The Shadow Open Committee (SOMC), which was first founded by Monetarist economists as inflation spiked in the 1970s, celebrated its 50-year anniversary last October. For the monetarists of the 1970s, such as Milton Friedman, inflation is always caused by the money supply increasing too fast. The only way, therefore, to curb inflation is to curb the growth of the money supply, which can be achieved with only minimal effect on output and employment. Friedman’s study of inflation in the U.S. going back nearly 100 years, and his later study of inflation in the U.K., purported to show a close correlation between monetary growth and prices over long periods of time—which in his view proved his theory.
However, monetarism fell out of favor with most central banks during the 1980s and 1990s as inflation pressures eased. One reason was that the growth of money became less reliable in predicting the economy, as the velocity of money proved to not be stable over time as assumed in the monetarist view. At the same time, leading critics of monetarism argued that the relationship between money and prices was far less stable than Friedman suggested. They also questioned Friedman’s argument that a higher stock of money automatically translated into higher prices without impacting output.
When inflation again spiked in 2021, the Fed viewed it as being caused by supply chain shortages that would be temporary. However, the Monetarist members of SOMC argued that the inflation was due to mistakes made by the Fed – specifically believing that in inflation would stay low even as massive stimulus was injected into the economy in response to the Covid-19 pandemic. The Fed responded the same way to the pandemic as the Financial Crises of 2008, even though they were very different types of shocks. The injection of bank reserve during the Financial Crisis did not translate into rapid money supply growth, because banks opted to hold excess reserves rather than extend loans to borrowers. During the pandemic response, however, the monetarists believes that the Fed became to fixated on achieving maximum employment that it completely ignored money supply growth that caused the recent spike in inflation.
Discussion Questions:
1. Explain the main causes of macroeconomic instability, such as unemployment and inflation, according to the monetarist view.
2. Discuss how monetarists and more mainstream economists disagree on the impact of monetary policy on employment and inflation
Sources| Forbes: https://www.forbes.com/sites/nicksargen/2024/10/15/a-monetarist-view-of-where-the-fed-went-wrong-on-inflation; Finance Yahoo: https://finance.yahoo.com/news/myth-money-supply-controls-inflation-103404836.html; Hoover: https://www.hoover.org/sites/default/files/research/docs/22110-bordo-levy.pdf; St Louis Fed: https://www.stlouisfed.org/on-the-economy/2023/may/the-rise-and-fall-of-m2, https://fraser.stlouisfed.org/files/docs/historical/frbclev/econcomm/econcomm_19890115.pdf; Unsplash: Photo by Shutter Speed on Unsplash