Monetarism

Core propositions

Mainstream Keynesianism in the 1950s emphasized fiscal policy and downplayed money. In "The Quantity Theory of Money: A Restatement" (1956), Milton Friedman recast the quantity theory as a theory of money demand, arguing that money demand is a stable function of income, interest rates and other variables. If money demand is stable, changes in the money supply translate predictably into changes in nominal income. Karl Brunner (1968) named this position monetarism. Its core propositions are that fluctuations in money growth are the main cause of fluctuations in nominal income; that the effects arrive with long and variable lags; and that in the long run money is neutral, affecting no real variables, so that "inflation is always and everywhere a monetary phenomenon."

Monetary history, rules and the natural rate

Friedman and Anna Schwartz's A Monetary History of the United States, 1867–1960 (1963) showed with extensive data that major US cyclical episodes coincided with swings in the money stock. Most famously, it interpreted the Great Depression as a Great Contraction caused by the Federal Reserve allowing the money stock to fall by about a third amid banking panics. At Friedman's ninetieth birthday, Ben Bernanke (2002) accepted the interpretation: "You're right, we did it." As policy, Friedman (1960) argued that lags and uncertainty make discretionary fine-tuning destabilizing, and proposed the k-percent rule of increasing the money supply at a fixed rate each year. Friedman (1968) and Phelps (1967) also introduced the expectations-augmented Phillips curve, in which the trade-off between unemployment and inflation vanishes in the long run and unemployment returns to its natural rate. The stagflation of the 1970s bore out the prediction and greatly raised monetarism's influence.

Policy experiments, limits and legacy

In 1979 Paul Volcker's Federal Reserve and Margaret Thatcher's government in Britain adopted money-supply targets and brought inflation down sharply at the cost of high interest rates and recession. Financial innovation, however, made velocity and money demand unstable, unsettling the link between money and income. Charles Goodhart (1975) observed that any statistical regularity breaks down once it is used as a control target, Goodhart's law, and Poole (1970) showed that interest-rate targets perform better when money-demand shocks are large. By the mid-1980s central banks had abandoned money targets in favor of interest-rate operating targets (Laidler, 1981). Monetarism's legacy is nonetheless large. The view that inflation is the responsibility of monetary policy, the importance of rules and credibility (Kydland and Prescott, 1977) and the denial of a long-run trade-off carried over into the Taylor rule, inflation targeting and the new neoclassical synthesis (Goodfriend and King, 1997).

FAQ

What is monetarism in simple terms?

It is the view that the amount of money in the economy is the main driver of the business cycle and prices, so a central bank should follow a rule of growing the money supply at a steady pace rather than acting on case-by-case judgment.

Is monetarism still used today?

Directly targeting the money supply was largely abandoned after the 1980s, but the ideas that inflation is the central bank's responsibility and that rules and credibility matter live on in today's inflation targeting.

Sources reviewed: 2026-10-26

References

1. Friedman, M. (1956). The quantity theory of money: A restatement. In M. Friedman (Ed.), Studies in the Quantity Theory of Money (pp. 3–21). Chicago: University of Chicago Press.
2. Friedman, M., & Schwartz, A. J. (1963). A Monetary History of the United States, 1867–1960. Princeton: Princeton University Press.
3. Friedman, M. (1968). The role of monetary policy. American Economic Review, 58(1), 1–17.
4. Phelps, E. S. (1967). Phillips curves, expectations of inflation and optimal unemployment over time. Economica, 34(135), 254–281.
5. Brunner, K. (1968). The role of money and monetary policy. Federal Reserve Bank of St. Louis Review, 50(7), 9–24.
6. Friedman, M. (1960). A Program for Monetary Stability. New York: Fordham University Press.
7. Laidler, D. (1981). Monetarism: An interpretation and an assessment. Economic Journal, 91(361), 1–28.
8. Goodhart, C. A. E. (1975). Problems of monetary management: The U.K. experience. Papers in Monetary Economics (Vol. 1). Sydney: Reserve Bank of Australia.
9. Poole, W. (1970). Optimal choice of monetary policy instruments in a simple stochastic macro model. Quarterly Journal of Economics, 84(2), 197–216.
10. Kydland, F. E., & Prescott, E. C. (1977). Rules rather than discretion: The inconsistency of optimal plans. Journal of Political Economy, 85(3), 473–491.
11. Bernanke, B. S. (2002). On Milton Friedman's ninetieth birthday. Remarks at the Conference to Honor Milton Friedman, University of Chicago, November 8.
12. Nelson, E. (2020). Milton Friedman and Economic Debate in the United States, 1932–1972 (2 vols.). Chicago: University of Chicago Press.
13. Goodfriend, M., & King, R. G. (1997). The new neoclassical synthesis and the role of monetary policy. NBER Macroeconomics Annual, 12, 231–283.