The Monetarist Theory: Milton Friedman

Economic theories explore the relationships linking changes in the money put out to changes in stinting activity and prices. With a mixture of theoretical ideas, philosophical beliefs, and insurance prescriptions, these theories eject help elabo esteem on both historic and current financial situations. For instance, the general realizeing of the monetarist guess, founded by economist Milton Friedman, focuses on macro stinting activities that examine the impact of changes in the money depict and fundamental banking.This economic school of thought theoretically challenges Keynesian economics (OnlineTexts) to contend that variations in the money sum atomic number 18 the most significant determinants of the ramble of economic emergence, the behavior of the business cycle, the national rig in the minuscule run, and the price level oer longer extremitys of time (Investopedia). Through the developments from other theories, more than laissez-faire politics preliminaryes, an d the use of the quantity guess of money, monetarism has dramatically impacted and helped explain changes in monetary insurance and the banking system for nearly one snow years.To fully grasp this economic theory, the history behind it and what influenced its existence must be understood. Following the cracking Depression, Keynesian economics mainly dominated the United States as well as countries globally. This economic theory focused on total spending in the miserliness and its effects on output and flash (Blinder). Keynesians traditionally saw pecuniary policy as the find out tool for economic management, believed monetary policy should simply be used as a backup, and believed that the governments role was to maintain the economy at full employment (Biz/Ed).This theory besides emphasized interest positions as a target of monetary policy, raising rates to slow down the economy and reducing rates to rush along things up (Allen 283). Although these views were the main f ocus for some time, many economists saw that the theory was going away most of our economic problems unexplained. As Keynesian economics seemed unable to explain or cure the seemingly contradictory problems of emergent unemployment and inflation (Allen 284) economits like Milton Friedman began making different, more accurate observations.Monetarisms rise to intellectual prominence began with literary productions on basic monetary theory by Friedman and other economists during the 1950s (McCallum). These proposals were influential be apparent motion of their devotion to native neoclassical principles, particularly Friedmans presidential address to the American Economic Association in 1967, make 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 overtop for monetary policy (McCallum).From this point the monetarist theory drew its r oots from two almost entirely opposing ideas, the with child(p) money policies that dominated monetary thinking in the late 19th century, and the theories of Keynesian economics (Wikipedia). fleck Keynes had focused on total spending and the value stability of currency which resulted with problems based on an skimpy 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 non event (Wikipedia). Monetarists goals involved seeking to explain present problems while also striving to interpret historic ones. Since monetarists strongly believe that the money supply is the primary determinant of noun phrase gross domestic product in the short run and of the price level in the long run, they stress that the tame 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 should intervene in economic and monetary decisions by trying to manage the level of aggregate demand or total spending (Biz/Ed). Friedman explains that if we are experiencing government deficits and must make a monetary decision, then the deficits should be financed by increasing the money supply instead of affecting aggregate demand, and vice versa for budget surpluses.Monetarists argue that interventionist policy regarding managing total spending lead be destabilizing in the long run and should thitherfore be avoided. By trusting free markets kind of than large governments, monetarists quickly and simultaneously agreed that government intervention will destabilize the economy more than it will help, since intervention typically interferes in the workings of free markets and can lead to bloated bureaucracies, unnecessary well-disposed programs, and l arge deficits (OnlineTexts).Markets will benefit by working on their own since market forces will cause inflation, unemployment and production to adjust themselves automatically and efficiently around a fixed amount of money (Milton Friedman and Monetarism). A key problem with discretionary demand management policies is the time lags, which monetarists believe make fiscal policy too difficult to use to manage the economy effectively (Biz/Ed). The best thing therefore, is to take a long-run view of price stability and use monetary policy to achieve this.Monetarists always give tongue to that where fiscal policy could be beneficial, monetary policy would do the job better. Government attempts to influence GDP and other economic measures through fiscal policy are at best ineffectual, mainly because expansionary fiscal policy only causes inflation (Monetarist Theory of Inflation). The monetarist theory believes that the feed should not contrive discretion provided rather be bound to fixed rules in conducting monetary policy.For example, monetarists prefer the money growth rule which states that the Fed should be required to target the growth rate of money so that it equals the growth rate of real GDP, leaving the price level unchanged (OnlineTexts). The relationship between inflation and money growth is virtually a one-to-one relationship, so if the economy is expected to grow at a real percent in a given year, the Fed should allow the money supply to increase by the identical percent. By following this rule there will be a tight control of money and credit allowing the economy to maintain price stability (Riley).Monetarists stress incorrect central bank policy is often the root of large fluctuations in inflation and price stability, showing that the key to success is to ensure that monetary policy is credible so that peoples expectations of inflation are controlled (Riley). Friedman states at heart his academic paper, The Role of Monetary Policy that monet ary authorities should croak themselves by magnitudes that they can