Monetarists- Old School Econ

Monetarists are an old school brand of economists that believe that monetary policy should emphasize the money supply. Monetarists consider the proven formula of MV=PQ (where M is M2 money supply, V is the number of times each dollar is spent on goods and services, P is the CPI and Q is real GDP) as telling of their fundamental principle. They believe that both V and Q are essentially fixed; changes in V (aka how we use our money) are slow and predictable and that in the long run real GDP will also grow at steady pace. With these assumptions, it becomes clear how crucial the money supply is on price level. Changes in M will have a direct impact on P. This interpretation is called the quantity theory of money.

According to monetarists, in the long run, if money supply growth is faster that the growth in potential real GDP (with velocity remaining stagnant) then we will experience inflation. Prices are inflexible in the short term, meaning that it takes time for prices to change (especially for them to decrease), so in the short term M would likely have an effect on Q. This would make monetary policy appear to be effective in countering short term fluctuations in GDP. However, over the long term, as prices eventually change and GDP returns to its potential level, then the rate of change in M will directly affect the rate of change in P. According to this rational, monetary policy might appear to stimulate the economy in the short term, but over a longer period of time the economy will move back towards its potential level with a higher rate of inflation. For this reason, monetarists believe that monetary policy should be avoided. They argue that because of our difficulty in forecasting problems, our inability to measure the money supply (which is ironic considering the flaws in monetarist thinking), and because of the potential political bias to stimulate the economy to lower unemployment than full-employment rates, that we would be better served in not using monetary policy at all. Monetarists prefer a rule for steady continuous growth of the money supply. A