IS MONETARISM MAKING A COMEBACK? / PROJECT SYNDICATE

Is Monetarism Making a Comeback?

After decades on the margins of mainstream economic thinking, monetarism is beginning to re-enter the debate, most notably at the Federal Reserve. To regain credibility, however, monetarists must learn from past mistakes and adapt to the monetary and financial realities of the 21st century.

Tim Congdon

LONDON—Once again, many of the world’s leading central bankers have gathered in Jackson Hole, Wyoming, for the annual economic policy symposium hosted by the Federal Reserve Bank of Kansas City. 

This year’s meeting, organized around the theme “Financial Innovation: Implications for Payments and Policy,” will almost certainly focus on the monetary-policy challenges posed by fintech and global payment systems.

By contrast, monetarism and the economic effects of changes in the money supply are likely to receive little, if any, attention. 

That was not the case at the first symposium (then hosted in Kansas City) in 1978. 

Monetarism dominated discussions then and with good reason: inflation was rampant, and Margaret Thatcher was making monetary policy the centerpiece of the campaign that would carry her to 10 Downing Street the following spring.

For economists who continue to believe that the money supply matters, its near-total absence from the Jackson Hole agenda amounts to something close to policy malfeasance. 

After all, consumer-price inflation approached or exceeded 10% in most advanced economies at some point during 2022–23. 

Yet the inflation surge of the early 2020s—which caught most professional economists by surprise—has done little to prompt a reconsideration of the now reflexive dismissal of monetarism. 

Indeed, economists had become so dismissive of monetarism that, at the onset of the COVID-19 pandemic, the prevailing view was that weaker demand would push prices down rather than up.

Prominent scholars have since acknowledged economists’ failure to anticipate the inflationary surge that followed the pandemic lockdowns and other economic distortions. 

A January 2022 commentary by Harvard University’s Jason Furman, for example, described economists’ performance as “dismal.” 

In the years since, however, attempts to explain this “collective error” have largely overlooked the money supply as a possible cause.

Only a handful of economists noticed the rapid growth of the money supply during the spring and summer of 2020, warning that, after the usual lag, inflation would rise sharply. 

The increase was initially most pronounced in the United States, but soon spread across virtually all the world’s major economies in 2020–21.

The Rise and Fall of Monetarism

I was among the small group of economists who identified these inflationary risks and repeatedly warned about them (my writings from the period were collected in my 2025 book, Money and Inflation at the Time of Covid). 

I am widely—and, I believe, correctly—described as a monetarist because of my long-standing interest in the relationship between money and inflation, which dates back more than half a century, to the 1970s, when the concept of monetarism was just breaking into the worlds of policymaking and central banking.

Since the turn of the century, monetarism has fallen so completely out of fashion that it has virtually disappeared from both academia and the institutions that shape economic policymaking, especially central banks. 

But has the latest inflationary surge revived interest in the money supply? 

And could it bring monetarism back from the dead?

Discussions of monetarism often revolve around the reputation of Nobel laureate economist Milton Friedman, widely regarded as the leading figure of the Chicago School of economics. 

A champion of free markets, sound money, limited government, and individual liberty, Friedman was also one of the foremost critics of the Keynesian consensus that dominated postwar economic policymaking, with its emphasis on government intervention and a large public sector.

Friedman was a formidable off-the-cuff debater and an exceptionally influential scholar. 

Such was his authority that, over a career spanning the second half of the 20th century, he came to define the meaning of monetarism in both academia and policymaking.+

This had two unfortunate consequences. 

First, Friedman’s political reputation became closely entwined with perceptions of monetarism. 

Although Friedman regarded himself as a classical liberal, he was often portrayed as a right-wing or even extreme right-wing figure. 

In her 2023 biography, Stanford historian Jennifer Burns described him as “the last conservative.”

As a result, many people hostile to conservatism associated monetarism with politicians and political causes that had little or nothing to do with monetary theory. 

Friedman was lambasted because economists trained at the University of Chicago advised the Chilean dictator Augusto Pinochet, while monetarism was stigmatized in some circles for its association with the social and economic policies of Margaret Thatcher in the United Kingdom and Ronald Reagan in the US.

Second, Friedman’s record as a commentator on contemporary economic developments was mixed. 

No one—not even his strongest critics—questioned his theoretical brilliance or technical grasp of macroeconomics. 

His economic mind was as sharp as his tongue. 

But because he was an active participant in public policy debates, he also made countless recommendations and predictions about social, political, and economic issues. 

Many were controversial, and some proved wrong.

The most significant of Friedman’s forecasting errors came in the early 1980s, at a pivotal moment in the battle against inflation. 

Central banks around the world, led by the US Federal Reserve under Paul Volcker, were deliberately trying to curb the growth of the money supply to defeat the stagflation that had plagued the world economy throughout the previous decade. 

In the US, the Fed’s actions were accompanied by a severe recession, with unemployment nearly doubling to more than 10% by the end of 1982. 

Friedman was reluctant to accept responsibility for the economic pain and distanced himself from Volcker.

Even so, inflation fell sharply. 

In 1982 and 1983, Volcker slashed interest rates, and the US economy recovered. 

Friedman, however, became alarmed as M1—a narrow measure of the money supply that includes only currency and immediately accessible bank deposits—began to rise again. 

