Monetarism

Monetarism is one of the most influential approaches in economic science regarding monetary theory and played a decisive role in macroeconomic thought and policy design especially during the second half of the 20th century. At its core, Monetarism emphasizes the determining influence of the money supply on economic activity and price levels and has become a systematic doctrine largely through the work of American economist Milton Friedman.

Conceptual Foundations of Monetarism

Monetarism is an economic theory primarily concerned with the relationships between the money supply and the general price level. Its theoretical basis rests on the Classical Quantity Theory of Money (MV = PT). In this theory:

• M: Money supply,
• V: Velocity of money,
• P: General price level,
• T: Total volume of transactions.

Monetarists emphasize the role of the money supply particularly in relation to price stability and economic growth. They argue that increases in the money supply have effects on production and prices after a certain lag. Friedman noted that changes in the money supply affect output in the short run and the general price level in the long run.

Historical Development of Monetarism

Classical Quantity Theory and Early Monetarists

The roots of Monetarism extend back to analyses by thinkers such as David Hume, John Locke, and J.S. Mill on the impact of the quantity of money on prices. However, its scientific formulation was developed in the early 20th century by Irving Fisher. With Fisher’s contributions, the quantity theory became empirically testable.

Early Monetarism

During this period, led by Irving Fisher, Monetarism assumed that increases in the money supply directly affected prices. However, Fisher’s theory proved inadequate in addressing issues such as unemployment and fluctuations in production and faced criticism from Keynes. In his 1923 work Tract on Monetary Reform, Keynes criticized this view as follows: “In the long run we are all dead.”

Modern Monetarism: Friedman and the Chicago School

The systematic formulation of Monetarism became possible through Milton Friedman’s 1956 publication titled The Quantity Theory of Money – A Restatement. This period is also referred to as “Classical Monetarism” or “Modern Quantity Theory.”

Friedman argued for a strong but lagged relationship between the money supply and nominal income and articulated the following key principles:

• There is a positive relationship between the rate of growth of the money supply and nominal income.
• The effects of changes in the money supply emerge over time, typically with a lag of 6 to 18 months.
• In the short run, changes in the money supply affect output; in the long run, they affect prices.
• The impact of changes in the money supply is not certain but varies.

One of Friedman’s most important contributions was his rejection of the Keynesian approach advocating active monetary policy and his advocacy of a constant rate of money supply growth. According to this view, the central bank should increase the money supply annually at a rate equal to the economy’s growth rate and avoid discretionary intervention.

Impact of Monetarism on Policy and the 1970s

In the 1970s, rising inflation and stagflation worldwide led to a reevaluation of Keynesian policies, bringing monetarist policy proposals to the forefront. The shift by Paul Volcker, Chairman of the U.S. Federal Reserve, to a policy focused on the money supply in 1979 was seen as a triumph of the monetarist approach.

However, this victory proved short-lived. In the 1980s, fluctuations in the velocity of money and difficulties central banks faced in controlling money aggregates such as M1 and M2 made the practical application of Monetarism challenging. As a result, many central banks shifted from money supply targeting to interest rate targeting.

Criticisms of Monetarism

Hyman Minsky’s Criticisms

Minsky criticized Friedman and Schwartz’s analysis for excluding credit markets and the financial sector. According to Minsky, macroeconomic fluctuations cannot be explained solely by the money supply; financial institutions, borrowing dynamics, and speculative behavior are also fundamental factors.

Empirical Discrepancies

The direct relationship between money supply, prices, and income weakened after 1965. As seen in examples from the United States, China, Japan, and Switzerland, high growth in the money supply did not always lead to inflation. In China, high investment rates reduced pressure on prices, while in open economies such as Switzerland and Japan, foreign asset accumulation offset inflationary pressures.

Current Status and Legacy of Monetarism

DeLong’s Classification of Monetarism

J. Bradford DeLong classifies Monetarism into four subtypes:

• First Monetarism: The classical approach led by Irving Fisher,
• Old Chicago Monetarism: Expansionary monetary policy advocacy by figures such as Viner and Simons during the crisis period,
• Classic Monetarism: Systematic analyses by Friedman and his followers,
• Political Monetarism: The 1970s version obsessed with money growth, which proved practically unsuccessful.

According to DeLong, many of Friedman’s views have become integrated into contemporary New Keynesian thought. For instance, the idea that the long-run unemployment rate is natural, the effectiveness of monetary policy, and the notion of policy rules continue to hold relevance today.

IMF View

According to the IMF, Monetarism has helped policymakers emphasize the importance of the money supply in combating inflation over the long run. However, due to practical difficulties, it is no longer applied in its pure form; nevertheless, many central banks still shape monetary policy around the objective of price stability.

Monetarism has been one of the most influential economic approaches of the 20th century, institutionalized largely through Milton Friedman and exerting significant impacts on policy practice. Although it has exhibited certain shortcomings and problems in application, its theoretical contributions have become part of modern economic literature.

The relationship between the money supply and the general price level is now analyzed within a more flexible and multidimensional framework. While Monetarism’s rigid assumptions have been abandoned, its core principles continue to persist in many macroeconomic approaches.