Monetarism

Monetarism is a theory that explains inflation as the inevitable consequence of an increase in the money supply. It is conventionally explained in terms of the "quantity theory of money" which derives from the identity MV=PT, in which M is money stock, V the velocity with which money circulates, P the average price level and T the number of transactions. An implication of that equation is that if V and T can be assumed constant, an increase in the money supply (normally taken to be cash plus bank deposits) will produce a corresponding increase in the general level of prices. Monetarism is founded upon the contention that for practical purposes, V and T can be assumed constant. Its validity thus depends upon the empirical confirmation of that assumption. An analysis of United States statistics , indicated that price increases had, in fact, followed money supply increases, but with time-lags that were long and variable. Critics argued that this was not conclusive proof, and further statistical tests were attempted to test it against the Keynesian theory that increases in the money supply would not affect the prices of goods because they would be spent on financial assets. The results did not give conclusive support to that alternative explanation, nor to the contention that it could safely be ignored.