Monetarism
What is Monetarism?
Monetarism holds that the money supply is the main driver of inflation and economic activity, so central banks should control money growth steadily.
Led by Milton Friedman, it argues 'inflation is always and everywhere a monetary phenomenon' and favors stable, rules-based money growth over discretionary policy. It builds on the quantity theory of money.
Monetarism: a worked example
Start from the equation of exchange, MV = PY. Suppose the money supply M is $800 billion, velocity V is 8, and real output valued at base-year prices is $3,200 billion. Nominal spending is 800 times 8, or $6,400 billion, so the price level is 6,400 divided by 3,200, which equals 2.0. Now let the central bank raise M by 10 percent to $880 billion while velocity stays at 8 and output stays at potential. Nominal spending becomes $7,040 billion and the price level becomes 7,040 divided by 3,200, or 2.2, a 10 percent rise. In growth-rate form the same result reads as money growth plus velocity growth equals inflation plus real growth. If a monetarist central bank wants 2 percent inflation and expects 3 percent real growth with stable velocity, the k-percent rule sets money growth at 5 percent and leaves it there.
The mistake students make with monetarism
Students read MV = PY as a promise that any increase in the money supply raises prices by the same percentage right away. The equation is an identity, and the monetarist prediction only follows once you add two assumptions: velocity is stable and output already sits at potential. Drop either one and the arithmetic changes. With idle factories and unemployed workers, part of the extra spending shows up as higher real output rather than higher prices. If velocity falls while M rises, nominal spending can even stall. Name the assumptions before you claim the conclusion.
Monetarism questions
What is the difference between monetarism and Keynesian economics?
Monetarism puts money growth at the center and treats the private economy as basically stable, so it favors a fixed money rule over active management. Keynesian analysis puts aggregate demand at the center, treats private spending as unstable, and accepts discretionary fiscal and monetary action to close output gaps. The practical split shows up in policy lags: monetarists argue that by the time a stimulus lands the economy has already turned, so the intervention adds noise instead of stability.
What is Friedman's k-percent rule?
Friedman's k-percent rule tells a central bank to expand the money supply by the same fixed percentage every year and to ignore the news. The value of k is chosen to cover trend real output growth plus whatever inflation the central bank is willing to accept, and then it stays put through booms and slumps alike. The point is not that any particular number is correct. A predictable rule removes the timing errors and shifting expectations that Friedman blamed on discretionary fine-tuning.
Do monetarists think fiscal policy is useless?
Monetarists treat fiscal policy as weak rather than literally useless. Their argument is crowding out: government borrowing to fund a deficit pushes up interest rates, which trims private investment and consumer borrowing, so the net effect on total spending is small unless the central bank expands the money supply alongside it. In that case, monetarists would say the money growth did the work, not the spending bill. The policy conclusion is to steady money growth and leave the budget out of stabilization.
Related terms
Common comparisons
Get AP Econ exam tips in your inbox
Occasional emails with study tips, new interactive graphs, and exam-season reminders. Free, no spam.
No spam. Unsubscribe anytime. Read our privacy policy.
Keep track of what you have studied
A free EconLearn account adds progress tracking, your quiz history, and achievements. Studying here is free either way, and there is nothing to pay for as a student.
Create a free accountAlready have one? Sign in
Last updated