What is Monetarism?
Monetarism is a school of economics most closely associated with the American economist Milton Friedman. It holds that changes in the quantity of money are the main cause of short-run swings in output and the main long-run cause of inflation. Friedman summed this up in his claim that inflation is always and everywhere a monetary phenomenon. Monetarists argue that central banks should let the money supply grow at a steady, predictable rate rather than trying to fine-tune the economy. Politically, monetarism became linked with the free-market revival of the 1970s and 1980s, because it offered an alternative to Keynesian demand management.
Core beliefs
- Inflation is caused mainly by money growing faster than the output of goods and services.
- Changes in the money supply affect output in the short run but mostly prices in the long run.
- Monetary policy works with long and variable lags, so fine-tuning is risky.
- Central banks should follow stable rules, such as a fixed rate of money growth.
- Active fiscal policy is a weak and unreliable tool for managing the economy.
- There is no lasting trade-off between inflation and unemployment.
History
Monetarism grew out of the older quantity theory of money and was developed at the University of Chicago from the 1950s. In 1963 Friedman and Anna Schwartz published A Monetary History of the United States, 1867-1960, which argued that a sharp contraction of the money supply turned the downturn after 1929 into the Great Depression. In the late 1960s Friedman, and separately Edmund Phelps, argued that attempts to hold unemployment below its natural rate would only raise inflation. When the 1970s brought high inflation and high unemployment together, these ideas gained wide support. Karl Brunner and Allan Meltzer founded the Shadow Open Market Committee in 1973 to press monetarist policy in the United States. Friedman received the Nobel memorial prize in economics in 1976. In 1979 the US Federal Reserve under Paul Volcker shifted to targeting money growth, and the British government of Margaret Thatcher adopted money supply targets from 1980. Both later moved away from strict targets as the link between money measures and spending became unstable.
Variants
Classic monetarism, led by Friedman, proposed a fixed annual growth rate for the money supply, often called the k-percent rule. Brunner and Meltzer developed a version focused on credit markets and policy institutions. Later, many monetarist ideas were absorbed into mainstream inflation targeting by independent central banks. Market monetarism, a twenty-first century approach, favors targeting the growth of total nominal spending.
Criticisms
Keynesian economists argue that monetarism understates the role of demand and the risk of prolonged unemployment, and that monetary policy can lose force when interest rates are near zero. Critics point out that the relationship between money measures and spending broke down in the 1980s, making targets hard to meet. Experiences in Britain and the United States in the early 1980s, where tight money coincided with deep recessions and high unemployment, are cited by critics as social costs of the approach. Supporters respond that it brought inflation under control.
In practice
Monetarist ideas shaped the Volcker disinflation in the United States, the Medium Term Financial Strategy in Britain and policy at the German Bundesbank and the Swiss National Bank. Money targets were largely abandoned by the late 1980s, but the monetarist focus on price stability, central bank credibility and rules influenced the inflation targeting regimes adopted by many central banks from the 1990s.