Legal Definitions - monetarism

Monetarism is an economic theory asserting that the total amount of money circulating within an economy is the primary influence on economic activity, including inflation, employment levels, and economic growth. Adherents to this theory believe that by carefully managing the money supply, governments and central banks can effectively stabilize the economy and control inflation.

• Example 1: Central Bank Combating Inflation

  Imagine a country where consumer prices are rising rapidly, indicating high inflation. Following monetarist principles, the nation's central bank decides to significantly increase its benchmark interest rate. This action makes it more expensive for commercial banks to borrow money, which in turn leads to higher interest rates for consumers and businesses taking out loans. The goal is to reduce borrowing and spending, thereby slowing down the overall money supply and curbing inflationary pressures.

  This example illustrates monetarism because the central bank is directly manipulating the money supply (by making borrowing more expensive, thus reducing the amount of money in circulation) with the explicit aim of influencing a key economic outcome: inflation.

• Example 2: Government Stimulus During a Downturn

  Consider a period of economic recession where businesses are struggling, and unemployment is high. A government, influenced by monetarist thinking, might implement policies to inject a large amount of money into the economy. This could involve measures like quantitative easing (where the central bank buys government bonds to increase the money supply) or direct financial aid to citizens and businesses. The expectation is that this increased money supply will stimulate demand, encourage investment, and lead to economic recovery and job creation.

  Here, monetarism is demonstrated by the belief that increasing the money supply through government and central bank actions can directly stimulate economic activity and help lift an economy out of recession.

• Example 3: Explaining Hyperinflation

  In a scenario where a country experiences hyperinflation, with prices skyrocketing daily and its currency rapidly losing value, a monetarist perspective would primarily attribute this crisis to the government excessively printing money to finance its expenditures. This uncontrolled expansion of the money supply, without a corresponding increase in the production of goods and services, floods the economy with currency, causing its value to plummet and prices to soar.

  This situation exemplifies monetarism's core tenet that an excessive increase in the money supply is the fundamental cause of severe inflation, highlighting the direct link between the quantity of money and price stability.