Game of Theories: The Monetarists

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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