Circular Flow Of Goods And Services In A Free-Enterprise Economy Monetarism in Economics

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Monetarism in Economics

Monetarism is actually a set of views dependent on the perception that the total amount of money in an economy is actually the main determinant of economic development.

Monetarism is directly related to economist Milton Friedman, who, based on the concept of the quantity of cash, argued that the federal government should maintain a relatively constant money supply and increase it slightly each year, primarily to allow the economy to grow organically.

Monetarism is actually an economic idea that says that the source of cash in the economy is actually the main factor in economic development. As the availability of cash in societies increases, the overall need for goods and services increases. Aggregate demand growth really encourages job development, which lowers the rate of unemployment and affects economic development. However, in the long run, growing demand will eventually outstrip supply, leading to imbalances in the markets. Shortages resulting from demand being greater than supply will cause costs to rise, leading to inflation.

Monetary policy, an economic device used in monetarism, is actually used to change interest rates to manage the money supply. When interest rates improve, individuals have a much greater incentive to save than to invest, thus shrinking or reducing the money supply. On the other hand, when interest rates actually go down with an expansionary monetary system in mind, the cost of borrowing goes down, meaning people can borrow more and invest more, boosting the economy.

Due to the inflationary consequences that could be caused by an excessive expansion of the money supply, Milton Friedman, whose work shaped the concept of monetarism, argued that monetary policy should be conducted by focusing on the growth rate of the money supply in order to maintain economic and price stability. In his book A Monetary History of the United States 1867–1960, Friedman proposed a fixed growth rate known as Friedman’s k-percent rule, which recommended that the money supply should grow at a continuous annual rate related to nominal GDP growth, as well as conveyed as a fixed percent per year. With this, the money supply is likely to be moderate, companies will be able to count on changes in the money supply every year and also have a proper strategy, the economy will develop at a constant rate, and inflation will be kept at low levels.

Central to monetarism is actually the quantity theory of money, which states that the money supply multiplied by the rate at which some money is actually spent per year equals nominal spending in the economy.

Monetarist theorists believe that velocity is common, meaning that some of the money supply is actually the main element of economic growth or GDP growth. Economic development is actually a characteristic of economic activity, as well as inflation. If the velocity is indeed predictable and constant, the resulting increase (or perhaps decrease) in money will cause an increase (or perhaps decrease) in the eventual price or quantity of goods and services sold. An increase in the cost level means that the quantity of goods and services sold will continue to be constant, while an increase in the quantity of goods produced means that the typical price level will be fairly constant. Under monetarism, variations in the money supply will affect cost levels above economic and long-term output in the short run. A shift in the money supply will consequently immediately determine employment, output and prices.

The view that velocity is actually regular serves as a bone of contention with Keynesians, who believe that velocity should not be regular since the economy is actually subject and variable due to regular instability. Keynesian economics states that aggregate needs are actually the answer to economic development and also supports some activities by central banks to inject more money into the economy to increase interest rates. As previously reported, this goes against the monetarist idea, arguing that such actions can lead to inflation.

Proponents of monetarism believe that managing the economy through fiscal policy is actually a bad decision. Increased government intervention interferes with the functions of a fully free market economy and can lead to large deficits, enhanced national debt and also higher interest rates, which would ultimately plunge the economy into a state of destabilization.

Monetarism was at its peak in the early 1980s, when economists, investors and governments eagerly jumped on any brand new money supply statistic. Nevertheless, in the many years that followed, monetarism fell out of favor with economists, and the connection between the various methods of inflation and the money supply turned out to be much less pronounced than almost all monetarist theories suggested. Many central banks have now stopped setting monetary targets and have instead adopted strict inflation targets.

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