Monetarism is the belief that changes in the money supply drive aggregate output and price level fluctuations that ultimately affect economic activity.
Monetarism is an economic theory that emphasizes the role of monetary policy in controlling inflation and promoting stable economic growth. Monetarists argue that excessive increases in the money supply can lead to inflation, while insufficient growth can result in economic stagnation.
Central to monetarism is the equation:
MV = PQ
M is the money supply, V is the velocity of money, P is the price level, and Q is the quantity produced. If V is assumed to be constant, any increase in the money supply must increase the price level and/or output. Once an economy approaches its productive capacity, the price level must rise.
Monetarists argue that policymakers have caused instability and uncertainty when finetuning the economy because it is difficult to predict when and how much changes in the money supply will impact the economy. Instead, monetarists advocate for a more rules-based approach to monetary policy, where the central bank adheres to pre-determined guidelines. The Nobel Prize winner, Milton Friedman, recommended the central bank expand the money supply slightly each year at a rate tied to the nominal gross domestic product growth to allow for the economy’s natural long-term growth and promote stable prices.
Monetarism has significantly influenced economic policy and central banking practices, particularly in the late 20th century. However, it has also been subject to criticism and alternative theories, such as Keynesian economics, which emphasize the role of fiscal policy and government intervention in managing the economy. The debate between monetarists and Keynesians continues to shape economic policy discussions.