Monetarism in a Nutshell
The term “monetarism” was coined by Karl Brunner to label a specific set of analytical and empirical propositions brought forward to contest the conventional wisdom of postWorld War II macroeconomics (Brunner 1968).
The first contributions to what came to be known as monetarism were published during the 1950s. Within the economics profession, it had its heydays in the 1970s due to its ability to predict the US stagflation by means of the expectations-augmented Phillips curve. Monetarist policy views spread quickly and rose to dominance in the 1980s (with the rise of “Ronald Thatcher”, see Laidler 2012: 24, fn 27). Whereas the success of monetarism within the economics profession was largely due to the expectations-augmented Phillips curve, its sway over public opinion was fostered by the monetarist short-run and policy-orientated quantity theory of money.The towering figure of the monetarist school was Milton Friedman, who set the tone in an, at times, heated controversy with the proponents of the neoclassical synthesis. Other prominent members are Karl Brunner, Bennett McCallum, David Laidler, Allan Meltzer, Anna Schwartz, and Carl Warburton (who is the “pioneer monetarist”; see Bordo and Schwartz 1979). It is, however, the work of Friedman that is generally acknowledged to define “monetarist orthodoxy”, that is, the beliefs and methods that characterize the monetarist school. He did no less than to invert the prevailing view of why the Great Depression had happened, and of what had proven to be an effective remedy.
Before the rise of monetarism, the dominant view was Keynesian in that it held responsible for the Great Depression the inherent instability of the private sector. According to this view, investment choice reflects consensual market expectations that are prone to fads and collective passions (“animal spirits”). Fickle market sentiments translate into volatile investment spending and expose the economy to self-fulfilling prophecies.
If the private sector is left on its own, there exists a multiplicity of demand-constrained equilibria so that full-employment becomes a matter of chance. Government intervention is beneficial as it is able to select for the right equilibrium: whenever private spending collapses, the government is able to offset the impact on aggregate demand and, thus, to defend the output level consistent with full-employment.In their seminal monograph A Monetary History of the United States, Friedman and Schwartz argued the opposite (1963: ch. 7). According to their “monetarist view”, a small shock that would otherwise have caused a minor recession was turned into a deep slump by a series of blunt policy mistakes. In particular, monetary policy stood by as the money multiplier collapsed in consequence of a bank run. Monetarists believe that, in general, the monetary authority always and completely controls the level of nominal income. In the short run, when nominal rigidities prevail, monetary policy is fully accountable for the level of real income. Accordingly, significant inflationary booms, like the post-World War I inflation, and significant deflationary busts, like the Great Depression, cannot be blamed on the private sector, which they believed to be inherently stable (Mayer 1978: 2, 14-15). Instability is rather inflicted upon the private sector by monetary policy: “The contraction is in fact a tragic testimonial to the importance of monetary forces” (Friedman and Schwartz 1963: 300).
Further, because nominal income in monetarist analysis is always and everywhere controlled by monetary policy, deficit spending has no impact on aggregate demand, output, and employment. If not accommodated by a monetary authority, fiscal policy just induces a reallocation of resources, crowding out private investment to finance unproductive government consumption instead (on the “fiscalist-monetarist debate”, see Brunner 1989: 259-80). In the longer run, which in monetarist analysis is not necessarily a steady state, it is in vain to target real variables like output and the rate of unemployment. Because the private sector is not exposed to money illusion and, thus, cannot be fooled permanently, there is no exploitable long-run trade-off between inflation (a nominal target) and unemployment (a real target).