What is a monetarist?
Key takeaways
– Monetarists believe that the money supply is the primary driver of nominal demand, inflation, and economic cycles.
– The core theoretical framework is the quantity theory of money (MV = PY): money supply (M) times velocity (V) equals nominal output (P × Y).
– Monetarists generally favor steady, predictable control of money growth to stabilize inflation and support long‑run growth; notable proponents include Milton Friedman and Anna J. Schwartz.
– Monetarism influenced policy in the late 1970s and early 1980s (notably under Fed Chair Paul Volcker), but its assumptions—especially a stable velocity of money—have been debated and revised in modern practice.
Understanding monetarists and monetarism
– Basic claim: Changes in the money supply are the chief determinant of changes in nominal spending and the price level. If the money stock grows faster than real output, monetarists expect inflation; if it grows too slowly, they warn of recession or deflationary pressure.
– Formal expression: MV = PY, where
– M = money supply (currency + deposits + some credit measures),
– V = velocity of money (how fast money circulates),
– P = price level,
– Y = real output (goods and services).
– Crucial assumption: V is relatively stable in the short to medium term. If true, managing M gives predictable control over nominal GDP (PY) and therefore inflation. The stability of V has been questioned since the 1980s because financial innovation, regulation, and market structure can change how quickly money circulates.
Historical context and influence
– Monetarism was a minority view until the 1970s when many advanced economies experienced stagflation (high inflation and weak growth). Keynesian models had difficulty explaining that combination.
– Milton Friedman and Anna J. Schwartz’s A Monetary History of the United States, 1867–1960 argued that poor monetary policy (mismanagement of money supply) amplified the Great Depression, helping to popularize the monetarist perspective.
– In response to 1970s inflation, central banks—most notably under U.S. Fed Chair Paul Volcker (1979–1987)—implemented tight monetary policies that dramatically reduced inflation, an outcome many saw as a vindication of monetarist ideas.
– Monetarists generally opposed a fixed gold standard because it ties the money supply to gold reserves, preventing deliberate control of money growth to stabilize prices and output.
Notable monetarists
– Milton Friedman (most prominent)
– Anna J. Schwartz (coauthor of the monetary history)
– Influential public figures often associated with monetarist-influenced policy: Paul Volcker, Margaret Thatcher (policy influenced by monetarist ideas), and to varying degrees Alan Greenspan.
Critiques and limits
– Velocity instability: If V is variable, the relationship MV = PY does not give policymakers a reliable handle on PY via control of M alone.
– Financial innovation and deregulation can change money multipliers and velocity quickly.
– Lags: Monetary policy impacts the real economy with uncertain and variable delays.
– Liquidity traps and the zero lower bound (when interest rates are near zero) limit the effectiveness of conventional monetary tools.
– Fiscal policy interaction: Large government deficits and debt (“fiscal dominance”) can complicate or overwhelm monetary control of inflation.
– Modern central banking has synthesized lessons from monetarism with other approaches—e.g., direct inflation targeting, use of interest‑rate rules, and broader communication strategies.
Practical steps — for policymakers and central banks
1. Define clear objectives
– Set a primary goal (e.g., price stability / inflation target) and publish it to anchor expectations.
2. Choose an operational framework
– Options: explicit inflation targeting, nominal GDP targeting, or rules-based money growth (monetarist approach). Modern practice favors inflation targeting combined with data‑dependent policy.
3. Monitor multiple indicators
– Track money aggregates, but also credit flows, inflation expectations, wage dynamics, output gaps, and financial conditions—because velocity and money multipliers can change.
4. Use predictable, rules‑based communication
– Clear forward guidance reduces uncertainty and helps anchor expectations (a central monetarist insight is that stable expectations reduce inflationary spirals).
5. Coordinate with fiscal policy
– Ensure fiscal policy is consistent with monetary objectives—large deficits can undermine monetary control of inflation.
6. Be prepared to use strong measures when necessary
– If inflation expectations de‑anchor, tightening decisively can restore credibility (the Volcker episode is a historical example).
7. Maintain flexibility for special conditions
– In crises or when policy rates hit the zero lower bound, non‑standard tools (asset purchases, credit programs) may be needed alongside monitoring money measures.
Practical steps — for businesses, investors, and households
1. Monitor money growth and central bank signals
– Rapid expansions in money supply or easy central bank policy can signal future inflationary pressure; tightening signals risk to growth and asset prices.
2. Diversify assets and hedge inflation risk
– Consider a mix of nominal and real assets (e.g., Treasury Inflation-Protected Securities, real estate, commodities) depending on risk tolerance and outlook.
3. Manage cash and working capital
– In high‑inflation environments, holding excess cash erodes purchasing power; in tight monetary conditions, liquidity access is critical.
4. Include monetary scenarios in planning
– Businesses should stress‑test pricing, wages, and financing under alternative monetary outcomes (high inflation, disinflation, sudden tightening).
5. Watch inflation expectations
– Surveys and market‑based measures (breakeven inflation from TIPS) matter because expectations themselves can be self‑fulfilling.
Example policies and outcomes
– Tight money to break inflation: Volcker-era Fed tightened monetary policy aggressively in the early 1980s to reduce inflation. The move produced a severe recession but ultimately brought inflation down, illustrating a monetarist prescription (control money growth to control inflation), though the implementation was through interest-rate policy rather than strict money-supply targeting.
– Modern practice: Many central banks have shifted to inflation targeting and focus on interest-rate policy and communication. Monetarism influenced this evolution by stressing the importance of monetary factors and expectations, even if rigid monetary-aggregate targeting fell out of favor.
Conclusion
Monetarism emphasizes the central role of money supply in determining nominal activity and inflation. Its core insight—that monetary forces and expectations are crucial to macroeconomic stability—has shaped modern central banking despite debates over the practicalities of targeting money aggregates. Policymakers, businesses, and investors benefit from monitoring both money measures and a broader set of indicators, and from applying rules, clear communication, and flexibility to manage the tradeoffs between inflation control and supporting growth.
Sources and further reading
– Investopedia. “Monetarist.” https://www.investopedia.com/terms/m/monetarist.asp
– Milton Friedman and Anna Jacobson Schwartz. A Monetary History of the United States, 1867–1960. Princeton University Press, 1963.
– Federal Reserve Bank of St. Louis. “The Great Inflation.” (accessed Feb. 6, 2021). https://www.stlouisfed.org
– Federal Reserve Bank of St. Louis. “Paul A. Volcker.” (accessed Feb. 6, 2021). https://www.stlouisfed.org
If you’d like, I can:
– Summarize how to apply monetarist indicators (money growth, velocity, inflation breakevens) in an investment dashboard;
– Provide a brief timeline or case study of monetary policy from the 1970s–1980s (Volcker era) with data charts. Which would you prefer?