Monetarism

Monetarism is an economic concept that states money supply as a primary factor on which rate of inflation depends. It plays a vital role in calculating national income and in monetary economics. Monetarism as a concept was popularized by economist, Milton Friedman. Friedman claimed that excessive money supply leads to an inflationary situation. He advocated the use of monetary policies by the central bank in order to maintain price stabilization. To achieve this purpose, Friedman formulated a fixed monetary rule known as Friedman’s k per cent rule.

Some economists opine that monetarism may lead to destructive economic policies since they are likely to be formulated by central bankers selected by politicians. Central bankers may introduce policies that serve a government or political party’s interest more than a public interest. Monetary policy of the US had a positive role to play during the Asian financial crisis. But economists also regard it to be a major reason that led to the development of the housing bubble of 2004-06.

Friedman’s k per cent rule

Friedman’s k per cent rule recommended that a percentage increase in the money supply should be maintained on a yearly basis. This should be done without taking into account business cycles and may help in countering inflation.

Equation

Theory of monetarism is based on the following equation:

• MV = PQ, where,
• M= Money supply
• V= Velocity or number of times in a year an average currency is spent
• P= Prices (goods and services)
• Q= Quantity (goods and services)

It suggests that velocity remaining constant, an increase in money supply can increase prices or quantity of goods and services.

Housing Bubble

Several economists criticize US’ loose monetary policies for the creation of excess liquidity that eventually led to the housing bubble of 2004-06. Former Federal Reserve chairman, Alan Greenspan, a true monetarist, has been blamed for implementing policies that resulted in US’ current economic crisis.

General Criticism

Economists point out that adopting a policy of monetarism may cause politicians to hire central bankers without taking into account their competence level. Incompetence at the highest level may lead to destructive economic policies.

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