Editing Inflation (section)

==== Monetarism ====
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{{legend|#0076BA |Inflation}}
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{{legend-line|#1DB100 solid 3px|[[Money supply|M2 money supply]] increases Year/Year}}
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[[File:M2 and Inflation USA.svg|thumb|right|upright=2.4|Inflation and the growth of money supply (M2)]]
{{Further|Monetarism}}

During the 1960s the Keynesian view of inflation and macroeconomic policy altogether were challenged by [[Monetarism|monetarist]] theories, led by [[Milton Friedman]].<ref name=Blanchard/>{{rp|528–529}} Friedman famously stated that ''"Inflation is always and everywhere a monetary phenomenon."''<ref>{{cite book|first1=Milton|last1= Friedman|first2=Anna Jacobson |last2=Schwartz|title=A Monetary History of the United States, 1867–1960|url=https://archive.org/details/monetaryhistoryo00frie|url-access=registration|year=1963|publisher=Princeton University Press}}</ref> He revived the [[quantity theory of money]] by [[Irving Fisher]] and others, making it into a central tenet of monetarist thinking, arguing that the most significant factor influencing inflation or deflation is how fast the [[money supply]] grows or shrinks.<ref name="Lagassé2000">{{cite book |author=Lagassé, Paul |title=The Columbia Encyclopedia |publisher=Columbia University Press |location=New York |year=2000 |chapter=Monetarism |isbn=0-7876-5015-3 |edition=6th |url-access=registration |url=https://archive.org/details/columbiaencyclop00laga }}</ref>

The quantity theory of money, simply stated, says that any change in the amount of money in a system will change the price level. This theory begins with the [[equation of exchange]]:

:<math>MV = PQ,</math>
where
:<math>M</math> is the nominal quantity of money;
:<math>V</math> is the [[velocity of money]] in final expenditures;
:<math>P</math> is the general price level;
:<math>Q</math> is an index of the [[real versus nominal value (economics)|real value]] of final expenditures.

In this formula, the general price level is related to the level of real economic activity (''Q''), the quantity of money (''M'') and the velocity of money (''V''). The formula itself is simply an uncontroversial [[accounting identity]] because the velocity of money (''V'') is defined residually from the equation to be the ratio of final nominal expenditure (<math> PQ </math>) to the quantity of money (''M'').<ref name=Mankiw2002/>{{rp|81–107}}

Monetarists assumed additionally that the velocity of money is unaffected by monetary policy (at least in the long run), that the real value of output is also [[exogenous]] in the long run, its long-run value being determined independently by the productive capacity of the economy, and that money supply is exogenous and can be controlled by the monetary authorities. Under these assumptions, the primary driver of the change in the general price level is changes in the quantity of money.<ref name=Mankiw2002/>{{rp|81–107}} Consequently, monetarists contended that monetary policy, not fiscal policy, was the most potent instrument to influence aggregate demand, real output and eventually inflation. This was contrary to Keynesian thinking which in principle recognized a role for monetary policy, but in practice believed that the effect from interest rate changes to the real economy was slight, making monetary policy an ineffective instrument, preferring fiscal policy.<ref name=Blanchard/>{{rp|528}} Conversely, monetarists considered fiscal policy, or government spending and taxation, as ineffective in controlling inflation.<ref name="Lagassé2000"/>

Friedman also took issue with the traditional Keynesian view concerning the Phillips curve. He, together with [[Edmund Phelps]], contended that the trade-off between inflation and unemployment implied by the Phillips curve was only temporary, but not permanent. If politicians tried to exploit it, it would eventually disappear because higher inflation would over time be built into the economic expectations of households and firms.<ref name=Blanchard/>{{rp|528–529}} This line of thinking led to the concept of [[potential output]] (sometimes called the "natural gross domestic product"), a level of GDP where the economy is stable in the sense that inflation will neither decrease nor increase. This level may itself change over time when institutional or natural constraints change. It corresponds to the Non-Accelerating Inflation Rate of Unemployment, [[NAIRU]], or the "natural" rate of unemployment (sometimes called the "structural" level of unemployment).<ref name=Blanchard/> If GDP exceeds its potential (and unemployment consequently is below the NAIRU), the theory says that inflation will ''accelerate'' as suppliers increase their prices. If GDP falls below its potential level (and unemployment is above the NAIRU), inflation will ''decelerate'' as suppliers attempt to fill excess capacity, cutting prices and undermining inflation.<ref>{{cite journal | last = Coe | first = David T. | title = Nominal Wages. The NAIRU and Wage Flexibility | publisher = Organisation for Economic Co-operation and Development (OECD) | url = http://www.oecd.org/dataoecd/59/19/33917832.pdf | year = 1985 | id = MPRA Paper 114295 | journal = OECD Economic Studies | issue = 5 | pages = 87–126 | s2cid = 18879396 | access-date = February 24, 2010 | archive-date = February 26, 2018 | archive-url = https://web.archive.org/web/20180226211933/http://www.oecd.org/dataoecd/59/19/33917832.pdf | url-status = live }}</ref>