exchange: M*V = P*Q where M is the total amount of money in circulation in an economy at any one time (say, on... Joseph Stiglitz (born February 9, 1943) is an American economist, author and winner of Nobel Prize for economics ( 2001). ...


Though monetarism is commonly associated with conservative economics and economists, not all conservatives are monetarists, and not all monetarists are conservatives.

Contents

What is monetarism?

Monetarism is an economic theory which 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 article does not cite its references or sources. ... Milton Friedman (July 31, 1912 – November 16, 2006) was an American economist and public intellectual who made major contributions to the fields of macroeconomics, microeconomics, economic history and statistics while advocating laissez-faire capitalism. ... In mainstream economics, inflation is a rise in the general level of prices, as measured against some baseline of purchasing power. ...


This theory draws its roots from two almost diametrically opposed ideas: the hard money policies which dominated monetary thinking in the late 19th century, and the monetary theories of John Maynard Keynes, who, working in the interwar period during the failure of the restored gold standard, proposed a demand-driven model for money which was the foundation of macroeconomics. Whereas Keynes had focused on the value stability of currency—with the resulting panics based on an insufficient money supply leading to alternate currency and collapse—Friedman focused on price stability: the equilibrium between supply and demand for money. John Maynard Keynes (right) and Harry Dexter White at the Bretton Woods Conference John Maynard Keynes, 1st Baron Keynes, CB (pronounced canes, IPA ) (5 June 1883 – 21 April 1946) was a British economist whose ideas, called Keynesian economics, had a major impact on modern economic and political theory as well... This article is on the monetary principle. ... This article does not cite its references or sources. ...


The result was summarized in Friedman's historical analysis of monetary policy: Monetary History of the United States 1867-1960, which attributed inflation to excess money supply generated by a central bank. It attributes deflationary spirals to the reverse effect: failure of a central bank to support the money supply during a liquidity crunch. The examples and perspective in this article or section may not represent a worldwide view. ... Market liquidity is a business or economics term that refers to the ability to quickly buy or sell a particular item without causing a significant movement in the price. ...


Friedman originally proposed a fixed monetary rule, where the money supply would be calculated by known macroeconomic and financial factors, targeting a specific level or range of inflation. There would be no leeway for the central reserve bank, and business could anticipate all monetary policy decisions.


The rise of monetarism

The rise of monetarism within mainstream economics dates mostly from Milton Friedman's 1956 restatement of the quantity theory of money. Friedman argued that the demand for money depended predictably on several major economic variables. Thus, if the money supply were 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 was reduced people would want to replenish their holdings of money by reducing their spending. Thus Friedman challenged the Keynesian assertion that "money does not matter"; he argued that the supply of money does affect the amount of spending in an economy. Thus the word 'monetarist' was coined. Milton Friedman (July 31, 1912 – November 16, 2006) was an American economist and public intellectual who made major contributions to the fields of macroeconomics, microeconomics, economic history and statistics while advocating laissez-faire capitalism. ... In economics, the velocity of money refers to a key term in the quantity theory of money, which centers on the equation of exchange: where is the total amount of money in circulation in an economy at any one time (say, on average during a month). ... The examples and perspective in this article or section may not represent a worldwide view. ...


The rise of the popularity of monetarism in political circles accelerated as 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 deflation. The result was a significant disillusionment with Keynesian demand management: a Democratic President Jimmy Carter appointed a monetarist Federal Reserve chief Paul Volcker who made inflation fighting his primary objective, and restricted the money supply to tame inflation in the economy. The result was the most severe recession of the post-war period, but also the creation of the desired price stability. An 1837 political cartoon about unemployment in the United States. ... Wikipedia does not have an article with this exact name. ... At the height of the crisis in the United States, drivers of vehicles with odd numbered license plates were allowed to purchase gasoline only on odd-numbered days of the month, while drivers with even-numbers were limited to even-numbered days. ... This article is in need of attention from an expert on the subject. ... Deflation occurs when prices deflate, i. ... James Earl Jimmy Carter, Jr. ... Economist Paul Adolph Volcker (September 5, 1927 - ) born in Cape May, New Jersey, is best-known as the Chairman of the Federal Reserve under United States Presidents Jimmy Carter and Ronald Reagan (from August 1979 to August 1987). ... A recession is usually defined in macroeconomics as a fall of a countrys real Gross Domestic Product in two or more successive quarters of a year. ...


