Monetarism

Monetarism

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Friedman’s successful critique of Keynesianism – encouraged acceptance of other views

Monetarist macroeconomics – no fine tuning

Money supply targeting

- Nominal income identity MV=PY

- Assume stable velocity + full employment

- Growth of money stock determines inflation

- Central bank can control this

- Choice of monetary aggregate – base money M1, M2, M3

Failure of monetary targeting

- Financial innovation associated with deregulation – made money supply measures hard to interpret

- More fundamental – changes in behavior associated with targeting – Goodhart’s law – the lost of its role for indicators of the target.

- Policy abandoned by early 1980s

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Monetarism is the view within monetary economics that variation in the money supply has major influences on national output in the short run and the price level over the longer periods and that objective of monetary policy are best met by targeting the growth rate of the money supply.

Monetarism today is mainly associated with the work of Milton Friedman, who was among the generation of economists to accept Keynesian economics and then criticize it on its own term. Friedman and Anna Schwartz wrote an influential book, A Monetary History of US, 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 measure 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. The former head of US Federal Reserve, Alan Greenspan, is generally regarded as monetarist in his policy orientation. The European Central Bank officially bases its monetary policy on money supply targets.

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. Joseph Stiglitz has argued that the relationship between inflation and money supply is weak when inflation is low.

Description

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 theory draws its roots from two almost diametrically opposed ideas: the hard money [Hard money policies are those which are opposed to fiat currency and this in support of a specie standard, usually gold or silver, typically implemented with representative money] policies that dominated monetary thinking in the late 19^th 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 which as the foundation of macroeconomics. While 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, then Friedman focused on price stability, which is the equilibrium between supply and demand for money.

This result was summarized in a historical analysis of monetary policy, Monetary History of the US 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.

Friedman originally 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. Under this rule, there would be no leeway for the central reserve bank as money supply increased could be determined “by a computer”, and business could anticipate all monetary policy decisions.