Monetarist

What Is a Monetarist?

A monetarist is an economist who holds the strong belief that money supply_ — including physical currency, deposits, and credit — is the primary factor affecting demand in an economy. Consequently, the economy's performance — its growth or contraction — _can be regulated by changes in the money supply.

The key driver behind this belief is the impact of inflation on an economy's growth or health and the idea that by controlling the money supply, one can control the inflation rate.

Understanding Monetarists

At its core, monetarism is an economic formula. It states that money supply multiplied by its velocity (the rate at which money changes hands in an economy) is equal to nominal expenditures in the economy (goods and services) multiplied by price. While this makes sense, monetarists say velocity is generally stable, which has been debated since the 1980s.

The most well-known monetarist is Milton Friedman, who wrote the first serious analysis using monetarist theory in his 1963 book, A Monetary History of The United States, 1867–1960. In the book, Friedman along with Anna Jacobson Schwartz argued in favor of monetarism as a way to combat the economic impacts of inflation. They argued that a lack of money supply amplified the financial crisis of the late 1920s and led to the Great Depression, and that a steady increase in the money supply in line with growth in the economy would produce growth without inflation.

The monetarist view was a minority view in both academic and applied economics until the financial troubles of the 1970s. As unemployment and inflation soared, the dominant economic theory Keynesian economics was unable to explain the current economic puzzle presented by economic contraction and simultaneous inflation.

Keynesian economics said that high unemployment and economic contraction would lead to deflation through a collapse in demand and conversely that inflation was the result of demand outstripping supply in an over-heated economy. The final collapse of the gold standard in 1971, the oil shocks of the mid-1970s, and the beginning of de-industrialization in the United States in the late 1970s all contributed to stagflation, a new phenomenon that was difficult for Keynesian economics to explain.

Monetarism, however, argued that restricting the money supply would kill inflation, which would be a necessary step to regulating the economy even if it came at the cost of a short-term recession. That is exactly what Paul Volcker, the head of the Federal Reserve from 1979 to 1987, did. The result was a final vindication of monetarism in the eyes of economists and policymakers.

Examples of Monetarists and Monetarism

Most monetarists opposed the gold standard in that the limited supply of gold would stall the amount of money in the system, which would lead to inflation, something monetarists believe should be controlled by the money supply, which is not possible under the gold standard unless gold is continually mined.

Milton Friedman is the most famous monetarist. Other monetarists include former Federal Reserve Chair Alan Greenspan and former British Prime Minister Margaret Thatcher.