"Monetarism" is a term first coined by Karl Brunner in 1968.
Economists such as Milton Friedman and Karl Brunner developed a
view of the macroeconomy in which the money stock held a central
role. According to these economists, it was the determining
factor of inflation and a leading indicator of business cycles.
In the 1970's their ideals became widely accepted, and known as
monetarism and became important in the United Kingdom in the
mid-1970's, which, after abandoning pegged exchange rates,
experienced rapid inflation. The essence of monetarism is the
quantity theory of money (MV=PQ), which means that the quantity
of money multiplied by the velocity of its circulation is equal
to the general price level multiplied by the goods and services
produced. It is because they hold to this theory that they
believe that a sustained growth in money that is in excess of the
growth of output produces inflation. Monetarists hold the
position that in the long-run, increases in nominal aggregate
demand will mainly be reflected in prices, with output tending to
some "natural" rate. Unlike New Classicists, Monetarists believe
that prices are sticky in the short-run, thus producing long and
variable lags in the adjustment process.
Another proposition held by monetarists, according to Meltzer, is
that "when inflation is expected to be high, interest rates on
the open market are high and the foreign-exchange value of a
currency falls relative to more stable currency.
The underpinnings of Monetarism according to K. Alec Chrystal and
Simon Price in,"Controversies in macroeconomics", are as
follows:
In conclusion, monetarists stress the role that money plays
in an economy, especially in regard to inflation. According to
the monetarists, money can have real effects in the short-run.
They also believe that the outcome of monetary policies are
subject to "long and variable lags", and thus, shouldn't be used
as a control instrument. Instead, they recommend a set of rules
that would control the growth of the money supply.
" Important to the understanding of modern monetarism
is the story about how changes in the money supply are
transmitted throughout the economy...[rise in money stock ->
excess money supply in portfolios ->excess demands for bonds]
This leads to a rise in the price of bonds, which is equivalent
to a fall in the rate of interest. The fall in the rate of
interest then produces an increase in investment which through
the multiplier effect influences income...the Keynesian disregard
for monetary policy arose from the failure to find convincing
evidence of a significant interest elasticity of investment
expenditure. Many in the Monetarist camp, however, believe that
the link from money to expenditure is much more direct. The
direct effect is often called the "real balance effect"...The
real balance effect is more general than the Pigou effect, though
it relates to the same behavioral phenomenon. Anything which
causes real money balances (or perhaps real liquid assets) to
deviate from their desired level will cause a change in
expenditures while the desired level of real balances is out of
equilibrium. Thus a rise in the money supply could lead directly
to an increase in expenditure. Instead of the excess money
balances being reflected entirely as an excess demand for bonds,
there would also be an excess demand for goods. The system as a
whole cannot reduce its holdings of nominal money balances, so
the excess real money balances have to be eliminated by either
price level or real income increases until the nominal money
supply is just demanded." "It is the hypothesis of "rational
expectations" in the presence of continuous market-clearing that
distinguishes New Classical macroeconomics from Monetarism."
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