Monetarist Economic Views

Monetarists are modern classical economists that believe:

• Markets are highly competitive, which gives it a high degree of stability

• Little government interference in the economy - laissez faire

• Government creates rigidities which weaken capacity of the market system to provide stability

• Equation of Exchange

• money supply is the single most factor in determining output, employment, and prices

• money supply should be increased by a steady rate each year

• money velocity is stable

• fiscal policy is ineffective because of crowding-out

Monetarist Equation of Exchange

MV = PQ

such that

• M = money supply

• V = velocity (number of times average dollar is spent)

• P = price level

• Q = physical volume of all goods and serves produced

MV = total amount of money spent on purchases

PQ = total amount received by sellers of output

Monetarists believe that changes in the money supply are the single most important factor in determining the levels of output, employment, and prices.

Money supply directly changes aggregate demand

• Increasing money supply increases demand

• Decreasing money supply decreases demand

Changing aggregate demand causes a change in GDP

• An increase in M will increase P or Q , or a combination of both

• A decrease in M will decrease P or Q, or a combination of both

Monetarists argue that velocity of money is stable.  Why?

• People have a stable desire to hold money

• The amount of money people will want to hold will depend on level of nominal GDP

Views on Fiscal Policy

• Monetarists argue against fiscal policy because of crowding out effect

• Monetarists believe that the demand for money curve is steep, and the investment-demand curve is relatively flat, meaning investment spending is very sensitive to changes in the interest rate

• Therefore, crowding out effect is great

Monetarist View on Monetary Policy

• Demand for money curve is relatively steep

• Investment demand curve is relatively flat

• Therefore, monetary policy is very effective

• HOWEVER, extreme monetarists advise against the use of monetary policy because they argue that changes in money supply only destabilize the economy.  Why?

changes in money supply have irregular time lags

the Fed cannot simultaneously stabilize both money supply and interest rates

they advocate the monetary rule - increasing the money supply by the same annual rate. This shifts AD in same proportion to AS

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