Monetarists not only sought to explain contemporary 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 1930 was caused by a massive contraction of the money supply 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 coined the famous assertion of monetarism that 'inflation is always and everywhere a monetary phenomenon'. At first, to many economists whose perceptions had been set by Keynesian ideas, it seemed that the Keynesian vs. monetarist debate was merely 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 more profound matters as monetarists presented a more fundamental challenge to Keynesian orthodoxy. Anna Schwartz is an economist who has changed our understanding of how the world works. ... The Great Depression was an economic downturn which started in 1929 and lasted through most of the 1930s. ... Monetary policy is the government or central bank process of managing money supply to achieve specific goals—such as constraining inflation, maintaining an exchange rate, achieving full employment or economic growth. ...


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 an equilibrium 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 (I) to the consumer sector (C).


Monetarism in practice

The crucibles of economic theories are the cataclysmic events which reshape economic activity. Hence, major economic theories which aspire to a policy role must explain the great deflationary waves of the late 19th Century with their repeated panics, the Great Depression which began in the late 1920s and peaked in early 1933, and the stagflation period beginning with the uncoupling of exchange rates in 1972. Stagflation is a term in macroeconomics used to describe a period characteristic of high inflation combined with economic stagnation, unemployment, or economic recession. ...


Monetarists argue that there was no inflationary investment boom in the 1920s, in contrast to both Keynesians and to economists of the Austrian School, who argue that there was significant asset inflation and unsustainable GNP growth during the 1920s. Instead, monetarist thinking centers on the contraction of the M1 during the 1931-1933 period, and argues from there that the Federal Reserve could have avoided the Great Depression by moves to provide sufficient liquidity. In essence, they argue that there was an insufficient supply of money. This argument is supported by macroeconomic data, such as price stability in the 1920s and the slow rise of the money supply.


The counterargument is that microeconomic data supports the conclusion of a maldistributed pooling of liquidity in the 1920s, caused by excessive easing of credit. This viewpoint is argued by followers of Ludwig von Mises, who stated at the time that the expansion was unsustainable, and at the same time by Keynes, whose ideas were included in Franklin D. Roosevelt's first inaugural address. Ludwig Heinrich Edler von Mises (September 29, 1881 – October 10, 1973) was a notable economist and a major influence on the modern libertarian movement. ... John Maynard Keynes John Maynard Keynes [ˈkeɪns], 1st Baron Keynes of Tilton (June 5, 1883 - April 21, 1946) was an English economist, whose radical ideas had a major impact on modern economic and political thought. ... FDR redirects here. ...


From their conclusion that incorrect central bank policy is at the root of large swings in inflation and price instability, monetarists argued that the primary motivation for excessive easing of central bank policy is to finance fiscal deficits by the central government. Hence, restraint of government spending is the most important single target to restrain excessive monetary growth.


With the failure of demand-driven fiscal policies to restrain inflation and produce growth in the 1970s, the way was paved for a new change in policy that focused on fighting inflation as the cardinal responsibility for the central bank. In typical economic theory, this would be accompanied by austerity shock treatment, as is generally recommended by the International Monetary Fund. Indeed in the United Kingdom, government spending was slashed in the late 70s and early 80s with the political ascendance of Margaret Thatcher, whereas in the United States, real government spending increased much faster during Reagan's first four years (4.22%/year) than it did under Carter (2.55%/year) [ref: 2006 Economic Report of the President, Table B-78 and B-60]. In the ensuing short term, unemployment in both countries remained stubbornly high while central banks raised interest rates to restrain credit. However, the policies of both countries' central banks dramatically brought down the inflation rates (e.g. the United State's inflation rate fell from almost 14% in 1980 to around 3% in 1983), allowing the liberalisation of credit and the reduction in interest rates which paved the way for the ultimately inflationary economic booms of the 1980s. Some claim that the use of credit to fuel economic expansion is itself an anti-monetarist tool, as it can be argued that an increase in money supply alone constitutes inflation. The International Monetary Fund (IMF) is an international organization that oversees the global financial system by observing exchange rates and balance of payments, as well as offering financial and technical assistance when requested. ...


Monetarism re-asserted itself in central bank policy in western governments at the end of the 1980s and beginning of the 1990s, with a contraction in spending and in the money supply ending the booms experienced in the US and UK.


With the crash of 1987, questioning of the prevailing monetarist policy began. Monetarists argued that the 1987 stock market decline was simply a correction between conflicting monetary policies in the United States and Europe. Critics of this viewpoint became louder as Japan slid into a sustained deflationary spiral and the collapse of the savings-and-loan banking system in the United States pointed to larger structural changes in the economy. our fence fell over DJIA (19 July 1987 through 19 January 1988) FTSE 100 Index (19 July 1987 through 19 January 1988) Black Monday is the name given to Monday, October 19, 1987, when the Dow Jones Industrial Average (DJIA) fell dramatically across the world. ...