control, not by ones that they cannot (Friedman 14), which is why the quantity theory of money and other monetarist concepts are of huge vastness and assistance.The quantity theory of money is a basic theoretical explanation for the link between money and the general price level. This theory helps describe how by controlling the growth of the money supply and leaving interest rates unchanged the Fed can better control inflation and foster inactive economic growth (Riley). This identity relates total aggregate demand to the total value of output, and holds that changes in nominal prices reflect changes in the money supply and the fastness of money (Monetarism). Monetarists assume that the velocity of money within the economy, or rather the average number of times a dollar is used to purchase last(a) good or service is assumed constant or changes at a predictable rate (Wikipedia). The value of real output (GDP), or the total volume of production of goods and services, is not influenced by monetary variables (Riley) allowing monetarists to also treat GDP as a constant. Looking at the quantity of money theory equation, M*V = P*Y, where M is the rate of growth in the money supply, V is the velocity of money, P is the overall price level, and Y is the total output or GDP, one can chink that with V and Y as constants, changes in the rate of money supply will equal changes in the price level (Riley).By using this equation and theory, economists can determine and solve problems within the economy and we have seen this end-to-end history. The monetarist theory can effectively explain the deflationary waves of the late 19th Century, the Great Depression, and the stagflation period beginning in the early 1970s (Wikipedia). Monetarists argue that there was no inflationary boom in the 1920s, while Keynesians argue that there was significant asset inflation and unsustainable growth.Monetarists claim t hat the contraction of the M1 money supply during 1931-1933 is to blame for the Great Depression and if the Fed had provided sufficient liquidity to make up for the insufficient money supply, then that financial crisis would have be avoided (Pettinger). In comparison, the increase in inflation rates throughout the 1970s led many to consider monetarist policies to steady the money growth (Hafer 18). Even though the explosive rise in inflation in the 1970s was related directly to oil price shocks, there was also a similar increase in the average rate of money growth.To combat this, the Fed began adopting a monetarist platform and monetary targets were effectively used in official policy analysis (Hafer 18). later(prenominal) in the 1980s President Reagan imposed strict monetarist policies of restricted money stock growth in an effort to stop the dramatic rise of inflation. At this time, the prime interest rate was at cardinal percent and unemployment reached double digits. The mone tarist policies Reagan proposed brought down inflation and unemployment rates, suggesting that monetarist policies were succeeding (Allen 284).Most recently in the early 1990s, John Taylor, an economics professor at Stanford, showed that U. S. monetary policy could be accurately described by relating movements in the national funds rate to deviations in inflation from a target rate and deviations in real output growth from potential growth (Hafer 19). This Taylor rule dominates much of the research on monetary policy during the quondam(prenominal) decade, both as a model of Fed behavior and as a model to guide policy decisions (Hafer 19).While some disagreement remains, certain things are clear. Since 1990, the classical form of monetarism has been questioned because of events that have been interpreted as inexplicable in monetarist terms, primarily the unhinging of the money supply growth from inflation in the 1990s and the misadventure of monetary policy to stimulate the econom y in the early 2000s (Wikipedia). Alan Greenspan, former chairman of the national Reserve, explains why the monetarist theory unfortunately had no success in combating early financial problems.He argued that the 1990s economic decline had little to do with the monetarist view of the money supply and rather was explained by a right cycle of productivity and investment on one hand, and a certain degree of irrational exuberance in the investment sector (Wikipedia). Along with Greenspan, economist Robert Solow of MIT suggested that the 2001-2003 failure of the expected economic recovery also was not attributed by monetary policy, but by the decreasing productivity growth in all important(p) sectors of the economy (Investopedia).Despite both the successes and failures of the monetarist theory, in 2005 most academic specialists in monetary economics described their penchant as pertly Keynesians (McCallum). However, even with that focus, most of the changes to Keynesian thinking that monetarists proposed are accepted today as part of standard macroeconomic and monetary analysis and most economists accept the proposition that monetary policy is more powerful and useful than fiscal policy for stabilizing the economy (McCallum).In addition, current thinking all the way favors policy rules in contrast to discretion of central banks and stresses the importance of maintaining inflation at low rates. With new Keynesian views prominent in todays society, it can be determine that it is only in the emphasis on monetary aggregates that monetarism is not being widely practiced today. Economic theories, including monetarism, are incessantly changing to provide outlets for research in all areas of economics based on theoretical reason and analysis of economic problems.Despite the drastic differences between the late 19th century and todays economy, the same economic problems remain the same. We cannot put so much doubt and negativity onto monetarist views as we can be ass ured that new economic theories will continuously emerge as changes in the economy solve fresh insights and cause existing ideas to become obsolete.Throughout these changes, the same motivating force is present regarding the need to understand the economy in order to achieve societys goals. These economic theories are highly significant in finding the right monetary policy to bring about economic growth and financial stability in a country. The monetarist theory, as well as others more prominent today, will continue to be debated and tried and true in order to find answers to some of the most troubling economic questions throughout our history.