Monetarism
An economic theory holding that money supply growth is the primary determinant of inflation and nominal economic output.
What is Monetarism?
Monetarism is a school of macroeconomic thought asserting that changes in the money supply are the most important driver of nominal GDP growth and the price level over the medium to long run, and that excessive money supply growth is the root cause of inflation. Associated primarily with Nobel laureate Milton Friedman and the University of Chicago's 'Chicago School,' monetarism holds that monetary policy operates with long and variable lags, making activist fine-tuning of the business cycle counterproductive and prone to error. Friedman's prescription—the 'k-percent rule'—called for the central bank to grow the money supply at a constant, predictable rate matching long-run potential GDP growth, rather than discretionary stimulus. Monetarism's emphasis on money supply targets was dominant in central bank policy during the late 1970s and early 1980s but gave way to inflation targeting frameworks as the empirical link between money supply and prices weakened.
Example
Between October 1979 and summer 1982, Federal Reserve Chairman Paul Volcker applied monetarist principles by shifting the Fed's operating target from the federal funds rate to M1 money supply growth, allowing interest rates to float freely. The federal funds rate rose above 20% in mid-1981 as the Fed tightened M1 growth. The resulting back-to-back recessions of 1980 and 1981–1982 drove unemployment to nearly 11%, but successfully broke the entrenched 1970s inflation—validating the monetarist prescription that inflation is always a monetary phenomenon.