Meaning of Monetarist Revolution: The “monetarist revolution” refers to the new and important contributions made to monetary theory and policy by Prof. Friedman and his colleagues at the University of Chicago. The rate of change of prices has also usually been omitted, except in studies of hyper-inflation, and the ratio of non-human to human wealth has seldom been included. A constant and moderate growth in the money supply will ensure economic stability. Monetarist Theory Second, we have Monetarist Theory, which was created by economist Milton Friedman, among others, as a criticism to what was seen as the shortcomings of the Keynesian Theory… Criticisms. In the long run, an increase (decrease) in M will cause a rise (or a fall) in the aggregate price level, which is a nominal variable. Monetarists contend that following an increase in the money supply, there can be a portfolio adjustment involving a movement out of money directly into goods and services or assets. It is, therefore, not correct to say that the quantity theory is outworn or has outlived its utility. Modern QTM refers to Friedman’s reformulation or restatement of the earlier simple or crude QTM (or Friedman’s QTM), first pre­sented by him in his well-known article, “Quantity Theory of Money— A Restatement” (Friedman, 1956), repeated in Friedman (1968 b). In other words, monetarists do not accept the Keynesian view of the adjustment process that increased money supply will lead to increased spending only indirectly by changing interest rates or by changing yields on financial assets or profitability of acquiring real assets. If the rate of interest on equities is re i.e., £1 of equities can be expected to yield annually the sum of £ re if prices are stable, the nominal rate of return is affected both by changes in this rate of interest and by changes in the price level. The more elastic the aggregate supply curve is, .the greater will be the increase in Y and the lesser will be the rise in P. Thus, in the short run, if the economy has unutilised resources and excess production capacity, as is found in times of recession, an increase in M will stimulate production and at the same time raise the price level. Disclaimer Copyright, Share Your Knowledge Keynesian argue that aggregate demand is much more stable than velocity, that is, multiplier is more stable than the velocity of money. However, the most important is the inclusion of the variable 1/p dp/dt as showing the expected price level change of one unit of wealth (say one dollar). His greatest contribution lies in accepting variations in velocity as consistent with the quantity theory. The Monetarists Propositions The 4 Main Propositions and their Implications The Reformulation of the Quantity Theory of Money Money and the Early Keynesians Friedman’s Restatement of the Quantity Theory of Money Friedman’s Monetarist Position Fiscal and Monetary Policy The Monetarists Position Contrast with Keynes Unstable Velocity and the Declining Policy Influence of Monetarism This branch of work contains a coherent theoretical criticism of Neo-Keynesian economics as represented by the IS/LM model. M.Friedman stated: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. Friedman asserted that events of 1930s had been wrongly assessed and did not in fact offer evidence against the quantity theory of money. 1. Its theoretical significance lies in the conceptual integration of wealth and income as influences on behaviour. Friedman’s basic money demand equation is presented as follows: where P is the price level, Y is the level of real income, rb is the rate of interest on bonds, re is the rate of return on equity shares and rd is the rate of return on consumer durables. According to monetarists the central bank should follow a rule of constant growth of the money supply. Milton Friedman created the theory of monetarism in his 1967 address to the American Economic Association. This leads both households and firms to adjust both financial and real asset holdings until the desired composition of asset holdings are achieved. The other direction in which the emphasis on money as an asset has led to is towards the development of a theory of the demand for money along the same lines as the theory of the demand for other assets and for commodities and services. The product of P and Y in equation (3) is nominal income and this is the primary determinant of the demand for money Md increases when PY increases. It … Essentially, they argue that there is a direct link between money and the level of economic activities (GNP). Friedman’s k-percent rule All unemployed factors are homogeneous, perfectly divisible and interchangeable. The end result need not be a change in interest rates at all; it may be a change in the general price level or in output. They hold that the proportion of national output over which people wish to keep command in money form is constant. