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
- 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
- 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 was very unstable. This has
led to a decline in the influence of Monetarist thought over the
last fifteen years.