Monetarism

By the early 1950's, Keynesian thinking seemed to rule the day in economics. However, the opposition had not gone away, and had found a powerful new mind to lead in a reformulation of the older economic ideas. Dr. Milton Friedman, of the University of Chicago, was the central figured in the reformulation. In fact, that reformulation was to take decades and the effort of many first-rate minds; but in Friedman's ideas it made a strong beginning. The group that formed around his leadership were called "monetarists."

In particular, the Monetarists and their successors, the New Classical Economists wanted to revive the view that employment is determined by the supply and demand for labor, that is, that the supply and demand for labor are equal. When supply and demand are equal, we say that the market "clears," so we could call this "the Market-Clearing Proposition."

Monetarists saw no need for a new kind of economic theory based on "aggregate demand." They took the view that relative prices and production could be fully explained by the theory of supply and demand, with (perhaps!) a little help from monopoly theory. That left the average price level to be explained, and it was to be explained in terms of the quantity of money. The Great Depression was considered a unique historical event, calling for explanation in terms of unique events rather than in terms of a new kind of economic theory. One important historical event that played a role in the Great Depression was a collapse of the money and banking system -- so that the Great Depression, unique as it might be, could still illustrate the power of changing monetary conditions.

That was the central issue, for the monetarists. The economics of supply and demand didn't leave any role for fiscal policy and aggregate demand at all; accordingly the Monetarists didn't argue against this aspect of Keynesian thinking but just dismissed it as nonsensical. However, it still seemed possible that government policy might influence production by changing the money supply -- by monetary policy.

The Controversy