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Definition of 'Monetarism'

Monetarism is a school of economic thought that holds that the money supply is the main determinant of economic activity. In other words, if the money supply is growing, the economy will grow, and if money-supply growth is accelerating, so will economic growth. Monetarism's leading advocate is the economist Milton Friedman.

Central to monetarism is the equation MV = PQ. M is the money supply; V is velocity -- the number of times per year the average dollar is spent; P is prices of goods and services; and Q is quantity of goods and services. The equation suggests that if V is constant and M is increasing, there must be an increase in either Q or P. Accordingly, monetary policymakers can control inflation by allowing the money supply (M) to grow no faster than the desired rate of economic growth (Q).

From 1979 to 1982, U.S. monetary policy focused on achieving a certain rate of M1 money supply growth. If money supply growth outpaced the target rate, the Fed would raise the fed funds rate to curb it.

The Fed stopped targeting money supply growth and reverted to targeting the fed funds rate because the development of new types of financial products complicated measurement of the money supply.

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