Demand Management

The development of macro-economic policy during the 1980s owed much to the simplistic appeal of monetarism. The core of the monetarist approach was that inflation was purely a monetary phenomenon. The original monetarist theory as set out by Milton Friedman1 was based on the long-standing ‘quantity theory of money’. and postulated that the rate of inflation depended on the rate of increase in the supply of money in the form of cash and bank credit. Thus if the growth of the money supply were properly controlled, so would be the rate of inflation. This assumption was, however, based on the faulty hypothesis that the correlation between increases in the money supply and rising prices demonstrated that the former was the cause of the latter. As is so often true in such cases, the causal sequence is not nearly so simple. The relationship depended to a large extent on the fact that the banking system is there to supply the credit needed to enable the economy to operate, and when prices rise the supply of money will automatically tend to rise in response. It is true that the availability and cost of credit affect the ease with which prices and wages can be increased, but only through their effect on business conditions, not by any automatic direct link between the quantity of money and prices.