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- [Tyler] Monetarism is[br]another framework

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for thinking about business cycles.

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Nobel laureate Milton Friedman[br]of the University of Chicago,

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he was the most famous proponent[br]of monetarism.

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And, as the name suggests,[br]monetarism emphasizes

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the importance of the money supply,

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and it emphasizes the decisions[br]central banks make

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about what to do[br]with the money supply.

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Now monetarism is based[br]on something called

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the quantity theory of money.

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That means, in the long run,

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the absolute amount of money[br]in an economy doesn't matter,

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doesn't influence real output[br]or real employment.

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But, in the short run, changes[br]in the rate of inflation can matter.

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So there are two potential dangers[br]in monetarism:

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too much inflation,[br]and too little inflation.

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Let's think first[br]about too much inflation,

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because this is a big part

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about how monetarism[br]became more popular.

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In the 1970s, in America,

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rates of inflation were considered[br]to be too high,

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and monetarism had a way[br]to explain this.

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It said the Federal Reserve[br]was creating

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too much new money for the economy,

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and that means prices will be rising

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and inflation tends to distort

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the allocation[br]of economic resources.

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Individuals cannot tell[br]which prices are going up

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because of the inflation,

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and which prices are going up

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because something is[br]more or less valuable,

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and that what we should do[br]is lower the rate of inflation

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and bring about[br]more economic stability.

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So, at the time, a lot of Keynesian economists were accepting this higher rate of inflation,

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but monetarism was saying that yes, at first more inflation is going to get you higher economic output,

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but pretty quickly people figure out[br]that there's inflation going on,

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and that inflation ceases to be effective

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in stimulating the economy.

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On the other side of the ledger,

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there's the danger that[br]monetary growth will be too low,

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and that means the rate[br]of price inflation will be too low

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or there may be deflation all together.

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And, in that setting,[br]according to monetarism,

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aggregate demand will be too low.

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In this case, monetarist[br]and Keynesian doctrine,

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they're actually pretty similar.

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Monetarists, like Keynesians,

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believe that a lot[br]of nominal wages are sticky--

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that is they can't be readjusted[br]or renegotiated all the time.

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This may be a matter of contract,[br]or a matter of law, minimum wages,

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or maybe just a matter[br]of workplace morale.

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But when you have sticky wages,

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and that flow of nominal purchasing power