Monetarist Theory

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Economic theories explore the relationships linking changes in the money supply to changes in economic activity and prices. With a mixture of theoretical ideas, philosophical beliefs, and policy prescriptions, these theories can help elaborate on both historic and current financial situations. For instance, the general understanding of the monetarist theory, founded by economist Milton Friedman, focuses on macroeconomic activities that examine the impact of changes in the money supply and central banking. This economic school of thought theoretically challenges Keynesian economics (OnlineTexts) to contend that variations in the money supply are the most significant determinants of the rate of economic growth, the behavior of the business cycle, the national output in the short run, and the price level over longer periods of time (Investopedia). Through the developments from other theories, more laissez-faire government approaches, and the use of the quantity theory of money, monetarism has dramatically impacted and helped explain changes in monetary policy and the banking system for nearly one hundred years. To fully grasp this economic theory, the history behind it and what influenced its existence must be understood. Following the Great Depression, Keynesian economics mainly dominated the United States as well as countries globally. This economic theory focused on total spending in the economy and its effects on output and inflation (Blinder). Keynesians traditionally saw fiscal policy as the key tool for economic management, believed monetary policy should simply be used as a backup, and believed that the government’s role was to maintain the economy at full employment (Biz/Ed). This theory also emphasized interest rates as a target of monetary policy, raising rates to slow down the economy and reducing rates to speed things up (Allen 283). Although these views were the main focus for some time, many economists saw that the theory was leaving most of our economic problems unexplained. As Keynesian economics seemed unable to explain or cure the seemingly contradictory problems of rising unemployment and inflation (Allen 284) economits like Milton Friedman began making different, more accurate observations. Monetarism’s rise to intellectual prominence began with writings on basic monetary theory by Friedman and other economists during the 1950s (McCallum). These proposals were influential because of their devotion to fundamental neoclassical principles, particularly Friedman’s presidential address to the American Economic Association in 1967, published in 1968 as “The Role of Monetary Policy.” In this paper Friedman developed the natural-rate hypothesis and used it as a pillar in the argument for less government intervention and a constant-growth-rate rule for monetary policy (McCallum). From this point the monetarist theory drew its roots from two almost entirely opposing ideas, the hard money policies that dominated monetary thinking in the late 19th century, and the theories of Keynesian economics (Wikipedia). While Keynes had focused on total spending and the value stability of currency which resulted with problems based on an insufficient money supply, Friedman centered on price stability acting as the equilibrium between supply and demand for money (Wikipedia). Friedman and other monetarists began challenging Keynesian ideas and strongly started to suggest that "money does not matter” (Wikipedia). Monetarist’s goals involved seeking to explain present problems while also striving to interpret historical ones. Since monetarists strongly believe that the money supply is the primary determinant of nominal GDP in the short run and of the price level in the long run, they stress that the control of the money supply should not be left to the discretion of central bankers and that the focus should shift to a more laissez-faire approach for the banking system (OnlineTexts). Monetarists do not believe that the government...
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