Comparison of fiscalist and monetarist views on the role of money

Abstract

The 1930's saw the rise of the Keynesian Revolution in economics emphasizing discretionary fiscal actions for stabilizing the economy. A counter-revolution has emerged in recent years to challenge the views of the Fiscalists. The proponents of the counter-revolution emphasize the importance of the quantity of money in actions to stabilize the economy. Their spiritual ancestors were the classical economists. Today the proponents of the importance of money are known as Monetarists. The Fiscalists of the 1930's downplayed the role of money contrary to the accepted theory until that time. This paper traces the changes which have occurred in the views of Fiscalists and in the views of the spiritual heirs of the Quantity Theorists, the Monetarists, concerning the role of money in the economy. A Wall Street Journal article of July 20, 1972 discussed the current importance of the Monetarist school in economic thought. At the Federal Reserve Bank of St. Louis, the headquarters of Monetarism in government, there is a motto and a symbol of the Monetarists. The motto is "Under this sign we conquer." Underneath it is the symbol of the classical equation of exchange: MV = Py, which is the summary of the quantity theory of money of the Classicists. The Monetarist "counter-revolution" is based on a reconstructed version of the quantity theory. The unique characteristic of the reconstructed quantity theory is that a discrepancy between the demand for real money and supply of nominal money will be eliminated directly by increased or reduced spending which, as a result, changes prices and incomes. From this adjustment process it follows that stabilization actions should involve control of the money supply. Inflation is the result of an over-supply of nominal money assuming the demand for money to be relatively stable, and any framework for stability in an economy must be built around controlling the growth of the money supply. This paper shows that the transmission mechanism from monetary impulses to economic activity is the key element leading to differences between the two schools of thought. Fiscalists do not subscribe to the theoretical underpinnings of the quantity theory. As a result monetary policy is not seen as being as powerful as fiscal policy. Fiscal measures are seen as having a direct income and spending effect while the effects of changes in money supply are indirect. The transmission mechanism from monetary impulses to economic activity is via raising or lowering interest rates which then causes portfolio, wealth, and credit availability effects. These effects influence investment spending which in turn affects income. This adjustment process leads to the conclusion that stabilization actions involving money must be concerned with interest rates or money-market conditions. The money supply becomes secondary. Inflation is not caused by money if the economy is at less than full-employment. A framework for economic stability must build its main weapons around fiscal measures. The paper examines the theoretical background and framework for each school. Then noting the theoretical differences as well as assumptions to make their models determinate, the paper proceeds to the issues that are logical consequences of their thinking. Thus the paper develops a comparison and contrast of the ideas of Fiscalists and Monetarists showing the debate as it stands presently.