Abstract

A Monetarist Model of the Monetary Process

This paper assesses the Monetarists’ model of money, emphasizing those analytical aspects which differentiate it from the Fiscalists’ monetary model. Although these two models are sometimes categorized in terms of “money matters” or “only money matters”, this mnemonic classification does not highlight the analytical distinctiveness of their respective monetary theories. To obtain a better understanding of the Monetarists’ model we also need to distinguish the money veil of theory and the extremely potent, and highpowered, money of stabilization policy, and between nominal money and the real money stock. The monetary model (Quantity theory) of the Monetarists incorporates a theory of money, prices and interest rates that differs substantially from the liquidity preference analysis of interest rates of the Fiscalists. Monetarists have a monetary theory of the price level, a non-monetary theory of the (real) interest rate, and a theory relating rising (or high) market rates (nominal interest rates) to rising prices: they postulate, following Fisher, a sequence leading from monetary expansion to rising prices and high market rates; they distinguish, therefore, between rising rates and high rates, and between market rates and real (interest) rates; and they rationalize a rise in market rates (relative to real rates) by introducing a price expectation variable in their model to capture the impact of rising prices on nominal interest rates. The Fiscalists, in contrast, have a monetary theory of the interest rate, a non-monetary theory of the price level, and do not distinguish either between rising and high rates or between nominal and real rates: they assume that high (or rising) market rates reflect corresponding changes in real rates; and they associate the variability of market rates with volatility in real rates. The implication concerning the instability of the real economy is, in this sense, related to this particular analytical framework. The Monetarists’ view of fiscal policy ma yalso be somewhat misunderstood, because it is closely tied to the manner in which they calibrate and measure the posture of monetary policy. An action defined by Fiscalists as one of fiscal stimulus may also be defined by Monetarists as one of monetary stimulus, so that clear-cut discriminating tests of the two theories are not readily available. Thus, it is only when movements in the money stock and in the full-employment surplus go in opposite directions - as in 1966 and in 1968 - that we get any real tests of their relative effects. The Monetarist advocacy of stable monetary growth does not necessarily imply that discretionary fiscal policy actions have no short run aggregate demand effects. It is sufficient for Monetarists to argue that the effects of temporary budgetary changes are uncertain, that they have long and variable lags, that they are not superior (and may be inferior) to monetary actions in terms of effectiveness, and that budgetary changes should be instituted primarily for their important allocative effects. The post-1968 experiences, and the discovery that some fiscal effects may also be subject to a lag, should serve to re-open theoretical and policy discussions of the relative roles of Monetary and Fiscal policy in stabilization.