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. Fiscalist argue that tangible real investment is highly interest inelastic so that IS schedule is highly interest inelastic. (iv) A rate of increase in the price level. Milton Friedman (/ ˈ f r iː d m ən /; July 31, 1912 – November 16, 2006) was an American economist who received the 1976 Nobel Memorial Prize in Economic Sciences for his research on consumption analysis, monetary history and theory and the complexity of stabilization policy. He begins from the broad concepts of wealth as comprising all sources of income, including human beings and relates the demand for money to total wealth and the expected future streams of money income obtainable by holding wealth in alternative form. The quantity theory of money approach 4. Money will be traded or substituted for financial assets and this process of trading or substituting money for other financial assets will be carried to the point, at which owners find no advantage in further trading or substitution of this kind. If the price level falls, money appreciates and shows a capital gain in real terms which must be added to the nominal yield, while in the more common condition of rising prices a real capital loss has to be deducted from the nominal yield. In his earlier years after graduation, Friedman gained much experience as a research economist. Reprinted in Friedman, 1969. Why Does Monetarism Matter? Nevertheless, it is also obvious that we cannot dismiss the money supply and other financial factors as unimportant in the determination of economic activity; rather it is to be understood that interest rates and the supply of credit may have a considerable impact on economic activity and that the monetary authorities have the ability to control these variables. 4, pp. However, the new approach emphasizes money as an asset that can be compared with other assets—it lays emphasis on the ‘portfolio’ analysis. His is a significant contribution in adding these new variables and splitting the old ones. In fact, we need not give to the money supply any special significance in the financial mechanism, we need not attribute to it any special direct causal influence on economic activity, and we need not believe that the monetary authorities adopt any very simple mechanism for its control. In Part IV … Before explaining the quantity theory of money, the term monetarism should be explained. It is probably fair to say, that a minimum consensus has been reached—regarding the following: (a) People’s decisions regarding their holding of money as well as other assets should be studied by the application of the general theory of choice—to use Johnson’s phrase. The argument is clear—they contend—control the stock of money and you control the economy—control the stock of money by determining in advance how fast it should increase, and give the monetary authorities a rule to follow. The Keynesian liquidity preference theory can still be defended, to some extent, on the ground that, if unemployment exists, changes in money supply may lead to more spending and expanded output rather than higher prices. If M increases in panel (a), V remaining constant, from MS1 to Ms2, aggregate demand will increase and the aggregate demand curve will shift to the right in panel (b) from AD1 to AD2. Monetarism failed to explain stagflation which occurred immediately after the oil shock of Oct. 1973 when output declined but the rate of inflation increased. Monetarists established a direct causation between M and P. Critics have pointed out just the opposite. Friedman makes use of permanent income Yp—a weighted average of current and past values of income—as an indicator. It came into its own after the desperate attempts of certain monetary economists of Europe and America succeeded in rehabilitating the same. Eight Key Propositions of Monetarism: Now we present eight key propositions of monetarism: 1. So every time the aggregate demand curve shifts to the right, there will be a rise in the price level. Since the supply of money is exogenously fixed by the central bank, the money supply curve is horizontal. Each of these has distinctive characteristics and each offers some return in money or in kind. He regards wealth as a factor that clearly overshadows all other determinants. Money in his analysis is viewed like any other commodity or good which yields some utility through its possession. Friedman states within his academic paper, “The Role of Monetary Policy” that “monetary authorities should guide themselves by magnitudes that they can control, not by ones that they cannot” (Friedman 14), which is why the quantity theory of money and other monetarist concepts are of … In panel (b), we see that since the SRAS Curve is upward sloping, an increase in M will lead to a rise in both real income (Y), measured on the horizontal axis and the price level, measured on the vertical axis. The cornerstone of monetarist theory is the quantity theory of money as restated by Friedman. The argument of the present paper is as follows: in both of the foregoing articles, Friedman presents what he calls a "reformulation of the quantity theory of money." The monetarist theory wins points for historical support; we can find plenty of evidence that deflationary pressures lead to economic downturns. 1 “Quantity Theory of Money” by Milton Friedman In The New Palgrave: A Dictionary of Economics, edited by John Eatwell, Murray Milgate, and Peter Newman, vol. 150 crore. The price level also rises from P1 to P2. However, the agreement, no matter how limited, does not indicate the discovery of truth. London: Macmillan. Milton Friedman has given a new and reformulated model of the quantity theory of money so that it may command greater respectability, as the general approach based on MV = PT fell into disrepute after the crash of 1929. The Keynesian approach finds the relation to be a loose one or one subject to considerable variation over time; the Monetarists, on the other hand, maintain that the relation is fairly close or one subject to only moderate variation over time. (ii) Yp = Money income in Professor Friedman’s permanent sense. 