In the late 1980s, Paul Volcker was succeeded by Alan Greenspan, former follower of Ayn Rand, and a leading monetarist. His handling of monetary policy in the runup to the 1991 recession was criticised from the right as being excessively tight, and costing George H. W. Bush re-election. The incoming Democratic president Bill Clinton reappointed Alan Greenspan, and kept him as a core member of his economic team. Greenspan, while still fundamentally monetarist in orientation, argued that doctrinaire application of theory was insufficiently flexible for central banks to meet emerging situations. Economist Paul Adolph Volcker (September 5, 1927 - ) born in Cape May, New Jersey, is best-known as the Chairman of the Federal Reserve under United States Presidents Jimmy Carter and Ronald Reagan (from August 1979 to August 1987). ... Alan Greenspan (born March 6, 1926) is an American economist and was Chairman of the Board of Governors of the Federal Reserve of the United States from 1987 to 2006. ... It has been suggested that The Ayn Rand Collective be merged into this article or section. ... George Herbert Walker Bush GCB (born June 12, 1924) was the 41st President of the United States of America serving from 1989 to 1993. ... William Jefferson Bill Clinton (born William Jefferson Blythe III on August 19, 1946) was the 42nd President of the United States, serving from 1993 to 2001. ...


The crucial test of this flexible response by the Federal Reserve was the Asian financial crisis of 1997-1998, which the Federal Reserve met by flooding the world with dollars, and organizing a bailout of Long-Term Capital Management. Some have argued that 1997-1998 represented a monetary policy bind—as the early 1970s had represented a fiscal policy bind—and that while asset inflation had crept into the United States, demanding that the Fed tighten, the Federal Reserve needed to ease liquidity in response to the capital flight from Asia. Greenspan himself noted this when he stated that the American stock market showed signs of irrational valuations. The Asian financial crisis was a financial crisis that started in July 1997 in Thailand and affected currencies, stock markets, and other asset prices in several Asian countries, many considered East Asian Tigers. ... Long-Term Capital Management (LTCM) was a hedge fund founded in 1994 by John Meriwether (the former vice-chairman and head of bond trading at Salomon Brothers). ...


In 2000, Greenspan pushed the economy into recession with a rapid and drastic series of tightening moves by the Federal Reserve to sanitize the intervention of 1997-1998, followed by a similarly drastic series of loosenings in the wake of the 2000-2001 recession. It was the failure of these moves to produce stimulus which led to the wider-spread questioning of the sufficiency of monetary policy to deal with economic downturns.


Currently the American Federal Reserve follows a modified form of monetarism, where broader ranges of intervention are possible in light of temporary instabilities in market dynamics. This form does not yet have a generally accepted name.


In Europe, the European Central Bank follows a more orthodox form of monetarism, with tighter controls over inflation and spending targets as mandated by the Economic and Monetary Union of the European Union under the Maastricht Treaty to support the euro. This more orthodox monetary policy is in the wake of credit easing in the late 1980s and 1990s to fund German reunification, which was blamed for the weakening of European currencies in the late 1990s. In economics, a monetary union is a situation where several countries have agreed to share a single currency among them. ... The Maastricht Treaty (formally, the Treaty on European Union) was signed on 7 February 1992 in Maastricht between the members of the European Community and entered into force on 1 November 1993, under the Delors Commission. ... ISO 4217 Code EUR User(s) European Union: Austria, Belgium, Finland, France, Germany, Greece, Republic of Ireland, Italy, Luxembourg, Netherlands, Portugal, Slovenia and Spain. ...


The current state of monetary theory

Since 1990, the classical form of monetarism has been questioned because of events which many economists have interpreted as being inexplicable in monetarist terms - the unhinging 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. Alan Greenspan, former chairman of the Federal Reserve, 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. Liberal economist Robert Solow of MIT suggested that the 2001-2003 failure of the expected economic recovery should be attributed not to monetary policy failure but to the breakdown in productivity growth in crucial sectors of the economy, most particularly retail trade. He noted that five sectors produced all of the productivity gains of the 1990s, and that while the growth of retail and wholesale trade produced the smallest growth, they were by far the largest sectors of the economy experiencing net increase of productivity. "2% may be peanuts, but as the single largest sector of the economy, that's an awful lot of peanuts." Alan Greenspan (born March 6, 1926) is an American economist and was Chairman of the Board of Governors of the Federal Reserve of the United States from 1987 to 2006. ... The Federal Reserve System is headquartered in the Eccles Building on Constitution Avenue in Washington, DC. The Federal Reserve System (also the Federal Reserve; informally The Fed) is the central banking system of the United States. ... In many parts of economics there is an assumption that a complex system of determinants will tend to lead to a state of equilibrium. ... Robert Merton Solow (born August 23, 1924) is an American economist particularly known for his work on the theory of economic growth. ...


