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Monetarism is a school of macroeconomic thought and research that holds variations in the money supply to be paramount to national output and price levels. Monetarists argue that monetary policy should be aimed at controlling the growth rate of the money supply. The monetarist school is generally associated with Milton Friedman, and is usually critical of Keynesian economics, which advocates a stronger role for government fiscal policy to manage the macroeconomy. Ironically, Friedman might have been one of the greatest Keynesian economists (the Keynesians adopted some of his criticisms of their models after the stagflation debacle).
Monetarists emphasize the following
- Long-run monetary neutrality: Over the long run, money only impacts nominal variables and has a negligible impact on real variables (income, consumption, output) if one at all.
- Short-run monetary nonneutrality: Unexpected monetary episodes, be they inflationary or deflationary, do impact real output and employment (stagflation in the 1970s USA).
- The distinction between real and nominal interest rates: Real interest rates are what counts, nominal rates are often misleading. Contrary to popular belief, high nominal interest rates don't mean money is tight. They often mean inflation is high and that banks are trying not to lose money by overcompensating with interest rates higher than expected inflation.
- The role of monetary aggregates in policy analysis: Some, though not all, monetary aggregates are critical in monetary policy, as changes in the money supply will change or distort interest rates, inflation, and expectations.
For the most part monetarists favor rule based monetary policy, that is, a specific policy a central bank cannot deviate from such as targeting the growth rate in the money supply. Additionally, most are of the view that monetary policy is more powerful than fiscal policy, so that increases in government spending or tax cuts are only effective if monetary policy is accommodative. If there is a major tax cut, a central bank need only raise rates to offset the tax cut if they fear the stimulus could become inflationary. Other key views include duel skepticism of the gold standard and central banking(especially activist banking),[note 1] a basic belief that markets are self correcting, the government has some role to play in monetary policy, exchange rates should be free floating, and inflation is a monetary phenomenon.
To current mainstream Keynesian thinkers, monetarism is not wrong, but only "half-right." It has long been government policy to use monetary policy to prevent both bubbles and recession first and resort to fiscal policy second. This has been more or less good enough with the stagflation of the late '70s and early '80s being rather anomalous (although Fed Chairman Paul Volcker is often credited for stomping it out).
However, the failure of monetary policy alone has been witnessed in Japan over the last 20-odd years. While they ran deficits, they concentrated mostly on monetary policy through massive quantitative easing. Yet despite printing ludicrous amounts of money and showering banks with it, they have experienced continuous and persistent deflation, not inflation. Mainstream Keynesians have been blaming this failure on the mother of all liquidity traps, i.e., that the Japanese public has mostly been concerned with paying down debt and all that money they printed up has been sitting in bank vaults doing nothing (and thus unable to curb deflation). MMTers, on the other hand, say that monetarism is more or less completely wrong and "liquidity traps" are irrelevant.
Various officials from around the political spectrum have declared themselves to be monetarists. These include Alan Greenspan, fabled former head of the US Federal Reserve, and Ben Bernanke, former chairman of the Federal Reserve, two individuals who oversaw US central bank policy during the time leading up to the financial downturn of 2007. However, monetarism is not usually considered the culprit in Greenspan's and Bernanke's failures. In fact, Greenspan is often criticized from all angles for not following monetarist policy by keeping interest rates artificially low and chucking money at failing enterprises like the S&L thrifts and Long Term Capital Management. Bernanke is usually criticized just for being a short-sighted idiot and claiming that "subprime problems were contained."
Christina Romer, an important economic advisor to former President Barack Obama, is also associated with monetarism.
- While most monetarists don't want to outright abolish their nation's central bank, most are uncomfortable with anything other than strict rule based policies. Many fear that over time central banks will simply stray from good discretionary policy and make mistakes.
- McCallum, Bennett. "Monetarism" Econlib. Retrieved 2020-02-12.
- Friedman, M., & Schwartz, A.J. (1986). Has government any role in money?. Journal of Monetary Economics, 17(1), 37–62.
- See the Wikipedia article on Lost Decade.
- In 2013 they're doing this again, this time printing $1.4 trillion as an economic defibrillator. (And you think US debt levels are a problem?)