Monetarism is a relatively modern view in economics that caught hold in the middle of the twentieth century. It is a specific view, within the broader topic of monetary economics which is discussed in chapter thirty three of the database. The growth of this view, of which Milton Friedman was a very strong proponent, coincided with periods of economic problems after the popularity of the Keynesian model and the polar force of communism being active in part of the world.
As such, it sought to challenge the widely accepted beliefs and showed a return to the principles of free market and allowing the invisible hand to bring about productive and allocative efficiency as the cure for the ills of the nations (Congdon, 2007). Despite its success however, it is argued that monetarism only had a limited impact in terms of being able to control inflation and unemployment as were its stated aims in monetary policy selection.
Monetarism is basically the standpoint in macroeconomics which looks to money supply as being able to explain predominant impacts on GDP in the near term while explaining inflation and variation in price levels in the long run. Thus the tools for controlling money supply include the open market operations of the central bank, the discount rate for controlling the federal funds rate; the banks reserve ratio and more recently, the term auction facility.
The theory was expounded to a great extent by the work of Milton Friedman who explained that the determinants of money demand were few such as for the transactive motive, the speculative motive and other variations such as the portfolio motive (Congdon, 2007). He tool this argument to emphasize that as a result, expansion in money supply would result in a rise in aggregate demand as people will already be holding the amounts of money required in the quantities requires for their purposes and the extra money would be spent.
The opposite case follows from a contraction in the supply since people would move to cut spending in order to restore their money holding to previous levels. Monetarism has to be taken in the backdrop of the prevailing theories at the time. The Keynesian and the Hayekian view had come out relatively simultaneously, the former advocating fiscal policy as a measure for economic growth while the latter advocating free market principles.
Keynesian economics however gained a stronger foothold as it was seen as a way out of the Great Depression as governments sought to intervene in markets and increase aggregate demand to stimulate them into growth and out of depression (Sullivan, 2009). However this view had started to become less prominent by the time monetarism arose which was closer to the views of Hayek. This was because Keynesian economics was unable to explain the inflationary and unemployment problems of the 1970s with the fall of the Bretton Woods and the oil problems arising from the Middle East.
Bringing this into perspective of the episode “The Battle of Ideas” and the contemporary economic situation coinciding with the recent financial crisis, the Keynesian view seems to be supported as governments have been forced to resort to fiscal stimuli in order to revive the economies and bail out failing financial institutions (Sullivan, 2009). This was however not the case in the time of the rise of monetarism where it was seen as a cure for the economic ills.
Demand management was downgraded as an inefficient tool at the time and the free market principles were espoused as the self correcting mechanisms of the market and free enterprise were seen as consistent with economic growth. Monetary policy was to be organized around the prediction of the need for money supply growth so that inflation could be reigned in and unemployment controlled as a result. Government intervention was shunned and de-regulation was particularly stressed.
These moves were easier to implement and bore fruitful results in developed countries such as the United States and the UK under Margaret Thatcher as Britain was able to control years of inflation and became one of the leaders of economic growth of the time (Congdon, 2007). However, it had its problems in developing countries and to some extent on developed countries as well as outlined in the episode “The Agony of Reform”.
This is because free market principles require that government intervention be lifted which takes away the support provided to the poor, regulations aimed at providing benefits to employees, aims at increasing employment, public sector enterprises and so on which temporarily increases unemployment and hits the lower and the middle class hard. The gap between the rich and the poor widens as the entrepreneurs are able to take in profits while cost cutting measures at the micro level reduce incomes for workers and their families, reducing their standard of living (Congdon, 2007).
However, it can be seen that Monetarism fails in its aims at curbing inflation and unemployment via monetary policy while allowing the free hand of the market to operate in some cases. The 1920s are researched by the Keynesians and the Austrian economists to show that it was a period of an inflationary investment boom and that excessive credit easing contributed to a worsening of the crisis at the time. This is contested by monetarists but there is more evidence from recent times.
In the time of the 1990s, the expansion of the money supply remained unhinged from price inflation which went against the theory of classical monetarism and could not be explained (Sullivan, 2009). Efforts were made to explain this in terms of the phrase “irrational exuberance” as coined by the Federal Reserve chairman at the time. Another occurrence of the failure was in 2001 to 2003 when the monetary policy was unable to result in a stimulation of the economy which should have been the case, as shown during the coursework based on the relationship between monetary policy and growth.
Prominent economists have also questioned the relationship between growth and money supply expansion in times of low inflation. As outlined therefore, it can be seen that Monetarism arose out of the inability of Keynesian economics to explain the economic ills of the 1970s and espoused principles of Hayek. These cured the problems of the time to some extent but not without causing severe shocks to struggling economies which had to implement free market principles ad reduce government intervention.
However, this did not work in all cases as in the 1990s and 2001-2003, the intended impact of the monetary policies could not be achieved and in current times, government are seeing a return to Keynesian principles as they try to opt for fiscal stimulus as a measure for economic growth out of recession. References Congdon, Tim. (2007). Keynes, the keynesians and monetarism. New York: Edward Elgar Publishing. Sullivan, A. (2009). Macroeconomics: principles, applications and tools. New York: Prentice Hall.