Though he opposed the existence of the Federal Reserve
Friedman advocated, given its existence, a central bank
policy aimed at keeping the growth of the money supply at a rate commensurate with the growth in productivity and demand for goods
Monetarism is an economic theory that focuses on the macroeconomic
effects of the supply of money and central banking. Formulated by Milton Friedman
, it argues that excessive expansion of the money supply is inherently inflationary
, and that monetary authorities should focus solely on maintaining price stability
This theory draws its roots from two historically antagonistic schools of thought: the hard money policies that dominated monetary thinking in the late 19th century, and the monetary theories of John Maynard Keynes
, who, working in the inter-war period during the failure of the restored gold standard
, proposed a demand-driven model for money.
While Keynes had focused on the stability of a currency's value, with panics based on an insufficient money supply leading to the use of an alternate currency and collapse of the monetary system, Friedman focused on price stability.
The result was summarised in a historical analysis of monetary policy, Monetary History of the United States 1867–1960
, which Friedman coauthored with Anna Schwartz
. The book attributed inflation to excess money supply generated by a central bank. It attributed deflationary spirals to the reverse effect of a failure of a central bank to support the money supply
during a liquidity
Friedman originally proposed a fixed monetary rule
, called Friedman's k-percent rule
, where the money supply would be automatically increased by a fixed percentage per year. Under this rule, there would be no leeway for the central reserve bank, as money supply increases could be determined "by a computer", and business could anticipate all money supply changes.
With other monetarists he believed that the active manipulation of the money supply or its growth rate is more likely to destabilise than stabilise the economy.
Opposition to the gold standard
Most monetarists oppose the gold standard
. Friedman, for example, viewed a pure gold standard as impractical.
For example, whereas one of the benefits of the gold standard is that the intrinsic limitations to the growth of the money supply by the use of gold would prevent inflation, if the growth of population or increase in trade outpaces the money supply, there would be no way to counteract deflation and reduced liquidity (and any attendant recession) except for the mining of more gold.
Thus, where the money supply
expanded, people would not simply wish to hold the extra money in idle money balances; i.e., if they were in equilibrium before the increase, they were already holding money balances to suit their requirements, and thus after the increase they would have money balances surplus to their requirements. These excess money balances would therefore be spent and hence aggregate demand
would rise. Similarly, if the money supply were reduced people would want to replenish their holdings of money by reducing their spending. In this, Friedman challenged a simplification attributed to Keynes suggesting that "money does not matter."
Thus the word 'monetarist' was coined.
In 1979, United States President Jimmy Carter
appointed as Federal Reserve chief Paul Volcker
, who made fighting inflation his primary objective, and who restricted the money supply (in accordance with the Friedman rule
) to tame inflation in the economy. The result was a major rise in interest rates, not only in the United States; but worldwide. The "Volcker shock" continued from 1979 to the summer of 1982, decreasing inflation and increasing unemployment.
Monetarists not only sought to explain present problems; they also interpreted historical ones. Milton Friedman and Anna Schwartz
in their book A Monetary History of the United States, 1867–1960
argued that the Great Depression
of the 1930s was caused by a massive contraction of the money supply (they deemed it "the Great Contraction
), and not by the lack of investment Keynes had argued. They also maintained that post-war inflation was caused by an over-expansion of the money supply.
They made famous the assertion of monetarism that "inflation is always and everywhere a monetary phenomenon." Many Keynesian economists initially believed that the Keynesian vs. monetarist debate was solely about whether fiscal or monetary policy
was the more effective tool of demand management. By the mid-1970s, however, the debate had moved on to other issues as monetarists began presenting a fundamental challenge to Keynesianism.
Monetarists argued that central banks sometimes caused major unexpected fluctuations in the money supply. They asserted that actively increasing demand through the central bank can have negative unintended consequences.
There are also arguments that monetarism is a special case of Keynesian theory. The central test case over the validity of these theories would be the possibility of a liquidity trap
, like that experienced by Japan. Ben Bernanke
, Princeton professor and another former chairman of the U.S. Federal Reserve, argued that monetary policy 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."
These disagreements—along with the role of monetary policies in trade liberalisation, international investment, and central bank policy—remain lively topics of investigation and argument.
- ^ a b Phillip Cagan, 1987. "Monetarism", The New Palgrave: A Dictionary of Economics, v. 3, Reprinted in John Eatwell et al. (1989), Money: The New Palgrave, pp. 195–205, 492–97.
- ^ Friedman, Milton (2008). Monetary History of the United States, 1867-1960. Princeton University Press. ISBN 978-0691003542. OCLC 994352014.
