In this article we will discuss about the difference in views of monetarists and classical economists on money.
The monetarists trace the origin of their ideas back to the classical and neo-classical predecessors. They base their analysis on the models developed by J.B. Say and Irving Fisher. However, the monetarists do not accept everything what their predecessors have advocated.
The monetarists agree with the classical economists on the following points:
(i) Both believe in the self-adjusting mechanism of a capitalist economy. If left alone, free markets will change relative prices in such a way that eventually full-employment equilibrium is restored in the economy.
In this way, disequilibrium shocks are automatically absorbed in the economy by the market forces. The general conclusion is that the government should do nothing to solve economic problems.
(ii) Both maintain the view that monetary policy and fiscal policy cannot affect the level of unemployment in the long run.
(iii) The monetarists accept the less rigid version of the quantity theory of money which assumes that there exists a high positive correlation between money supply changes and changes in the nominal national income in both the short run and the long run. Nominal income is the product of the price level and national output (PY).
(iv) Both agree that increases in the money supply lead to increases in overall spending.
The monetarists do not agree with the classical economists on the following points:
(i) The classical economists hold the view that money does not matter; it is neutral. Because money is merely a medium of exchange, changes in money supply change absolute, and not relative, prices.
Modern monetarists, on the other hand, believe that in the long run, money supply changes affect absolute prices, but in the short run, changes in the money supply can affect relative prices.
(ii) If money supply changes can affect relative prices in the short run, they can cause the unemployment rate to deviate from the natural rate of unemployment. The natural rate of unemployment is the rate which the unemployment level returns after relative prices have been properly adjusted; it depends upon the degree of competition in the markets.
(iii) The monetarists do not agree with the rigid version of the quantity theory of money according to which changes in money supply lead to exactly proportional changes in the price level.