The basic premise of Monetarism
is rooted in the belief that changes in the money
supply have a significant impact on the overall level of economic activity and inflation. Monetarists argue that the primary responsibility of monetary policy
should be to maintain a stable growth rate of the money supply
, as excessive or erratic changes in the money supply can lead to economic instability.
Monetarists emphasize the importance of the quantity theory of money, which posits that changes in the money supply directly affect the price level in the economy
. According to this theory, if the money supply increases faster than the growth rate of real output, prices will rise, leading to inflation. Conversely, if the money supply grows slower than the growth rate of real output, prices will fall, resulting in deflation
. Therefore, Monetarists advocate for a steady and predictable growth rate of the money supply to achieve price stability.
Monetarists also stress the role of monetary policy in influencing aggregate demand
and economic activity. They argue that changes in the money supply affect interest
rates, which in turn impact investment and consumption decisions. By controlling the money supply growth rate, central banks can influence interest rates and, consequently, aggregate demand. Monetarists contend that stable and predictable monetary policy can help stabilize the economy by reducing fluctuations in output and employment.
Furthermore, Monetarists criticize discretionary fiscal policy
and advocate for rules-based monetary policy. They argue that discretionary fiscal policy, which involves government intervention through changes in taxes
and spending, is often subject to political pressures and can lead to inefficient outcomes. In contrast, rules-based monetary policy, such as targeting a specific growth rate of the money supply, provides a more predictable framework that reduces uncertainty and allows individuals and businesses to make better-informed decisions.
Monetarism gained prominence in the 1960s and 1970s as a response to the perceived failures of Keynesian economics
to effectively address stagflation
, a combination of high inflation and high unemployment
. Monetarists, led by economists like Milton Friedman, challenged the dominant Keynesian view that fiscal policy was the primary tool for managing the economy. Instead, they argued for a greater focus on monetary policy and the importance of controlling the money supply.
In summary, the basic premise of Monetarism is that changes in the money supply have a significant impact on economic activity and inflation. Monetarists advocate for a steady and predictable growth rate of the money supply to achieve price stability and argue for the importance of rules-based monetary policy. By emphasizing the role of monetary policy in influencing aggregate demand, Monetarism provides an alternative approach to managing the economy compared to Keynesian economics