Chapter 17.3, Problem 1R

To determine

To evaluate significance of monetarism, monetarists. monetary rule, inflation targeting and time lags.

Explanation of Solution

Monetarism is an economic line of thought which asserts that the driving force of growth of the economy is the money supply in an economy. As capital becomes more available in the economy, aggregate demand for goods and services rises. A rise in aggregate demand fosters job formation, which decreases the unemployment rate and increases economic development.

A monetarist is an economist who maintains the firm conviction that the supply of money, namely physical currency, savings, and credit, is the primary factor influencing economic demand. Accordingly, the output of the economy, its growth or contraction can be driven by changes in the money supply. The main reason behind this assumption is the effect inflation has on the growth or health of an economy, and the notion that one can regulate the inflation rate by the regulation of money supply.

Monetary rule comprises of the system of drawing up, issuing and enforcing the action plan of a country's central bank, currency board or other competent monetary authority which controls the amount of money in an economy and the channels through which new money is provided. Monetary policy includes managing money supply and rates of interest to achieve macroeconomic goals such as controlling inflation, demand, productivity, and liquidity.

Inflation targeting is a central banking strategy that centers throughout monetary policy adjustment to reach a defined annual inflation rate. The theory of managing inflation is focused on the assumption that the best way to achieve long-term economic growth is to preserve price stability and to achieve price stability by regulating the inflation.

Time lags play an important part in economic policy performance. Interest-rate cuts are expected to take up to 18 months to have their full effect. This suggests that the past few months' rate cuts will not have full effect until mid-2010. The economy may have stabilized from the recession by that point. It's the same for monetary policy, if the government plans to boost spending, e.g. advance budget plans, the fiscal stimulus will also take several months to kick in.

Economics Concept Introduction

Introduction: The money supply, is all the currency and other liquid instruments in the economy of a country. The money supply contains approximately both cash and deposits and can be used just as easily as cash.