MONETARISM

Sociologyindex, Sociology Books 2009

An economic theory advocating that governments use interest rates and control of the supply of money for the purpose of economic regulation.

This is in contrast to Keynsian economics which advocates taxation and budgetary (‘fiscal’) policy . Use of monetary instruments for economic regulation is said to provide a lever to influence macro-economic cycles in the economy, while avoiding bureaucratic regulation or distortions of market forces.

Monetarism is the economic doctrine established by Milton Friedman, that the money supply, the total amount of money circulating in an economy, whether as currency or bank balances, is the chief controller of the level of economic activity. 

Monetarism has become the dominant framework of theory in both academic economics and public policy.

Monetarism is closely associated with neo-conservatism, a version of liberalism that stresses free markets and individualism rather than the ‘welfare state’ vision that had become dominant in most western societies.

There is controversy over the role of monetarist policies in the current deficit problems of most of the worlds' largest economies.

Friedman’s monetarism became popular in Thatcher’s Britain and Reagan’s U.S.A., in the 1970s and early 1980s after the failure of Keynesian policies after the breakdown of the Bretton Woods arrangements in 1968-71.

Friedman was a pragmatist who rejected the idea of any “realistic” theory of economic action, and instead sought simply to provide governments with a lever with which to control the economy. The Keynesian policies of post-World War Two capitalism was essentially a retreat from confrontation with the working class. This had led to governments becoming “addicted” to debt while inflation grew faster and faster. Capitalism turned to monetarism for a macroeconomic policy to manage the counter-attack.

The idea of monetarism is that if the money supply is restricted, then prices must fall and/or the rate of circulation of money must go down; that is, restricting the supply of money and credit could be used by the government to cut inflation and increase unemployment. This, it was said, would take effect more quickly than fiscal measures like reducing government spending or increasing taxes, which Friedman claimed were ineffective in controlling the business cycle and could destabilize the economy. Instead, Friedman advocated a gradual expansion of the money supply at an annual rate equal to the expected growth in the gross national product. 

Monetarism proved to be sheer witchcraft, and by the end of the 1980s monetarism was abandoned. In the meantime, it had provided the theoretical framework for plunging the world economy into permanent recession in order to break the resistance of the organized working class.

Macroeconomic policies were considered too crude an instrument to resolve a crisis whose roots lay deeper. Monetarism was supplanted by a variety of policies, such as “Micro-Economic Reform”, which emphasized the need to tackle the resistance of the working class in “hand to hand fighting” so to speak, with union-busting, unemployment, tougher management methods and divide-and-rule practices in the workplace.

The Success of the Fed and the Death of Monetarism
N. Kindan Kishor and Levis A. Kochin
Monetarists blamed fluctuations in inflation on excessively volatile growth in monetary aggregates. The data supported this hypothesis until 1982. Since 1983 monetary aggregates have been essentially uncorrelated with subsequent inflation in the U.S.. Kochin (1973) argued that well designed monetary policy would lead to zero correlation between any measure of monetary policy and subsequent inflation. We modify Kochin's criterion showing that if the effects of fluctuations in monetary aggregates were not precisely known then optimal policy would produce negative correlations between monetary aggregate and inflation. We find that in the period 1960-1982 the variance in the growth rate of monetary base in the US was too large, and in fact, destabilizing. However, from 1983 to 2003 variations in the monetary base growth rate were just right. In both periods the fluctuations in the federal funds rate were too small since federal funds rate in these two periods was positively correlated with subsequent inflation. The fluctuations in the federal funds rate were close to optimal size during 1983-2003. Using a similar criterion we could not reject the idea that deviations from the Taylor Rule in the federal funds rate were of optimal size in both periods. - econweb.tamu.edu

MODIGLIANI ON MONETARISM: A RESPONSE 
THOMAS MAYER, Professor, University of California Davis 
This reply to Franco Modigliani "s (1988) criticism of monetarism is not a consensual monetarist response but merely the reaction of a moderate monetarist or, perhaps I should say, a monetarist fellow traveler.Specifically,I comment on how Modigliani defines monetarism, how he treats stabilization policy, the lesson he draws from the 1980s monetary experience,and how he treats the velocity adjusted monetary growth rate rule. I then respond to his call for a compromise. - cep.oxfordjournals.org/cgi/content/abstract/VI/4/19

MONETARISM AND THE USE OF MARKET PRICES AS MONETARY POLICY INDICATORS 
ROBERT E. KELEHER
Recently proposed strategies for employing market price indicators as guides to monetary policy embody many key propositions of monetarism. Moreover, market price advocates' prescribed policy instruments and operating procedures for conducting monetary policy are not inconsistent with a monetarist perspective and fully incorporate the incentive structure of the money creation process. The market price approach differs from monetarism in three key areas: the data employed to measure intermediate indicators, the environments in which the approach works, and the policy role of the dollar. More specifically, the market price approach employs data that are readily available in unrevised form and that make better use of limited information than do monetary or reserve data. The approach produces the same results as does a monetarist approach when money demand is stable, and it produces monetarists' desired stable price results when money demand is unstable. Finally, the approach embodies a policy role for the U.S. dollar and (implicitly) recognizes the policy implications of the dollar as a reserve currency. - cep.oxfordjournals.org/cgi/content/abstract/VIII/2/36

