The Collapse of monetarism and the irrelevance of the new monetary consensus

Abstract

A common feature of the financial crisis is the destruction of wealth. Yet such episodes also provide important inflection points for societies, and can bring about the destruction of a number of social structures and institutions as well. This article brings into focus a specific casualty of the United States’ current financial crisis: the monetarist school of thought. Brought into the mainstream of academic economics during the 1960s as an alternative to the Keynesian establishment, monetarist theories, most famously championed by Milton Friedman, soon came to dominate both academic and policy circles. Based on the notion that free markets are intrinsically stable, monetarism proposed a direct relationship between money and prices, with money serving as a policy variable. The Central Bank could therefore create or destroy money in order to reach stable prices. When this principal doctrine proved untrue in the United States during the 1980s, other related monetarist doctrines followed, all of which focused on controlling inflation, generally ignoring unemployment and financial instability. As such, monetarism did not foresee the financial crisis of 2007, and currently leaves the worlds’ Central Banks with the dilemma of maintaining monetarist ideology or plunging the world further into crisis. Monetarism now faces irrelevance.