Impact of Money Supply on Economic Growth and Inflation: A Monetarist Perspective
In the realm of macroeconomics, two distinct schools of thought have emerged, each offering a unique perspective on how to manage a nation's economy. These are Monetarism and Keynesian Economics, named after their founding fathers, John Maynard Keynes and the Monetarists.
Monetarism, a school of thought championed by economists like Milton Friedman, emphasizes the role of the money supply as the primary driver of economic activity. According to Monetarists, controlling the quantity of money in circulation is the key to ensuring economic stability and controlling inflation. They argue that fluctuations in aggregate demand result primarily from changes in money supply rather than fiscal policy.
On the other hand, Keynesian Economics, based on the ideas of John Maynard Keynes, holds that prices and wages are sticky in the short run, meaning they adjust slowly to changes in aggregate demand. This stickiness causes fluctuations in output and employment when demand shifts. Keynesians argue that fiscal policy (government spending and taxation) and monetary policy (influencing interest rates) can be used actively to manage aggregate demand and stabilize the economy.
In terms of aggregate demand, Keynesians use fiscal and monetary policy actively to shift demand, while Monetarists focus on steady control of the money supply to stabilize aggregate demand indirectly. This difference in approach leads to distinct outcomes in real GDP, inflation, and employment.
Keynesians aim to boost GDP during downturns via demand stimulus, while Monetarists emphasize stable growth via money supply control. Keynesians expect inflation to rise if demand outpaces supply (short-run trade-off with unemployment), while Monetarists see inflation mainly as a monetary phenomenon controlled by the money supply. Keynesians accept active policies to reduce unemployment by raising demand, while Monetarists generally see employment determined by real factors in the long run and focus on stable monetary conditions.
Monetarists also believe that high inflationary pressure occurs if the money supply grows faster than aggregate output. They argue that inflation is a monetary phenomenon that can be directly influenced by controlling the money supply. They advocate for limited government intervention and predictable, steady growth of the money supply to avoid inflation or deflation.
The central bank, responsible for implementing monetary policy, carries out its duties using several instruments, including policy rates, open market operations, and reserve requirement ratios. Open market operations, for instance, involve the sale or purchase of government securities, which can pull or inject money out of circulation, respectively, affecting the money supply and the availability of credit in the economy. Lowering the reserve requirement ratio allows banks to lend out a larger portion of their deposits, increasing the money supply and stimulating economic growth, while increasing the reserve requirement ratio makes banks more cautious about lending, leading to tighter liquidity and potentially pushing interest rates up even further.
In contrast, Keynesian economics supports active government and monetary intervention to manage aggregate demand and smooth economic cycles, especially in the short run, due to wage and price stickiness. This approach involves using fiscal policy (government spending and taxation) and monetary policy (influencing interest rates) to change real GDP and employment by shifting demand directly, with some short-run price and wage rigidities causing output fluctuations.
In essence, Monetarism prioritizes controlling money supply growth to achieve long-run stability in inflation and output, with less emphasis on fiscal policy and short-run demand management. Keynesian economics, on the other hand, supports active government and monetary intervention to manage aggregate demand and smooth economic cycles, especially in the short run, due to wage and price stickiness. Both schools of thought are important in influencing aggregate demand, and their implications for economic policy continue to be debated among economists.
The approach of Monetarism, as advocated by economists like Milton Friedman, primarily focuses on controlling the money supply as a means to ensure economic stability and manage inflation, contrasting with the active utilization of fiscal and monetary policy by Keynesians to shift and manage aggregate demand.
In the realm of business, Monetarists prioritize steady growth and inflation control through money supply regulation, while Keynesians implement active fiscal and monetary strategies to boost GDP in economic downturns and stabilize employment levels.
