2. Monetarist?
• The British news magazine The Economist
defined a monetarist as someone
• “who thinks it more important to regulate the
supply of money in an economy than to
influence other economic instruments.
3. Founder of Monetarism
• Milton Friedman, who died at age 94 in
November 2006, was the major intellectual force
in the early development of monetarism.
• Friedman was a longtime professor at the
University of Chicago.
• After his retirement in 1977, he became a senior
fellow at the Hoover Institution at Stanford
University.
• Friedman published articles in professional
economics journals as late as 2005.
4. Monetarist Propositions
• 1. The supply of money is the dominant influence on nominal
income.
• 2. In the long run, the influence of money is primarily on the price
level and other nominal magnitudes. In the long run, real variables,
such as output and employment, are determined by real, not
monetary, factors.
• 3. In the short run, the supply of money does influence real
variables. Money is the dominant factor causing cyclical movements
in output and employment.
• 4. The private sector is inherently stable. Instability in the economy
is primarily the result of government policies.
• 5. Permanent income hypothesis
• 6. Expected Augmented Phillips Curve
• 7. Natural rate of Unemployment
5. • The central policy conclusion that follows from
these propositions is that stability in the
growth of the money supply is crucial for a
stable economy.
• Monetarists believe that such stability is best
achieved by adopting a rule for monetary
policy. Milton Friedman long proposed a
constant money growth rate rule
6. • Friedman is a self-proclaimed quantity theorist
and classical liberal. According to Friedman,
“Inflation is everywhere and at all times a
monetary phenomenon.” (To the Keynesians,
inflation is the result of excess demand for goods
and services, and hence arises out of conditions
in the real sector-not based on real sector.)
• Karl Brunner coins the phrase “Monetarism”;
Brunner and Alan Meltzer construct the micro
foundations of Monetarism, creating a second
“camp.”
7. 7
What is Monetarism?
According to David Laidler (Economic Journal, March 1981, p. 1-2),
Monetarism can be characterized by four elements:
(I) A ‘quantity theory’ approach to macroeconomic analysis in two distinct
senses: (a) that used by Milton Friedman (1956) to describe a theory of
the demand for money, and (b) the more traditional sense of a view that
fluctuations in the quantity of money are the dominant cause of
fluctuations in money income.
(II) The analysis of the division of money income fluctuations between the
price level and real income in terms of an expectations augmented
Phillips curve whose structure rules out an economically significant
long-run inverse trade off between the variables.
(III) A monetary approach to the balance-of-payments and exchange rate
theory.
(IV) (a) Antipathy toward activist stabilization policy, either monetary or
fiscal, and to wage and price controls, and (b) support for long-run
monetary policy “rules” or at least prestated ‘targets’, cast in terms of
the behavior of some monetary aggregate rather than of the level of
interest rates.
8. Friedman’s Restatement
of the Quantity Theory
Friedman, M. “The Quantity Theory of Money--A
Restatement.”
In Studies in the Quantity Theory of Money, Milton Friedman,
editor. Univ. of Chicago Press (1956).
• According to Friedman, total income (Y) is explained by
nominal wealth (W) and the returns (r) that it generates.
• Explicitly:
• Y = Wr.
• If wealth and returns are estimated via expectations of
lifelong streams, then Y is really permanent income.
• According to the quantity theory, money demand is
proportional to the value of nominal transactions, which
should be a function of permanent income.
9. Contd……
• Friedman expands the detail of wealth and returns to
indentify the variety of assets and returns in the potential
portfolio:
• where Pis the price level,
• rb is the return on bonds,
• Re is the return on equities,
• Ra is the return on real assets,
• W is the ratio of human to nonhuman wealth (to capture
the return on “human wealth”),
• γ /r is total wealth,
• and u is the “portmanteau/other variable.”
10. Contd….
• We can simplify this to:
• Note: at equilibrium, the inflation rate should
be equal to the nominal return on the entire
(aggregate) stock of real (physical) assets. If
individuals do no suffer money illusion, they
are not fooled by changes to scale, and fis
linearly homogeneous in prices and nominals.
11.
12. Monetarist version of IS-LM
• It is useful to represent the monetarist position in terms of
the IS– LM diagram and the aggregate supply–aggregate
demand framework used to explain the Keynesian position.
• The LM schedule is nearly, but not quite, vertical, reflecting
Friedman’s view that the interest elasticity of money
demand is low.
• Another divergence from the Keynesian position concerns
the slope of the IS schedule. Here a flatter IS schedule is
consistent with the monetarist position that aggregate
demand is quite sensitive to changes in the interest rate.
Modern Keynesians also believe that the interest rate
affects aggregate demand and would not argue that the IS
schedule should be as nearly vertical as we drew it for the
model of the early Keynesians
13. In the monetarist view, the IS schedule is quite flat, reflecting a
high interest elasticity of aggregate
demand. The LMschedule is nearly vertical, reflecting a very low
interest elasticity of money demand.
14. In the monetarist view, the position of the aggregate demand schedule is
determined by the money supply. Increases in the money supply from M0 to M1
, then to M2, shift the aggregate demand schedule from Yd( M0) to Yd( M1), then
Yd( M2).
