Monetarism

Monetarism. The economic theory known as monetarism holds that the money stock exerts an important influence on economic activity and prices. Economists who embrace monetarism hold that changes in the quantity of money are crucial in increasing aggregate income and productivity in the short run, and the inflation rate in the long run. The University of Chicago economist Milton Friedman (1912–) was the most prominent twentieth‐century proponent of monetarism, but the theory's intellectual origins extend back more than two centuries to the quantity theory of money of classical economics. According to such theories, changes in the money stock or the velocity of the circulation of money (the ratio of total spending to the money stock) determine nominal spending. Because velocity changes less over the longer run than the total money stock, the effects of the latter dominate.

Friedman and Anna Schwartz offered important empirical support for monetarism in A Monetary History of the United States, 1867–1960 (1963). They showed that since the Civil War, fluctuations in the rate of monetary growth led the peaks and troughs of all U.S. business cycles. Moreover, they associated especially severe economic downturns, such as 1929–1933, with large monetary contractions. While money powerfully affected the economy in the short run, its long‐term effect was less predictable. This fact underlies another precept of monetarism: Rather than actively using monetary policy to smooth business cycles, as Keynesians advocate, the monetary authority (in the United States, the Federal Reserve System) should adhere to a fixed rule such as maintaining a constant rate of growth of the money supply.

While changes in the money supply may affect the physical volume of output in the short run, over the long run nonmonetary factors determine economic growth. Monetary changes primarily affect the price level. Hence, monetarists argue, inflation or deflation are directly related to the rate of growth of the money supply.
See also Banking and Finance; Depressions, Economic; Economic Development; Keynesianism; Monetary Policy, Federal.

Bibliography

Milton Friedman , A Program for Monetary Stability, 1960.
Neil DeMarachi and and Abraham Hirsch , Milton Friedman: Economics in Theory and Practice, 1990.

John A. James