- ^ Doherty, Brian (June 1995). "Best of Both Worlds". Reason. Retrieved July 28, 2010.
- ^ Mankiw, N. Gregory. "Real Business Cycles: A New Keynesian Perspective". Journal of Economic Perspectives 3.3 (1989): 79–90. Web.|date=October 2013
- ^ Bordo, Michael D. (1989). "The Contribution of A Monetury History". Money, History, & International Finance: Essays in Honor of Anna J. Schwartz. The Increase in Reserve Requirements, 1936-37. University of Chicago Press. p. 46. CiteSeerX 10.1.1.736.9649. ISBN 0-226-06593-6. Retrieved 2019-07-25.
- ^ Thomas Palley (November 27, 2006). "Milton Friedman: The Great Conservative Partisan". Retrieved June 20, 2013.[unreliable source?]
- ^ Ip, Greg; Whitehouse, Mark (2006-11-17). "How Milton Friedman Changed Economics, Policy and Markets". The Wall Street Journal.
- ^ "Monetary Central Planning and the State, Part 27: Milton Friedman's Second Thoughts on the Costs of Paper Money". Archived from the original on November 14, 2012.
- ^ a b Friedman, Milton (1970). "A Theoretical Framework for Monetary Analysis". Journal of Political Economy. 78 (2): 193–238 [p. 210]. doi:10.1086/259623. JSTOR 1830684.
- ^ Reichart Alexandre & Abdelkader Slifi (2016). 'The Influence of Monetarism on Federal Reserve Policy during the 1980s.' Cahiers d'économie Politique/Papers in Political Economy, (1), pp. 107–50. https://www.cairn.info/revue-cahiers-d-economie-politique-2016-1-page-107.htm
- ^ "Real Gross Domestic Product for United Kingdom, Federal Reserve Bank of St. Louis". Retrieved December 16, 2018.
- ^ Milton Friedman; Anna Schwartz (2008). The Great Contraction, 1929–1933 (New Edition). Princeton University Press. ISBN 978-0-691-13794-0.
- Andersen, Leonall C., and Jerry L. Jordan, 1968. "Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilisation", Federal Reserve Bank of St. Louis Review (November), pp. 11–24. PDF (30 sec. load: press +) and HTML.
- _____, 1969. "Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilisation — Reply", Federal Reserve Bank of St. Louis Review (April), pp. 12–16. PDF (15 sec. load; press +) and HTML.
- Brunner, Karl, and Allan H. Meltzer, 1993. Money and the Economy: Issues in Monetary Analysis, Cambridge. Description and chapter previews, pp. ix–x.
- Cagan, Phillip, 1965. Determinants and Effects of Changes in the Stock of Money, 1875–1960. NBER. Foreword by Milton Friedman, pp. xiii–xxviii. Table of Contents.
- Friedman, Milton, ed. 1956. Studies in the Quantity Theory of Money, Chicago. Chapter 1 is previewed at Friedman, 2005, ch. 2 link.
- _____, 1960. A Program for Monetary Stability. Fordham University Press.
- _____, 1968. "The Role of Monetary Policy", American Economic Review, 58(1), pp. 1–17 (press +).
- _____,  2005. The Optimum Quantity of Money. Description and table of contents, with previews of 3 chapters.
- Friedman, Milton, and David Meiselman, 1963. "The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897–1958", in Stabilization Policies, pp. 165–268. Prentice-Hall/Commission on Money and Credit, 1963.
- Friedman, Milton, and Anna Jacobson Schwartz, 1963a. "Money and Business Cycles", Review of Economics and Statistics, 45(1), Part 2, Supplement, p. p. 32–64. Reprinted in Schwartz, 1987, Money in Historical Perspective, ch. 2.
- _____. 1963b. A Monetary History of the United States, 1867–1960. Princeton. Page-searchable links to chapters on 1929-41 and 1948–60
- Johnson, Harry G., 1971. "The Keynesian Revolutions and the Monetarist Counter-Revolution", American Economic Review, 61(2), p. p. 1–14. Reprinted in John Cunningham Wood and Ronald N. Woods, ed., 1990, Milton Friedman: Critical Assessments, v. 2, p. p. 72 – 88. Routledge,
- Laidler, David E.W., 1993. The Demand for Money: Theories, Evidence, and Problems, 4th ed. Description.
- Schwartz, Anna J., 1987. Money in Historical Perspective, University of Chicago Press. Description and Chapter-preview links, pp. vii-viii.
- Warburton, Clark, 1966. Depression, Inflation, and Monetary Policy; Selected Papers, 1945–1953 Johns Hopkins Press. Amazon Summary in Anna J. Schwartz, Money in Historical Perspective, 1987.
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