Definition
Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. It asserts that the management of the money supply has a direct and primary influence on inflation, economic output and unemployment. The theory was primarily championed by economist Milton Friedman.
Key Takeaways
- Monetarism is an economic school of thought that emphasises the role of governments in controlling the amount of money in circulation. It is largely based on the work of economist Milton Friedman.
- Monetarists believe that excessive expansion of the money supply is inherently inflationary, and that monetary policy should aim to maintain price stability. This opposes the Keynesian view that governments should stimulate economic growth through fiscal policy, such as government spending.
- Monetarism also supports a laissez-faire approach to economic management, advocating less government intervention in the economy. Monetarists argue that markets are generally efficient and that the economy can usually bring itself back to full employment without intervention, so long as the money supply is kept under control.
Importance
Monetarism is a crucial concept within the field of financial economics that emphasizes the role of governments controlling the amount of money in circulation.
It is important because it places a greater focus on the inflation-reducing effect of controlling the money supply, rather than targeting interest rates or fiscal policy to guide economic growth and stability.
Under the theories of monetarism, high levels of inflation are seen as the result of excess money in the economy, suggesting that by managing changes in the money supply economies can predict and control inflation rates.
Adherents of monetarism often advocate for monetary rules, such as a fixed growth rate in the money supply, to achieve stable inflation numbers, thereby influencing monetary policy on a global scale.
Understanding monetarism can provide a perspective on the causes and potential solutions for inflation and economic instability.
Explanation
Monetarism is a theoretical economic framework conceptualized by economist Milton Friedman, and it focuses on the macroeconomic effects of money supply. The key purpose of monetarism is to maintain a stable economy by controlling inflation and stabilizing the business cycle through managing the amount of money in circulation.
Adherents of this theory emphasize the role of governments in ensuring an appropriate money supply that matches economic growth rates, thus minimizing drastic fluctuations in prices. Monetarists propose that by carefully regulating the money supply, governments can tackle macroeconomic issues like inflation, recession, or high unemployment.
If the economy shows signs of inflation (rising prices), for example, a monetarist approach would be to reduce the money supply to suppress demand and subsequently slow down the overall price increase. Conversely, in periods of economic downturn, injecting more money into the system can help stimulate demand.
Therefore, in a monetarist framework, controlling the money supply serves as a critical tool for economic stability and growth.
Examples of Monetarism
Volcker Shock (Late 1970s and early 1980s): In an attempt to combat high inflation rates in the U.S, the Federal Reserve chairman, Paul Volcker, implemented a monetarist policy to reduce the growth of money supply. He significantly increased interest rates which ultimately led to a recession, but successfully brought inflation under control.
The Thatcher Government (1980s): UK Prime Minister, Margaret Thatcher was a strong advocate of monetarism. She, along with her Chancellor Geoffrey Howe, sought to control inflation by controlling the money supply. The policies included high interest rates, which led to a recession, but also ultimately to the taming of inflation.
Economic Stabilization in Chile (1973-1990): Under the dictatorship of Augusto Pinochet, Chile implemented monetarist policies influenced by the “Chicago Boys” – a group of Chilean economists who had trained at the University of Chicago. These policies included cuts in government spending and an attempt to restrain the growth of the money supply. The result was a more stable economy, albeit with high costs in terms of unemployment and social inequality.
FAQs about Monetarism
What is Monetarism?
Monetarism is a macroeconomic theory that suggests that the management of a nation’s money supply is the key to the control of inflation and recession. It assumes that the economy is stable and naturally leads to full employment.
Who are the main proponents of Monetarism?
The main proponent of Monetarism is the economist Milton Friedman. Monetarism significantly influenced the economic policies of the United States and other developed countries in the late 20th century.
How does Monetarism differ from Keynesian Economics?
Monetarism focuses on controlling inflation by controlling the money supply, whereas Keynesian economics emphasizes the importance of government intervention in the economy, particularly during recessions, through public spending and tax cuts.
What are the main tools used in Monetarism?
The main tools used in Monetarism are open market operations and reserve requirements. Open market operations involve the buying and selling of government bonds to control the money supply. Reserve requirements are the minimum amounts of money that banks are required to hold in reserve against deposits made by their customers.
What are the criticisms of Monetarism?
Critics of Monetarism argue that it is too simplistic and does not account for other factors that can affect inflation and economic stability. There is also criticism that its focus on controlling inflation can lead to high unemployment.
Related Entrepreneurship Terms
- Monetary Policy
- Inflation
- Friedman’s K-Percent Rule
- Quantity Theory of Money
- Central Banking
Sources for More Information
- Investopedia – A vast educational platform that offers comprehensive information about various financial terms including Monetarism.
- Britannica – An online encyclopedia that provides well-researched information about several topics, including economics and Monetarism.
- Corporate Finance Institute – They provide professional courses and free resources about different financial concepts, including Monetarism.
- Economics Help – This website is dedicated to helping people learn economics concepts, including Monetarism.
