Economics - Moneterist Theory

Moneterist theory placed the blame for the Depression on the wrong monetary policy and believed that it was the duty of government to ensure that inflation was controlled by following a strict monetary policy which would restrict the supply of money to an acceptable rate of growth.

Monetarist economics believes that the supply of money, as opposed to other ideas such as taxation, government intervention etc. is the key to understanding and solving all economic policies. The basic idea of Monetarist economics is that increases in the money supply are a necessary and sufficient condition for inflation.

Monetarism has two doctrines based on the belief that changes in the money supply have a substantial effect on aggregate demand but little effect on interest rates. The first holds that if you dropped ten pound notes over England, the local yocals would rush out and spend it thus driving up prices and stimulating aggregate demand. (Aggregate Demand is a fancy way of talking about all the things people in a society need).

Interest rates would only fall a little as a small amount would find its way into savings. This drop in interest rates would encourage further business expansion. Another school of Monetarists holds that an increase in the supply of money has a dramatic impact on interest rates as there is always the possibility that all or most of these notes would be saved. If this happened there would be a dramatic fall in interest rates. Furthermore, cheaper money (lower interest rates) may not always encourage business expansion.

 Much depends on the mood of the nation. Thus it is argued by the opponents of Monetarism that all that happens from expanding the money supply is that interest rates drop, and people hold more cash, without spending it. This implies that the speed with which cash circulates has merely slowed down to offset the extra cash.

The second belief of Monetarists is that any increase in aggregate demand caused by increasing the supply of money will lead to higher prices and not a demand for increased production. This, I think, a too purist view. There will certainly be inflationary price increases but to say that there will be no increase in aggregate demand is possibly an overstatement.

It seems to me that the monetarist policy is the correct one provided that national psychological and psycho/historical factors are taken into account. Because the latter is often forgotten, economists often appear more like theologians than scientists. Monetarists have traditionally been associated with the conservative and capitalist elements in society whereas the Keynesians are associated with state intervention which stems from a distrust of the functioning of the market mechanism.

Both Monetarist and Keynesian models are primarily concerned with the demand/expenditure side of the economy and for a long time both schools believed that inflation and unemployment could not occur simultaneously because the eradication of the one seemed to cause the other.