What are the key ideas behind Monetarism?
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Last updated 10 Jan 2023
Monetarism is an economic theory that emphasises the role of the money supply in determining economic activity and prices.
The key ideas behind monetarism include:
- Quantity of money matters: Monetarists believe that the money supply is the most important determinant of economic activity and prices. They argue that changes in the money supply lead to changes in economic activity, inflation, and interest rates.
- Long-run relationship between money and prices: Monetarists believe that in the long run, the money supply and prices are positively related. They argue that increasing the money supply will lead to inflation, while decreasing it will lead to deflation.
- Monetary policy should focus on controlling the money supply: Monetarists advocate that monetary policy should focus on controlling the money supply rather than on trying to stabilize the economy or manage the business cycle. They believe that controlling the money supply is the most effective way to control inflation in the long run.
- Money supply targeting: Monetarists argue that the central bank should target a specific rate of growth for the money supply and use monetary policy tools to achieve that target. This will help to achieve a predictable monetary environment, with a low and stable inflation rate.
- Ineffectiveness of fiscal policy: Monetarists generally argue that fiscal policy (taxation and government spending) is relatively ineffective in managing the economy and that instead monetary policy is the best tool for achieving stability and growth.
- Natural rate of unemployment: Monetarists argue that there is a natural rate of unemployment below which inflation will rise and above which there will be a fall in inflation. A central bank should focus on controlling inflation rather than unemployment, as trying to bring unemployment below the natural rate will result in higher inflation.