Monetarism

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Monetarism is a school of economic thought, whose representatives are Milton Friedman, Anna Schwartz, Karl Brunner, Allan Meltzer, David Laidler, Michael Parkin and Alan Walters. Monetarists formulated their views on macroeconomic policy as opposed to excessive Keynesian attachment to fiscal policy. Monetaryism examines the impact of the monetary policy of the state on national income, places particular emphasis on the neutrality of money in the long term and lack of its neutrality in the short term, as well as the difference between the real and nominal interest rate. It is characterized by a deep faith in self-regulating market mechanisms.

Monetaryism was created around 1956. The publication of the so-called quantitative theory of money by Milton Friedman.

Monetary policy

Monetarists argue that the goal of monetary policy is to recognize the control of the money supply. This control assumes breaking with the principle of constant exchange rates. In an open economy, at constant exchange rates, only the size of loans can be controlled, but not the money supply. According to monetarists, the government can maintain the nominal interest rate, while the real rate depends on the expected inflation rate. Equal and nominal interest rate equation is unlikely, but it can occur when the expected inflation rate is zero. Monetaryism assumes that in the short term the government may influence the unemployment rate by using monetary stimuli. However, if such a solution does not bring the unemployment rate closer to the natural rate, the effect in the long run will be the acceleration of inflation. Friedman argues that there should not be too many movements on the part of monetary authorities in the interim period. However, a good solution is the free operation of monetary regularities, manipulating gently with tools that reduce inflation, while simultaneously bringing the real rate closer to the natural unemployment rate.

Thus, monetary analysts focus on monetary policy. The state's fiscal policy, in their opinion, does not exert too much influence on the amount of real national income and employment. They also believe that in the free market economy one has to take into account the existence of some unemployment, but at the same time assuming the willingness of people and their desire to find the best possible jobs and the existence of a benefit system.

Friedman showed that the demand for money is strongly dependent on various economic variables and can be calculated quickly on their basis. Thus, when the state increases the emission of money above the calculated value, it will increase the amount of money in people, which will be spent mostly on additional consumption, and this in turn will lead to a temporary increase in the standard of living. Looking long-term, such an increase in the standard of living will not have coverage in the supply of goods and services. The short-term increase in the consumption of goods and services causes a constant increase in needs over the long term, which is associated with a constant emphasis on increased money supply. In this situation, the state will either continue to increase the money supply leading to inflation or raise public dissatisfaction with lowering citizens' incomes.

Impact of money supply on GNP

Another assumption of monetarism is the statement that the money supply is the basic, constant factor determining the growth of the nominal Gross National Product. This means that basic variables such as the global product, employment and prices are shaped primarily by money. According to the "quantitative exchange equation":

MV = PQ

where:

  • M - amount of money
  • V - speed of money circulation
  • P - average price level
  • Q - real price level.

At a constant rate of money circulation, only the money supply affects the nominal GNP.

Friedman accepted the money supply as the most important factor shaping the Gross National Product level, and inflation ascribing only the role of the monetary phenomenon. He recommended increasing the money supply at the rate of growth of the Gross National Product, which was to ensure stabilization in the economy.

The role of wages

The next point in monetary theory is the assumption that wages and prices are relatively flexible. As a result of changes in the money supply on the market, the average price level changes. Monetarists also believe that the private sector is stable. This is due to the fact that changes in nominal GNP are mainly caused by changes in the money supply, and monetary policy changes under the influence of external policies and events, which directly does not affect the private economy.

Examples of Monetarism

  • The monetarist approach to monetary and economic policy was the dominant approach in the United States during the 1980s under President Reagan. During this time, the Federal Reserve adopted a restrictive monetary policy, which was designed to reduce inflationary pressures and to increase economic growth. This policy was based on the monetarist belief that inflation was caused by excessive money supply growth, and that the only way to reduce inflation was to reduce the money supply.
  • The Bank of England has also adopted a monetarist approach to monetary policy since the late 1990s. This approach has been based on the belief that the Bank of England should set an inflation target and then use the money supply to achieve this target. This approach has led to the Bank of England setting an inflation target of 2% and then adjusting the money supply to meet the target.
  • Another example of monetarism is the use of quantitative easing by central banks. Quantitative easing is a tool used by central banks to increase the money supply in the economy, which can help to increase economic growth and reduce unemployment. This approach is based on the belief that an increase in the money supply can stimulate economic activity and spur economic growth.

Advantages of Monetarism

Monetarism has several advantages that have been demonstrated in practice.

  • Firstly, it is an effective tool for controlling inflation, as it focuses on the money supply rather than relying on fiscal policy measures such as taxes or government spending. This makes it easier to understand and predict the impact of monetary policy on inflation.
  • Secondly, it is a relatively simple approach to macroeconomics, with an emphasis on the long-term effects of monetary policy. This allows for a more efficient implementation of monetary policy without needing to account for complex fiscal policy measures.
  • Thirdly, monetarism also helps to maintain a stable economy by controlling the money supply and keeping the growth of money in line with the growth of the economy. This helps to prevent economic fluctuations, as the money supply can be adjusted in line with the economic situation.
  • Finally, monetarism also promotes economic efficiency by encouraging competition and free markets, which in turn leads to lower prices and greater choice for consumers.

Limitations of Monetarism

Monetarism is a school of economic thought which examines the impact of the monetary policy of the state on national income. However, it is not free from some limitations, such as:

  • Monetarism fails to adequately account for the role of demand-side factors in the economy, such as consumer spending and business investment. It does not take into account the effects of changes in the money supply on the aggregate expenditure.
  • Monetarism does not take into account the impact of other factors, such as changes in government policies, taxes, and regulations, on the economy.
  • Monetarism does not account for the effects of structural changes in the economy, such as technological advances and changes in the composition of the labor force.
  • Monetarism ignores the role of expectations in the economy and fails to account for the effects of uncertainty.
  • Monetarism relies heavily on the assumption of rational expectations, which is not always realistic.
  • Monetarism fails to provide a comprehensive account of the business cycle and cannot explain the causes of economic downturns.

Other approaches related to Monetarism

Monetarism is related to other approaches in macroeconomic policy such as Keynesianism, Supply-side economics, and the Austrian School of Economics.

  • Keynesianism is an economic theory which promotes the use of fiscal policy, such as government spending and taxation, to influence the level of economic activity.
  • Supply-side economics is an economic theory which emphasizes the importance of supply-side factors, such as technological change, in determining economic growth and inflation.
  • The Austrian School of Economics is an economic school of thought which emphasizes the importance of free markets, private property, and the decentralization of economic decision-making.

In summary, Monetarism is related to other approaches in macroeconomic policy, such as Keynesianism, Supply-side economics, and the Austrian School of Economics, which all emphasize different factors in determining economic growth and inflation.


Monetarism — recommended articles
David Ricardo — Austrian theory of money — Austrian business cycle theory — Price stability — Global demand — Interventionism — New keynesian economics — Expansionary monetary policy — IS-LM model

References

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