Diving Deeper: Can Select Monetarism Concepts Reboot the Economy?

Chasing Dollars, Catching Prosperity or simply delving into the world of Monetarism, and more…

Imagine a world where money isn’t just currency or digits on a screen, but the very pulse of an economy.

In the narrative that follows, Monetarism takes center stage, boldly declaring that the money supply – the total sum of currency swirling within an economy – wields the power to influence both short-term dollar GDP and long-term price levels.
How does it work this magic? Through the enigmatic art of “monetary policy,” where tools like interest rates are precisely tuned to steer the flow of money.

Monetarists, the modern-day economic visionaries, firmly believe that the path to economic prosperity lies in harmonizing with the rhythm of money supply growth. This theory made waves in the ’70s when it helped curbing inflation in the United States and the United Kingdom. It even influenced significant decisions made by the U.S. central bank during the 2007-2009 global recession.

Now, in the realm of Monetarism, one name echoes through the ages: the Nobel Prize-winning economist Milton Friedman. In his legendary masterpiece, “A Monetary History of the United States, 1867–1960,” Friedman argued that the Great Depression in the 1930s could largely be attributed to the Federal Reserve’s poor monetary policies.

❗His verdict? The Fed’s missteps in managing the money supply were the true culprits.

The Fed’s inability to ① counteract forces suppressing the money supply and ② its actions to reduce the money stock were fundamentally misguided. He also asserted that market forces naturally find their equilibrium and that an improperly set money supply could lead to market instability.

A bit of history:
The ’70s witnessed Monetarism’s rise like a phoenix. In 1979, as U.S. inflation soared to a staggering 20 percent, the Federal Reserve decided to embrace Monetarism.
Their approach? Tightening their grip on the money supply, just as Friedman prescribed. It was a bold move, and it worked, though not without a recession-shaped price tag.

the Quantity Theory of Money:
At its heart, monetarism relies on something very basic: the Quantity Theory of Money. This theory states that the total amount of money in an economy, when multiplied by how quickly it gets used (called “velocity”), equals the total money spent in the economy.

💡 So, if you have a lot of money moving around quickly, you’ll have a lot of spending.

Here’s where the debate starts:
Monetarists think that the speed at which money moves (velocity) stays pretty steady, meaning that how much money you have mainly decides how much you spend. If you see changes in how much money people spend, they believe it’s because of real economic activity and inflation, not so much because money suddenly moves faster or slower.

❗This theory leads to important ideas:

• Long-Run Monetary Neutrality: This means that over a long time, if there’s more money in the economy, prices should generally go up, but it shouldn’t really affect things like how much people buy or how much stuff is produced.
• Short-Run Monetary Nonneutrality: In the short term, if there’s suddenly more money, it can actually impact how much stuff gets made and how many people get hired. This happens because it takes a while for wages and prices to adjust to the changes.
• Constant Money Growth Rule: Friedman had a clever idea. He suggested that the folks in charge of managing the money (like the central bank) should stick to a fixed rule. They should make sure that the amount of money in circulation grows at the same rate as the overall economy (real GDP), and this way, prices would stay pretty stable. This rule aims to prevent the ups and downs that can come from making decisions on the fly.
• Interest Rate Flexibility: This rule says that interest rates, which affect how much it costs to borrow money, should be able to change. They should go up or down depending on what’s happening with inflation (how much prices are going up) and real interest rates (the cost of borrowing after considering inflation). This helps people and businesses plan for the future more effectively.

Stable markets:
Monetarists think that when there aren’t big surprises with how much money is around, markets tend to be stable. They say that when the government steps in, it can sometimes make things worse. Plus, they don’t believe in a long-term trade-off between inflation and unemployment.

The rival:
But, Monetarism started a big argument, especially with its rival, Keynesianism.
Keynesians say that what really matters is how much people want to buy things and services.
→ They think Monetarism has trouble because it’s hard to predict how fast money moves around (called velocity), and
→ they don’t give much importance to the quantity theory of money or strict money rules.
Keynesians want some flexibility in how we handle money to deal with the natural ups and downs in the economy.

The battle between these two ideologies played out prominently in the 1970s, a decade marked by high inflation and sluggish economic growth. Monetarists blamed rapid money supply growth for the soaring inflation rates and argued that controlling the money supply was the key to sound policy.

In 1979, Paul A. Volcker, as chairman of the Fed, prioritized taming inflation, leading to a dramatic reduction in inflation rates, albeit at the cost of a severe recession. A similar success story emerged in Britain when Margaret Thatcher implemented monetarism to combat inflation.

However, monetarism’s reign was short-lived. The relationship between money supply and nominal GDP, critical to monetarist policies, became unstable in the 1980s and 1990s.
* The once-predictable velocity of money fluctuated unpredictably, casting doubt on the utility of the quantity theory of money.

❗What caused this turmoil? Changes in banking rules and financial innovations, according to the experts.

Nevertheless, the legend of Monetarism persists. In a speech to honor Milton Friedman, Ben S. Bernanke, a future chairman of the Federal Reserve, acknowledged that Monetarism accurately explained the Great Depression. He even applied some of its ideas when addressing the global recession of 2007, which surprised quite a few people.

Today, while most economists have moved away from strict money supply targets, the teachings of Monetarism still reverberate through the world of economics.

One of the most important keypoints: Inflation cannot thrive indefinitely without the money supply feeding its flames. Controlling it remains the sacred duty of ❗central banks worldwide, a lesson for the ages.