Monetarism as the revival of the quantity theory of money

The monetarist theory is the Milton Friedman’s reworking of the traditional quantity theory of money, in conflict with the Keynesian economics. Friedman interprets the quantity theory as a theory of demand for money. Friedman asserted that the money demand function is a stable function founded on a stable velocity of money circulation which he renamed the monetary multiplier. He suggested also that consumption depends on permanent income (incomes received in past years besides that of the current year), the propensity to consume calculated on permanent income. Moreover, current income always contains a transitory component which is random and variable. Therefore, the propensity to consume and the Keynesian multiplier are not only low but change markedly in response to changes in income-level. He concluded that impulses from fiscal policy, through the Keynesian multiplier, are less effective than monetary stimuli. The crowding-out thesis comes to reinforce these assertions. Given the money supply, an increase in public spending financed by barrowing will increase the rate of interest, and consequently crowd out private investments, so that aggregate demand will not increase. On the contrary, given public spending, a rise in the money supply will increase incomes, without raising the interest rate. Friedman stated that the influence of the money supply is strong but irregular, the delay occurring between the monetary impulse and the real effects being long and variable. Even though money is able to disturb the real economy, owing to the unpredictable nature of its real effects, nobody would be able to use it as an instrument of discretionary policy. The effects of the monetary policies are supposed to be depending on the short-run expectations errors of agents. In the short-run, there can be a monetary illusion. Given certain inflationary expectations, authorities are able to reduce the level of unemployment only if they increase the money supply in such a way as to generate an inflation rate which is greater than the expected one. Thus the entrepreneurs believe in a reduction in the level wage and increase the demand for labour. The money wage will increase and the workers increase their supply of labour believing that their wage is raised. However, individuals are not fooled for long. When they understand that the prices have risen more than predicted, they will raise their expectations on the inflation rate and will realize that the real wage level is not more than the previous level. The will workers reduce the labour supply and the unemployment level will rise and return to its precedent level. This level, which is called the natural rate of unemployment (when the real variables are at their equilibrium level), cannot be modified at the long-run, by monetary policy. At the short-run the monetary policy can affect the unemployment level by fooling the agents’ expectations but it is without real influence in the long-run. The sole effect of this policy consists in raising the level of inflation.

Date: 2016-01-14; view: 640