BEYOND KEYNESIANISM AND MONETARISM 
MANCUR OLSON, University of Maryland 
Though there is consensus among economists about microeconomic theory, neither the Keynesian nor the Monetarist theory of macroeconomics has attracted a consensus, presumably because neither is compelling enough to persuade the skeptical. A new approach to the subject that combines insights from each of the familiar schools with considerations that both schools have overlooked is accordingly offered here. This argument accepts the evidence that involuntary unemployment and depressions sometimes occur and thus rejects the finding of the new classical or equilibrium macroeconomics, that markets always clear and that all individuals and firms are in equilibrium. It also rejects the Keynesian assumption of wages or prices arbitrarily fixed at disequilibrium levels, and insists that any adequate theory must show what interests are served by the existence of involuntary unemployment. The theory offered here shows that an institutional or organizational arrangement common in all societies which have experienced widespread unemployment and deep recessions entails that many firms and individuals will be in disequilibrium. This disequilibrium becomes more severe when there is unexpected deflation or disinflation. The disequilibrium is of precisely the type commonplace in recessions and entails involuntary unemployment. The theory also shows how groups of individuals and firms can gain from practices that entail involuntary unemployment and underutilization of resources for others. - ei.oxfordjournals.org/cgi/content/abstract/XXII/3/297

Monetarism and the Masses 
Denmark and Economic Integration in Europe 
Martin Marcussen, Mette Zølner 
The purpose of the article is to find out more about the informal rules that constrain the protagonists in a public discursive field. What are the rules? Under what conditions do they change? What consequences do they have for the way in which political elites frame their messages? With regard to the first question, we focus on the Danish Economic Monetary Union (EMU) referendum and identify rules at two different levels of analysis: causal ideas at the level of elites and deep-rooted cultural values at the level of the masses. In answering the second question about ideational change, we conclude that elite ideas pertaining to macro-economic policy-making are most likely to change in short periods that are generally perceived to be crisis situations. At the level of the masses, myths about `us' and `them' are more deeply institutionalized and more difficult to change. Finally, concerning the consequences that political elites can draw from the existence of constraining and enabling rules of the game on various levels, we conclude that, when they frame their purposes and visions, elites must take account of all these rules at the same time, even if they seem mutually contradictory. This last message may prove to be useful in the upcoming EMU referenda in Denmark, the United Kingdom and Sweden. - cac.sagepub.com/cgi/content/abstract/38/2/101

News-Magazine Monetarism 
EDWARD NELSON 
Federal Reserve Bank of St. Louis - Research Division; Centre for Economic Policy Research (CEPR) 
CEPR Discussion Paper No. 3506 
Abstract: This Paper examines some recent monetary policy debates, in light of commentary on those issues contained in some of the work of Milton Friedman. The specific aspect of Friedman's work considered here is the commentary on monetary policy in his Newsweek magazine columns from 1966 to 1984. My conclusions from this examination include: (1) In contrast to claims made in the VAR literature, the analysis of monetary policy and the business cycle by Friedman and other critics of monetary policy in the 1960s and 1970s did not assume that the money supply was exogenous, or contend that monetary policy shocks were the dominant source of cyclical fluctuations. Rather, the criticism was of the destabilizing tendency of the monetary policy feedback rule followed in those decades. (2) There is support for the argument of Orphanides (2000a) that many monetary policy prescriptions by commentators in the 1970s were based on over-optimistic estimates of the growth rate of productive potential. Friedman's Newsweek discussions, like his other work, were unusual for not making policy prescriptions based on output gap estimates. - papers.ssrn.com/sol3/papers.cfm?abstract_id=334520

IS-LM and Monetarism 
MICHAEL D. BORDO, Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
ANNA J. SCHWARTZ, National Bureau of Economic Research (NBER) - General; City University of New York 
Abstract: This paper discusses monetarist objections to the IS-LM model. We explore the views of two principal spokesmen for monetarism: Milton Friedman and the team of Karl Brunner and Allan Meltzer. Friedman did not explicitly state the reasons he generally chose not to use the IS-LM model in rejecting Keynesian views on the demand function for money, the role of autonomous expenditures in cyclical fluctuations, the potency of fiscal policy as against monetary policy, etc. He presented statistical findings, historical evidence, and econometric results to support his alternative analysis of macroeconomics, but his critics were unconvinced. In 1970, in an effort to use his critics' common language, he set up a model with explicit terms for IS-LM to encompass both the quantity theory and the income-expenditure theory. Friedman attributed the failure of this effort to the fact that he was a Marshallian, his opponents Walrasians. Brunner and Meltzer's objections to IS-LM were explicit. They found it too spare, so they elaborated it by adding a credit market, disaggregating the asset market by specifying three assets: Base money, government debt, and real capital. They set up a model with financial institutions and utilized it to study the effects of a variety of policies. In brief, summarizing the views of both Friedman and Brunner and Meltzer, monetarists dislike the IS-LM framework because it limits monetary influence too narrowly, essentially to the interest elasticity of money demand, and defines investment in an excessively narrow fashion, and even that is not explicit. - papers.ssrn.com/sol3/papers.cfm?abstract_id=408209

David Laidler on Monetarism
Michael Bordo, Anna J. Schwartz
Abstract: David Laidler has been a major player in the development of the monetarist tradition. As the monetarist approach lost influence on policy makers he kept defending the importance of many of its principles. In this paper we survey and assess the impact on monetary economics of Laidler's work on the demand for money and the quantity theory of money; the transmission mechanism on the link between money and nominal income; the Phillips Curve; the monetary approach to the balance of payments; and monetary policy. - ideas.repec.org/p/nbr/nberwo/12593.html