Monetarism: Printing money to curb inflation

Think of yourself as the host of an economist’s dinner, where no one has fun (maybe it’s not hard to imagine). There are two competing schools of thought as to what measures should be taken to rectify the party. The Keynesian economist in the room will tell you to break party games and snacks, and then force people into an exciting twisting game. At the same time, Milton Friedman and his monetarist partners have different solutions. Control your drinking and let the party take care of itself.

Of course, the economy is slightly more complicated than the worsening of the dinner party. But the basic question is the same: is it better to intervene when a problem occurs, or to try to prevent it before it starts? This article will explore the rise of the leisurely monetarist method of controlling inflation, involving its proponents, successes and failures.

The basis of monetarism
Monetarism is a macroeconomic theory criticizing Keynesian economics. It got its name from its focus on the role of currency in the economy. This is very different from Keynesian economics, which emphasizes the role of the government in the economy through expenditure, rather than the role of monetary policy. For monetarists, the best thing for the economy is to pay attention to the money supply and let the market take care of itself. Finally, the theory believes that the market is more effective in dealing with inflation and unemployment.

Milton Friedman (Milton Friedman) was a Nobel Prize winner in economics who had supported the Keynesian method. He was one of the first to break away from the generally accepted principles of Keynesian economics. In the book “A History of American Currency, 1867-1960” (1963) co-authored with the economist Anna Schwartz, Friedman believed that the Fed’s poor monetary policy was the main cause of the Great Depression in the United States. The United States is not a problem in the savings and banking system. He believes that the market will naturally tend to a stable center, and the wrongly set money supply will lead to irregular market behavior. With the collapse of the Bretton Woods system in the early 1970s and subsequent increases in unemployment and inflation, the government turned to monetarism to explain their plight. At that time, this school of economics became more prominent.

There are several key principles of monetarism:

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  • Controlling the money supply is the key to setting business expectations and combating the effects of inflation.
  • Market expectations of inflation will affect forward interest rates.
  • Inflation always lags behind the impact of production changes.
  • Fiscal policy adjustments will not have an immediate effect on the economy. Market forces are more efficient in making decisions.
  • There is a natural unemployment rate; attempts to lower the unemployment rate below this level will lead to inflation.

Quantity theory of money
Classical economists’ approach to money pointed out that the amount of money available in the economy is determined by the exchange equation:

M × V = P × T where: M = the amount of currency currently in circulation in a period of time V = speed-the frequency of currency spending or turnover in that period of time P = average price level T = expenditure value or quantity transactionbegin{ aligned} &M times V = P times T \ &textbf{where:}\ &M = text{current amount in circulation} \ &text{within a period of time} &V = text{Velocity -Frequency of spending or turnover of money} \ &text{end over a period of time} \ &P = text{average price level} \ &T = text{value of expenditure or number of transactions} \ end{ aligned}

riceXVolt=phosphorusXTonWhere:rice=The amount of currency currently in circulationIn a period of timeVolt=Speed-how often you spend or transfer moneyEnd of periodphosphorus=Average price levelTon=Spending value or number of transactions

Economists tested this formula and found that the velocity of money V usually remains relatively constant over time. Therefore, an increase in M ​​leads to an increase in P. Therefore, as the money supply increases, so will inflation. Inflation makes goods more expensive, which limits consumer and corporate spending, which harms the economy. According to Friedman, “Inflation is a monetary phenomenon everywhere.” Although economists following the Keynesian approach did not completely ignore the role of money supply on gross domestic product (GDP), but They do believe that the market needs more time to react to adjustments. Monetarists believe that the market will easily adapt to more available capital.

Money supply, inflation, and the K-percent rule
For Friedman and other monetarists, the role of the central bank should be to limit or expand the money supply in the economy. “Money supply” refers to the amount of cash available in the market, but in Friedman’s definition, “currency” is expanded to also include savings accounts and other on-demand accounts.

If the money supply expands rapidly, then the inflation rate will rise. This makes the goods of enterprises and consumers more expensive, and puts downward pressure on the economy, leading to economic recession or depression. When the economy reaches these lows, the central bank can aggravate the situation by not providing sufficient funds. If companies (such as banks and other financial institutions) are unwilling to provide credit to others, it may lead to a credit crunch. This means that there is simply not enough funds to make new investments and new jobs. According to monetarism, by injecting more funds into the economy, the central bank can incentivize new investments and increase investor confidence.

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Friedman initially proposed that the central bank set a target for inflation. To ensure that the central bank achieves this goal, no matter what stage of the business cycle the economy is in, the central bank will increase a certain percentage of the money supply every year. This is called the k-percent rule. This has two main effects: it prevents the central bank from changing the rate at which money is added to the overall supply, and it enables companies to predict what the central bank will do. This effectively limits the change in the velocity of currency circulation. The annual growth of the money supply corresponds to the natural growth rate of GDP.

The government has its own set of expectations. Economists often use the Phillips curve to explain the relationship between unemployment and inflation, and expect that as the unemployment rate falls, inflation will increase (in the form of higher wages). The curve shows that the government can control the unemployment rate, leading to the use of Keynesian economics to increase the inflation rate to reduce the unemployment rate. In the early 1970s, this concept ran into trouble due to the coexistence of high unemployment and high inflation.

Friedman and other monetarists studied the role of expectations in the inflation rate; specifically, if inflation increases, individuals will expect higher wages. If the government tries to reduce the unemployment rate by increasing demand (through government spending), this will lead to higher inflation and eventually cause the company to fire workers hired to meet the growth in demand. This happens whenever the government tries to reduce the unemployment rate below a certain point (usually called the natural unemployment rate).

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This realization has an important effect: monetarists know that, in the short term, changes in the money supply may change demand. But in the long run, this change will weaken as people expect inflation to rise. If the market expects higher inflation in the future, open market interest rates will remain high.

Monetarism in practice
Monetarism arose in the 1970s, especially in the United States. During this period, inflation and unemployment rates were rising, and the economy did not grow. Paul Volcker was appointed chairman of the Federal Reserve in 1979, and he faced the arduous task of curbing rampant inflation caused by high oil prices and the collapse of the Bretton Woods system. After he abandoned the previous policy of using interest rate targets, he restricted the growth of the money supply (reduced the “M” in the exchange equation). Although this change did help the inflation rate fall from double digits, it has an additional effect as interest rates rise, even if the economy falls into a recession.

Since the rise of monetarism in the late 20th century, a key aspect of the classic monetarist approach has not developed: strict supervision of bank reserve requirements. Friedman and other monetarists envisioned strict controls on the reserves held by banks, but as financial market deregulation was implemented and company balance sheets became more and more complex, this was mostly shelved. As the relationship between inflation and money supply becomes more relaxed, the central bank no longer pays attention to strict monetary targets, but pays more attention to inflation targets. This practice was overseen by Alan Greenspan, who was a monetarist for most of his nearly 20 years as chairman of the Federal Reserve from 1987 to 2006.

Criticism of Monetarism
Economists who follow the Keynesian approach are some of the toughest opponents of monetarism, especially after the anti-inflation policies of the early 1980s led to a recession. Opponents pointed out that the Fed’s failure to meet the demand for money has led to a reduction in available capital.

Economic policies, and the theories behind why they should or should not work, are constantly changing. A school of thought may explain a certain period of time well and then fail in future comparisons.Monetarism has a good record, but it is still a relatively new school of thought, which may be further refined over time.


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