Monetarism

Monetarism is a set of views concerning the determination of national income and monetary economics. It focuses on the supply and demand for money as the primary means by which economic activity is regulated. Monetary theory focuses on money supply and on inflation as an effect of the supply of money being larger than the demand for money.

The current state of monetary theory

Since 1990, the classical form of monetarism has been questioned because of events which many economists have interpreted as being inexplicable in monetarist terms - the unhinging of the money supply growth from inflation in the 1990s and the failure of pure monetary policy to stimulate the economy in the 2001-2003 period. Alan Greenspan, current chairman of the Federal Reserve, argued that the 1990s decoupling was explained by a virtuous cycle of productivity and investment on one hand, and a certain degree of "irrational exuberance" in the investment sector. Liberal economist Robert Solow of MIT suggested that the 2001-2003 failure of the expected economic recovery should be attributed not to monetary policy failure but to the breakdown in productivity growth in crucial sectors of the economy, most particularly retail trade. He noted that five sectors produced all of the productivity gains of the 1990s, and that while the growth of retail and wholesale trade produced the smallest growth, they were by far the largest sectors of the economy experiencing net increase of productivity. "2% may be peanuts, but as the single largest sector of the economy, that's an awful lot of peanuts."

Related Topics:
Alan Greenspan - Federal Reserve - Virtuous cycle - Robert Solow

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There are also arguments which link monetarism and macroeconomics, and treat monetarism as a special case of Keynesian theory. The central test case over the validity of these theories would be the possibility of a liquidity trap, such as experienced by Japan. Ben Bernanke, Princeton economics professor and Federal Reserve governor, has argued that monetarism could respond to zero interest rate conditions by direct expansion of the money supply. In his words "We have the keys to the printing press, and we are not afraid to use them." His colleague, Paul Krugman, has advanced the counterargument that this would have a corresponding devaluationary effect, as the sustained low interest rates of 2001-2004 produced against world currencies.

Related Topics:
Macroeconomics - Liquidity trap - Ben Bernanke - Paul Krugman

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David Hackett Fischer, in his study The Great Wave, questioned the implicit basis of monetarism by examining long periods of secular inflation that stretched over decades. In doing so, he produced data which suggests that prior to a wave of monetary inflation, there is a wave of commodity inflation, which governments respond to, rather than lead. Whether this formulation undermines the monetary data which underpins the fundamental work of monetarism is still a matter of contention.

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Monetarists of the Milton Friedman school of thought believed in the 1970s and 1980s that the growth of the money supply should be based on certain formulations related to economic growth. As such, they can be regarded as advocates of a monetary policy based on a "quantity of money" target. This can be contrasted with the monetary policy advocated by supply side economics or Austrian economics which are based on a "value of money" target.

Related Topics:
Supply side economics - Austrian economics

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In 2003, Milton Friedman renounced many of the policies from the 1980s that were based on quantity targets. In doing so he basically conceded that the demand for money is not so easily predicted. He stands, however, by his central formulations.

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These disagreements, as well as the role of monetary policy in trade liberalization, international investment, and central bank policy, remain lively topics of investigation and argument - proving that monetarist theory remains a central area of study in market economics.

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