DEFINITION: Broadly speaking, modern governments have two levers with which to influence the economy: (1) laws affecting taxation, regulation, and spending (fiscal policy) and (2) control of interest rates and the money supply through the central banking mechanism (monetary policy).
Traditionally, fiscal policy was considered more important than monetary policy. Monetarism is the economic doctrine which holds that monetary policy is just as important as fiscal policy, if not more so.
That is, according to monetarism, government control over the interest rate and the money supply can have a significant influence over national economic output and price levels.
ETYMOLOGY: The word “monetarism” derives from the Latin word moneta, meaning “money.”
USAGE: One of the differences between the earlier neo-classical economic consensus and the later reign of neoliberalism, following the Keynesian interlude of the postwar period, is the rise of monetarism during the latter period.
More specifically, monetarism is closely associated with Milton Friedman and the Chicago school of economics more generally, which came to international prominence in the 1970s.
Friedman basically began life as a supporter of Keynesian economics, then became convinced that the government should focus more on monetary policy than on fiscal policy. This would mean controlling the prime interest rate to fight recessions and the money supply to fight inflation.
One of Friedman’s most famous remarks encapsulates the intellectual case for monetarism in as single sentence:
Inflation is always and everywhere a monetary phenomenon.
Although Friedman did not approve of the Federal Reserve (the US central bank), he felt that, given that the Fed exists, its policy ought to be aimed primarily at keeping the growth of prices in line with the growth in economic output.