100 crore. Friedman states within his academic paper, “The Role of Monetary Policy” that “monetary authorities should guide themselves by magnitudes that they can control, not by ones that they cannot” (Friedman 14), which is why the quantity theory of money and other monetarist concepts are … Like money, their real return is affected by changes in the price level, but it is also affected by changes in the rate of interest on bonds. In the process of restoring equilibrium these balances will be converted into the real goods and services either directly or through the intermediation of financial institutions. As a result, there will be a decrease in private spending which will just balance the increase in G. The equilibrium level of national income will not change and the fiscal policy, as a result is rendered useless. The supply of money affects the level of current economic activity which is measured by nominal GNP (income). (vi) u = The tastes and preferences of the wealth holding units. Friedman restated the Cambridge version of the QTM.He interpreted k as a traction or proportion of nominal income which people demand or desire to hold in the form of cash balance. These are determined by real factors such as the size and quality of the labour force the stock of capital and the state of technology. Friedman’s demand for money may be rewritten as: In the Cambridge equation k mainly depends on the transactions demand for money. But no further increase in real GNP (income) is possible. The second set of variables that is important is the rates of return on substitute forms of holding money. According to more recent emphasis, money is something more basic than a medium of transactions; it is something which enables people to separate the act of purchase from the act of sale. M. Friedman (1969) The Optimum Quantity of Money and Other Essays. Features of Monetarist Revolution 3. Welcome to EconomicsDiscussion.net! In such a theory, one asks what determines the amount of cash balances that people want to hold. The contribution of the school lies chiefly in making the demand function for money more broad- based. But economists do not find much statistical evidence in support of these propositions or some of the basic hypotheses of -the monetarist school. He includes in wealth various types of tangible capital (like producer and consumer durable goods) and human capital. 100 crore. Quantity Theory of Money. They argue that k and, therefore, V is not stable and as such the monetarist model is subject to much error in prediction. Assuming, in a broad sense, that there is a rate of return on all assets, in that all these assets provide their owners with benefits and further assuming that people are satisfied with their holdings of existing money balances—an increase in the supply of money would cause them to spend their additional money on financial assets. 150 crore. For example, if the level of money national income (Y/P,P) society wishes to hold money balances worth Rs. The following three points may be noted in this context: Statistical (empirical) evidence showed that up to the late 1980s the rate of growth of the money supply and the rate of inflation moved together. Economists who accept the quantity theory of money are usually called monetarists. He said that the antidote to inflation was higher interest rates, which in turn reduces the money supply. 2 Milton Friedman’s Restatement of QTM • According to Friedman, “Inflation is always and everywhere a monetary phenomenon.” • “Money alone Matters” • When Money Supply increases in the economy, there is excess supply o Under the present circumstances, it is not possible to accept that a change in the quantity of money by certain percentage will change the price level in the same proportion, nor can we agree that velocity is a constant in the short-run. They argue that there is a stable and predictable relationship between the amount of money people wish to hold and the level of national output. American economist Milton Friedman is generally regarded as monetarism’s leading exponent. Monetarists do not treat the use of discretionary monetary policy with favour because it is likely to do more harm to the economy than good. Share Your PPT File, Keynes’s Expertise Guide to Inflation and Inflationary Process. Since this process takes place with a considerable lapse of time, therefore, in the short run the ratio of w will be relatively stable. 23.3, where an increase in M leads to rise in aggregate demand from AD1 to AD2 and there is a rise in real GNP from Yf to Ya, where Ya denotes actual output and Yf is full-employment output. According to the monetarists, emphasis should be shifted from the various Keynesian components of aggregate demand (C + I + G) to the demand for money. According to early Keynesians ‘money does not matter’. Thus, one of the great implications of Friedman’s or monetary approach is that because there is a stable relationship between the quantity of money and the level of national income in the long-run, the task of the monetary authority is to let the money supply rise in accordance with the growth rate of GNP. 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