The document summarizes the key ideas of monetarism. It discusses how monetarism reestablished the quantity theory of money and added expectations to the Phillips curve. One of the main monetarist ideas is that changes in the money supply are the predominant factor influencing money income and inflation. The economy is inherently stable unless disturbed by erratic monetary growth, and there is no long-run tradeoff between unemployment and inflation. Monetarism contributed important and lasting ideas to modern macroeconomics.

1. The orthodox
monetarist
school
Presentation in Macroeconomics Class
University of San Carlos, Cebu City
Sept.10. 2016

2. • Karl Brunner coins the phrase “Monetarism”; Brunner
and Alan Meltzer construct the microfoundations of
Monetarism, creating a second “camp.”

3. The quantity theory of money approach

5. Quantity Theory of
Money
• The first stage in the development of orthodox
monetarism can be traced from the mid-1950s to the
mid-1960s, and involved an attempt to re-establish the
quantity theory of money approach to macroeconomic
analysis

9. Friedman’s restatement of QTM
• Friedman avows that the quantity theory is
fundamentally a theory of the demand for money. It is not
a theory of output, or of money income, or of the price
level.
• Friedman regards the amount of real cash balances as a
commodity which is demanded because it yields
services to the person who holds it. Thus money is an
asset or capital good, hence demand for money forms
part of capital or wealth theory.

10. 5 different forms of
wealth
i. Money
ii. Bonds
iii. Equities
iv.Physical goods
v. Human capital

11. • The present discounted value of expected income flows can
be expressed as:
W=y/r
• Where W is the current value of total wealth, y is the total flow
of expected income from the five forms of wealth and r is
interest rate.
• Friedman expands the detail of wealth and returns to indentify the
variety of assets and returns in the potential portfolio:
• where P is the price level, rb is the return on bonds, re is the return
on equities, ra is the return on real assets, w is the ratio of human to
nonhuman wealth (to capture the return on “human wealth”), /r is
total wealth, and u is the “portmanteau variable.”




  u
r
wrrrPfM aeb ;,,,,,

15. An assessment
1. Changes in the money stock are the predominant factor explaining
changes in money income.
2. In the face of a stable demand for money, most of the observed
instability
in the economy could be attributed to fluctuations in the money supply
induced by the monetary authorities.
3. The authorities can control the money supply if they choose to do so
and when that control is exercised the path of money income will be
different from a situation where the money supply is endogenous.
4. The lag between changes in the money stock and changes in money
income is long and variable, so that attempts to use discretionary
monetary policy to fine-tune the economy could turn out to be
destabilizing.
5. The money supply should be allowed to grow at a fixed rate in line with
the underlying growth of output to ensure long-term price stability.

16. The Expectations-
augmented Phillips
Curve Analysis
second stage in the development of orthodox
monetarism

17. • The direction of the monetarist attack against the
Keynesian demand management policies and policy-
activism changed at the end of the 1960s when
Friedman (1968) augmented the basic Phillips curve with
the expected rate of inflation as an additional variable
determining the rate of change of money wages (Phelps
1967 provided a similar analysis from a nonmonetarist
perspective).

19. Friedman argued that in the long run the Phillip curve is vertical. The vertical
long run Phillips curve is located at the natural rate of unemployment.
The diagram shows that workers believe that the inflation rate is likely to be 5%.
Excess demand may push inflation higher, causing the actual inflation rate to be
9%. Workers expectations of the inflation rate will influence their pay demands.

21.  At 9% inflation, workers are relatively cheaper. Firms will
demand more workers. Demand for labour will crate upward
pressure on wages. Unemployment will reduce from A to B.
 Workers will eventually recognise that the inflation rate is 9%
and will raise their pay demands, causing prices and wages to
converge
 Inflation at the natural rate of unemployment is zero. At this
rate workers may believe that the current rate of inflation will
continue in the immediate future. Government may choose to
intervene in order to lower unemployment below the natural
rate of unemployment. This action may increase aggregate
demand through expansionary policies.

22. • within the orthodox monetarist approach the output–
employment costs associated with monetary contraction
depend upon three main factors:
• first, whether the authorities pursue a rapid or gradual
reduction in the rate of monetary expansion;
• second, the extent of institutional adaptations – for
example, whether or not wage contracts are indexed;
and
• third, the speed with which economic agents adjust their
inflationary expectations downwards.

23. • The development of orthodox monetarism can be
appraised in a positive light, given that it displayed both
theoretical and empirical progress over the period of the
mid-1950s to the early 1970s.
• The reformulation of the quantity theory of money
approach (QTM), the addition of the expectations-
augmented Phillips curve analysis (EAPC), using the
adaptive expectations hypothesis (AEH), and the
incorporation of the monetary approach to the balance of
payments theory and exchange rate determination
(MTBE), generated a large amount of real-world
correspondence and empirical support

24. Summary
1. Changes in the money stock are the predominant, though not the
only, factor explaining changes in money income.
2. The economy is inherently stable, unless disturbed by erratic
monetary growth, and when subjected to some disturbance, will return
fairly rapidly to the neighbourhood of long-run equilibrium at the natural
rate of unemployment.
3. There is no trade-off between unemployment and inflation in the long
run; that is, the long-run Phillips curve is vertical at the natural rate of
unemployment.
4. Inflation and the balance of payments are essentially monetary
phenomena

25. Monetarism has therefore made several important and
lasting contributions to modern macroeconomics.

26. • Thank you.