There are also arguments which link monetarism and macroeconomics, and treat monetarism as a special case of Keynesian theory. The central test case over the validity of these theories would be the possibility of a liquidity trap, such as experienced by Japan. Ben Bernanke, Princeton Professor and current Chairman of the US Federal Reserve, has argued that monetarism 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." Another popular economist, Paul Krugman, has advanced the counterargument that this would have a corresponding devaluationary effect, as the sustained low interest rates of 2001-2004 produced against world currencies. This article does not cite its references or sources. ... In monetary economics, a liquidity trap occurs when the economy is stagnant, the real interest rate is close or equal to zero, and the monetary authority is unable to stimulate the economy with traditional monetary policy tools. ... Ben Shalom Bernanke (born December 13, 1953) (pronounced ber-NAN-kee, bər-nan-kē or ), is an Jewish-American macroeconomist, who is the Chairman of the Board of Governors of the United States Federal Reserve (the Fed). He was previously Chairman of the U.S. Presidents Council of... Paul Krugman Paul Robin Krugman (born February 28, 1953) is an economist at Princeton University who has written several books and since 2000 has written a twice-weekly op-ed column for The New York Times. ...


David Hackett Fischer, in his study The Great Wave, questioned the implicit basis of monetarism by examining long periods of secular inflation that stretched over decades. In doing so, he produced data which suggests that prior to a wave of monetary inflation, there is a wave of commodity inflation, which governments respond to, rather than lead. Whether this formulation undermines the monetary data which underpins the fundamental work of monetarism is still a matter of contention. This article needs to be cleaned up to conform to a higher standard of quality. ...


Monetarists of the Milton Friedman school of thought believed in the 1970s and 1980s that the growth of the money supply should be based on certain formulations related to economic growth. As such, they can be regarded as advocates of a monetary policy based on a "quantity of money" target. This can be contrasted with the monetary policy advocated by supply side economics or Austrian economics which are based on a "value of money" target. Supply-side economics is a school of macroeconomic thought which emphasizes the importance of tax cuts and business incentives in encouraging economic growth, in the belief that businesses and individuals will use their tax savings to create new businesses and expand old businesses, which in turn will increase productivity, employment... The Austrian School is a school of economic thought which rejects opposing economists reliance on methods used in natural science for the study of human action, and instead bases its formalism of economics on relationships through logic or introspection called praxeology. ...


In 2003, Milton Friedman renounced many of the policies from the 1980s that were based on quantity targets. In doing so he basically conceded that the demand for money is not so easily predicted. He stood, however, by his central formulations.


These disagreements, as well as the role of monetary policy in trade liberalization, international investment, and central bank policy, remain lively topics of investigation and argument - proving that monetarist theory remains a central area of study in market economics, even if it is no longer a realistic consideration for implementation by policymakers.


Articles and books

  • Monetary creation, aggregates and GDP growth On the inverse relation between Excess Money Supply and Growth. - J.P. Chevallier

See also

This article does not cite its references or sources. ... Political economy was the original term for the study of production, the acts of buying and selling, and their relationships to laws, customs and government. ... What follows is a list of over 250 Wikipedia articles on finance topics. ... This aims to be a complete list of the articles on economics. ...

External links

  • Monetarism from the Economics A-Z of The Economist
  • Smartalec Economics Discussion Board: [2] - Growing community for Economics discussion.

  Results from FactBites:
 
Monetarism - HISTORY AND BACKGROUND, THE MONETARIST COUNTERREVOLUTION, KEY MONETARIST PROPOSITIONS (5813 words)
Monetarism asserts that monetary policy is very powerful, but that it should not be used as a macroeconomic policy to manage the economy.
First of all, it should be noted that monetarism was an attempt by conservative economists to reestablish the wisdom of the classical laissez faire recommendation and was an attack on the activist macroeconomic policy recommendations of the Keynesian economists.
At a more theoretical level, proponents of monetarism argue that investment (a component of private sector demand) is very sensitive to changes in interest rates, whereas the demand for money (the amount of money people want to hold in cash and checkable deposits for various purposes) is not very sensitive to changes in interest rates.
Monetarism - Wikipedia, the free encyclopedia (2692 words)
Monetarism is a set of views concerning the determination of national income and monetary economics.
Monetarism today is mainly associated with the work of Milton Friedman, who was among the generation of liberal economists to accept Keynesian economics and then critique it on its own terms.
Monetarism is an economic theory which focuses on the macroeconomic effects of the supply of money and central banking.
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