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- [Tyler] Monetarism is another framework
for thinking about business cycles.
Nobel laureate Milton Friedman of the University of Chicago,
he was the most famous proponent of monetarism.
And, as the name suggests, monetarism emphasizes
the importance of the money supply,
and it emphasizes the decisions central banks make
about what to do with the money supply.
Now monetarism is based on something called
the quantity theory of money.
That means, in the long run,
the absolute amount of money in an economy doesn't matter,
doesn't influence real output or real employment.
But, in the short run, changes in the rate of inflation can matter.
So there are two potential dangers in monetarism:
too much inflation, and too little inflation.
Let's think first about too much inflation,
because this is a big part
about how monetarism became more popular.
In the 1970s, in America,
rates of inflation were considered to be too high,
and monetarism had a way to explain this.
It said the Federal Reserve was creating
too much new money for the economy,
and that means prices will be rising
and inflation tends to distort
the allocation of economic resources.
Individuals cannot tell which prices are going up
because of the inflation,
and which prices are going up
because something is more or less valuable,
and that what we should do is lower the rate of inflation
and bring about more economic stability.
So, at the time, a lot of Keynesian economists were accepting this higher rate of inflation,
but monetarism was saying that yes, at first more inflation is going to get you higher economic output,
but pretty quickly people figure out that there's inflation going on,
and that inflation ceases to be effective
in stimulating the economy.
On the other side of the ledger,
there's the danger that monetary growth will be too low,
and that means the rate of price inflation will be too low
or there may be deflation all together.
And, in that setting, according to monetarism,
aggregate demand will be too low.
In this case, monetarist and Keynesian doctrine,
they're actually pretty similar.
Monetarists, like Keynesians,
believe that a lot of nominal wages are sticky--
that is they can't be readjusted or renegotiated all the time.
This may be a matter of contract, or a matter of law, minimum wages,
or maybe just a matter of workplace morale.
But when you have sticky wages,
and that flow of nominal purchasing power