Monetarism

Definition

Monetarism is an economic theory which suggests that the overall economic health of a country can be controlled by regulating the supply of money. This theory asserts that governments should aim to keep the money supply steady, expanding it slightly each year to encourage economic growth. Essentially, it focuses on the role of monetary policy in controlling inflation and managing the business cycles.

Phonetic

Monetarism is pronounced as /ˈmɑːnɪtɛrˌɪzəm/.

Key Takeaways

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1. Monetarism emphasizes the role of governments in controlling the amount of money in circulation. It argues that varying the amount of money in the economy is the most effective way of stabilizing the economy.
2. Monetarism stipulates that inflation is a result of too much money in the economy, suggesting that to control inflation, it’s essential to control the money supply.
3. Monetarists believe in a natural rate of unemployment and argue that governments should not intervene with monetary policy to try and lower the unemployment rate as it could lead to inflation. They assert that the focus should be on maintaining price stability.

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Importance

Monetarism is a fundamental concept in business and finance, signifying the macroeconomic school of thought that emphasizes the role of governments in controlling the amount of money in circulation. Keynesian economists often criticize its undue focus on monetary policy while disregarding fiscal policy. Nevertheless, monetarism is crucial because it underpins the belief that managing the money supply can effectively control inflation and stabilize the economy. It posits that excessive growth of the money supply is inherently inflationary, and economic recessions can be overcome by increasing liquidity in the economy. Therefore, monetarism informs monetary policies used by central banks across the globe, including the Federal Reserve in the U.S., inspired largely by the theories of economist Milton Friedman. It’s essential in maintaining price stability and ensuring sustainable economic growth.

Explanation

Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. Developed by economist Milton Friedman, it is essentially an inherent part of economic policy strategy aiming to manipulate the money supply in order to manage and control inflation, promote economic stability and foster growth. Central banks use tools like open market operations, reserve requirements, and interest rate adjustments to control the money supply, which, according to monetarist theories, has a direct impact on inflation or price stability. The purpose of monetarism is to provide a framework for economic policy where inflation can be controlled by managing monetary factors. Inflation is seen as a major threat to long-term economic stability; therefore, by managing the money supply, governments hope to prevent inflationary build-ups and the boom-bust cycles that can cripple economies. Monetarism also guides the implementation of macroeconomic policy, shaping government responses to economic conditions. For instance, during periods of slow economic growth, governments, guided by monetarist principles, might increase the money supply to try and stimulate demand. In times of quick economic growth, they may do the opposite to prevent overheating the economy.

Examples

1. United Kingdom Under Margaret Thatcher: From the late 70s through the 80s, UK Prime Minister Margaret Thatcher adopted monetarism principles as a part of her economic policy to control inflation. She aimed to do this by controlling the supply of money circulating within the UK economy. The government also increased interest rates to reduce borrowing and decrease money supply.2. The United States during the 1980s Recession: The Federal Reserve under Chairman Paul Volcker put monetarism theories into practice in response to the high inflation of the 1970s. By tightening the money supply and allowing short-term interest rates to rise, the U.S. was able to curb inflation, which eventually led to a recession in the economy. Nevertheless, it set the ground for economic growth in the 1990s.3. Chile under Augusto Pinochet: From 1973 to 1990, Chile’s military government implemented monetarist policies with the help from a group of economists known as the “Chicago Boys.” These neoliberal policies aimed to reduce government spending, privatize state-owned industries, and reduce inflation by controlling money supply. Despite significant social and political turmoil, these policies led to economic stabilization and growth, sometimes referred to as the “Miracle of Chile.”In each of these examples, the common theme is the control of money supply by the central banks or government to influence the overall economy, typically to combat inflation. However, the effectiveness and social implications of these actions have been highly debated.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Quantity Theory of Money
• Friedman’s K-percent rule
• Macroeconomic Stabilization Policy
• Neutral Money
• Inflation Targeting

Sources for More Information

• Investopedia
• Encyclopedia Britannica
• Economics Help
• International Monetary Fund