Chapter Seventeen: Module Summary -- Monetarism

• Monetarism is an economic school of thought that stresses the primary importance of the money supply in determining nominal GDP and the price level. The "Founding Father" of Monetarism is Milton Friedman.

• Monetarism gained in popularity during the high inflation period of the 1970s.

• The theoretical foundation for Monetarism is the Quantity Theory of Money.

• Monetarists believe that the economy is inherently stable. Therefore, laissez-faire is often the best policy. Moreover, the Federal Reserve should follow fixed rules in conducting monetary policy.

• The Equation of Exchange states that M x V = P x Y.

• Monetarists transform the equation of exchange into the Quantity Theory of Money by making the seemingly small assumption that velocity is stable in the short run. This implies that in the short run, changes in the money supply are the dominant forces that change nominal GDP.

• In the long-run, the economy is at potential output, so changes in the money supply only lead to higher prices, not higher output.

• Monetarists believe in a set of rules that the Fed must follow. In particular, Monetarists prefer the Money growth rule: The Fed should be required to target the growth rate of money such that it equals the growth rate of real GDP, leaving the price level unchanged.

• Keynesians feel that the Fed should have some leeway or "discretion" in conducting policy. So far, Keynesians have won this debate.

• Monetarism hinges on the stability of velocity. However, in the 1980s and 1990s, velocity has been very unstable. This has led to a decline in the influence of Monetarist thought over the last fifteen years.