Monetarism is an economic theory advocating that
governments use interest rates and control of the supply of money for the purpose of
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
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.
Friedmans monetarism became popular in
Thatchers Britain and Reagans U.S.A., in the 1970s and early 1980s after the
failure of Keynesian policies after the breakdown of the Bretton Woods arrangements in
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
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
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.
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.
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.
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.
Monetarism and the Masses
Denmark and Economic Integration in Europe
Martin Marcussen, Mette Z°lner
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
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.
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.
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.