Impact of Money Supply on Economic Growth and Price Levels: A Monetarist Perspective
In the realm of macroeconomics, two prominent schools of thought have emerged: Monetarism and Keynesianism. Both approaches seek to understand and influence economic fluctuations, but their perspectives on the causes of these fluctuations and the roles of fiscal and monetary policy differ significantly.
Monetarists, led by figures such as Milton Friedman, emphasize the importance of the money supply as the primary driver of economic activity and inflation. They argue that stable and predictable growth in the money supply leads to stable prices and economic growth. Monetarists typically favour limited government intervention, advocating that markets usually clear and economies are self-correcting when left alone, except for monetary policy interventions to control inflation.
On the other hand, Keynesians, with John Maynard Keynes as their founding father, contend that aggregate demand is the main driver of economic fluctuations. They believe markets do not always clear quickly due to price and wage stickiness, leading to involuntary unemployment and underused resources. Keynesians argue for active government intervention through fiscal policy (public spending and taxation) and monetary policy to manage demand, especially in recessions.
The key differences between these two economic policies lie in their views on the causes of economic fluctuations and the roles of fiscal and monetary policy in influencing aggregate demand, real GDP, inflation, and employment.
| Variable | Monetarist View | Keynesian View | |-------------------|-----------------------------------------------------------|------------------------------------------------------------| | **Aggregate Demand** | Primarily driven by money supply; stable money leads to stable demand. | Driven by consumption, investment, and government spending; unstable without intervention. | | **Real GDP** | Growth influenced by stable money supply growth; short-run fluctuations mostly monetary. | Can be below potential due to insufficient demand; fiscal/monetary policy can stabilize. | | **Inflation** | Mainly caused by excessive money supply growth; controlled by monetary policy. | Result of demand outstripping supply; managed via fiscal and monetary tools. | | **Employment** | Tends toward full employment in long run; unemployment mostly voluntary or frictional. | Price/wage stickiness can cause involuntary unemployment; policy can reduce it. |
Monetarists argue that inflation is not simply a byproduct of a growing economy, but rather a monetary phenomenon. They believe that a high inflationary pressure occurs if the money supply grows faster than aggregate output. In contrast, Keynesians see inflation as a consequence of excessive demand, which can be managed by contracting demand through tighter policies when the economy overheats.
In practice, central banks implement monetary policy to influence the money supply and the availability of credit in the economy. They use several instruments, including policy rates, open market operations, and reserve requirement ratios. Open market operations involve the central bank buying and selling government bonds in the open market. In a contractionary policy, the central bank sells government securities to banks and other investors, reducing the money supply.
Expansionary policies are suitable when the economy is weak or in recession due to a decrease in aggregate demand. Lowering the benchmark interest rate makes borrowing costs cheaper for consumers and businesses, encouraging spending and investment. By lowering the reserve requirement ratio, the central bank allows banks to lend out a larger portion of their deposits, increasing the amount of money available for loans.
New Keynesian models integrate sticky prices and wages and expectations into Keynesian theory, showing that monetary policy can be effective in stabilizing the economy, particularly during downturns. Keynesians highlight the role of expectations affecting consumption and investment, which can amplify economic cycles.
In summary, Monetarists view money supply management as central to stabilizing the economy and inflation control, placing less emphasis on fiscal policy, while Keynesians argue for active fiscal and monetary policies to stabilize aggregate demand, reduce unemployment, and manage inflation, especially in the short run where markets do not adjust instantaneously. Both approaches influence aggregate demand, real GDP, inflation, and employment but differ in their prescriptions for government and central bank roles in the economy.
In the context of business and finance, Monetarists, such as Milton Friedman, argue that the money supply is a primary driver of economic activity and inflation. On the contrary, Keynesians, led by John Maynard Keynes, maintain that aggregate demand is the main driver of economic fluctuations in businesses.
In implementing policy decisions, Monetarists focus on monetary policy interventions to control inflation, while Keynesians advocate for active government intervention through both fiscal and monetary policy to manage demand, particularly in recessions.
