Milton's 1956 Restatement of the quantity theory of money states that the general price level of goods and services is directly proportional to the amount of money in circulation. Though it can be argued that the velocity of money cannot in any way be stable, and that for most part in the short run prices are sticky, so the direct relationship between money supply and price level cannot possibly hold, Friedman argued that the demand for money could be described as ‘dependent upon a small number of economic variables.’ As a result, Friedman held the view that when money supply expanded, people would not simply wish to save the extra money – in short, if they were at equilibrium before the increase, they would already hold money balance to suit their requirements, and therefore would have a ‘surplus’ of money. Thus, excess money would be spent within the economy and, in line with the theory behind the aggregate demand, AG would rise. Similarly, if the money spending was reduced, people would want to increase their savings by reducing their spending due to a lack of consumer confidence. In this, Friedman challenged a simplification attributed to Keynes suggesting that ‘money does not matter.’ Simply put, the Monetarists, viewed money as incredibly stable in its velocity, and change in expenditure would, and could only be, the result of a change in the money supply. This came into direct conflict with the Keynesian perspective, which viewed the economy as an incredibly volatile entity. To me at least, perhaps one of the most prevalent factors which led to the rise of monetarism, was the failings of Keynesian economics; whilst Keynesian economists view consumer demand as the pivotal point of the economy, its inability to explain the seemingly contradictory problems of rising unemployment and inflation during the oil shocks of 1973, aroused a lack of confidence in the theory. Here, it was the monetarists who seemed capable of offering a gleaming solution – control the money supply, and inflation will disappear, and the economic playground will be spotless. It was this school of thinking which then gave rise to monetary policy.
Monetary policy, in the immediate post-WWII period, was an attempt to get rid of societal economic subservience to governmental policy and regain sovereignty on the decisions by the central bank. A form of macroeconomic policy that can be laid down by the central bank, monetary policy involves, as the previous discussion suggests, the management of money supply and interest rate – it is the prevailing demand-side economic policy used by the governments in order to achieve macroeconomic objectives such as inflation, consumption, growth and liquidity; by effectively ‘modifying’ the supply of money, (often achieved through altering interest rates or printing more money) monetary policy aims to ‘manage’ the ‘undesirable’ aspects associated with the phenomenon that is the business cycle.
Monetary policy can be categorised as being either expansionary or contractionary, with contractionary policy maintaining short-term interest rates at level higher than the norm, slowing the rate of growth of the money supply, or even decreasing it to combat inflation alongside acting as a support for slow short-term economic growth. contractionary policy can result in increased levels of unemployment and bears a magnanimous impact upon consumers, drastically altering (decreasing) both borrowing and spending by consumers and businesses, which, if implemented with too much enthusiasm (as seen in 1980s Britain) can eventually result an economic downturn. Expansionary policy, on the other hand, occurs when a monetary authority uses its procedures to stimulate the economy. An expansionary policy maintains short-term interest rates at a lower than usual rate or, in contrast to contractionary policy, increases the total supply of money in the economy at an expediated level. Traditionally used to try to reduce unemployment, expansionary policy decreases interest rate in an attempt to try and increase levels of investment and consumer spending, both major components of aggregate demand, in order to increase short term growth. Essentially, by increasing the amount of money in circulation, expansionary monetary policy eradicates competition between rival exchange rates, raising the amount foreign consumers will be able to purchase with their currency within a country practicing expansionary monetarism.
Perhaps one of the most prevalent practitioners of monetarism is former Prime Minister, Margaret Thatcher; her stint as PM saw her ultimately try to ‘control’ the money supply in an attempt to control inflation. Her primary aim in through her monetarism was to ensure the British people believed inflation would fall and so reduce their wage demands. For a period of time, this was actually rather successful, and the previous increases associated with the cost of living fell rapidly in the early 1980s. Whilst inflation hit over 20% by 1980, by 1982 it had subsided to less than 10% and continued until stabilising at around 4% by 1987. However, whether it was Thatcher’s monetarist policies or the Financial Services Act of 1986, which actually led to Britain’s great recovery continues to be a source of contentious debate today.
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