In a February 1983 column for Newsweek, he warned that faster M1 growth would lead to a “renewed acceleration of inflation.”

In fact, the opposite occurred. 

By the end of 1986, annual consumer-price inflation had fallen to just 1.1%. 

Friedman later described his error as a “blooper” in correspondence with his former student David Laidler. 

Worse still, he admitted that he could not explain why he had been wrong. 

As Burns recounts, Friedman later told a journalist: “I was wrong, absolutely wrong. 

And I have no good explanation as to why I was wrong.”

For critics of monetarism—and for the much larger number of economists hostile to the Chicago School’s free-market philosophy—Friedman’s blooper was a gift. 

Volcker’s temporary embrace of monetarism may well have been crucial to defeating inflation, but Friedman’s forecasting error gave them the evidence they needed to dismiss monetarism as pseudoscience.

Friedman’s mistake was not the only blow to monetarism’s standing. 

Its reputation suffered further following a series of failed forecasts by monetarist economists, many of them trained at the University of Chicago, in 2009–10. 

Central banks responded to the global financial crisis by dramatically expanding their balance sheets, leading to rapid growth in the monetary base. 

Like Friedman in 1983 and 1984, several Chicago-trained economists predicted rising inflation and currency depreciation. Instead, inflation remained subdued.

How COVID-19 Revived Monetarism

The retreat from monetarism, however, began long before the 2008 financial crisis. 

By the 1990s, central banks had abandoned money-growth targets in favor of inflation targeting, pursued primarily through interest-rate adjustments. 

In effect, the money supply was no longer at the center of mainstream monetary policy.

The pandemic exposed the consequences of this intellectual shift. 

In the summer of 2020, money-supply growth in the US reached its highest level since 1943, when the economy was being mobilized for World War II. 

Yet not a single Fed publication from that period mentioned any measure of the money supply. 

Monetary policy had come to be viewed almost exclusively through the lens of interest rates.

Because the Fed employs more economists than any other institution in the world, it exerts enormous influence over macroeconomic thinking. 

Unsurprisingly, other central banks also paid little attention to the money supply and said almost nothing about the inflationary risks posed by its rapid growth.

As a result, most economists simply failed to notice the surge in the money supply during the pandemic. 

In my book, I argue that the rise of interest-rate-only macroeconomics was a major reason for the forecasting failures of the early 2020s. 

Today’s dominant school of thought—New Keynesianism—is built around a three-equation model in which aggregate demand depends on the central bank’s policy interest rate.

That equation, known as the IS curve and inherited from the IS-LM model popularized by Nobel laureate Paul Samuelson in his influential 1948 textbook, leaves no room for money aggregates. 

In the same vein, New Keynesianism has no explicit role for the banking system and the financial sector in shaping macroeconomic outcomes. 

Often described as the “workhorse” of central-bank economics departments, this framework has damaged macroeconomic analysis and outcomes in the 21st century.

Central banks’ failure to forecast the post-pandemic inflation surge is the latest example, but the global financial crisis of 2007–08 provides another illustration. 

That crisis was, above all, about the solvency of major banks, which was strained by the amount of risk these organizations had taken on relative to their capital resources. 

When these resources proved insufficient to absorb the losses the banks had suffered on so-called “toxic securities,” mounting solvency and liquidity concerns amplified the shock throughout the financial system. 

Yet New Keynesianism’s three equations do not refer to banking-system capital at all.

Monetarism for the 21st Century

But signs of an intellectual shift are beginning to emerge, most notably at the Fed. 

Since becoming chair in May, Kevin Warsh has brought the money supply back into the monetary-policy debate. 

The Fed’s latest semiannual Monetary Policy Report discussed money growth for the first time in more than a decade, reflecting Warsh’s willingness to revisit ideas long neglected by central bankers. 

In his subsequent testimony before Congress, he denied being a monetarist but admitted that he was old-fashioned enough to believe that “monetary policy has something to do with money.”

Whether Warsh can overcome the skepticism toward money among the Fed’s more than 400 research economists remains to be seen. 

In their analyses, they have attributed the recent inflation surge to supply-side shocks and the resulting cost increases. 

Almost none has viewed the 2020s as another illustration of Friedman’s famous dictum: “Inflation is always and everywhere a monetary phenomenon.”

Warsh may or may not prove to be a closet monetarist, but the more important question is whether monetarism itself can come back from the grave and regain credibility. 

While the debate has been reopened, monetarists remain a small minority, both in the US and elsewhere, and—rightly or wrongly—are still associated with an unattractive conservative political outlook. 

Moreover, the Fed’s response to the inflation wave of the 2020s is probably more representative of the economics profession than Warsh’s renewed interest in a money-based approach to macroeconomics.

The future of monetarism will largely depend on the outcome of long-standing and often bitter disputes not only between Keynesians and monetarists but also among different schools of monetarist thought. 

The relevant money aggregate must be broadly defined to encompass all money balances. 

Depending on the country, such aggregates are typically labeled M2, M3, or M4.

Broad money does not change when funds are transferred between different types of bank accounts or between cash and deposits. 

By contrast, M1—which by definitions once favored in the US often accounted for less than 30% of the total money supply—can change dramatically when households and firms move funds between checking and savings accounts. 

If excessive money growth causes inflation, as monetarists argue, the relevant measure must be broad money, as it is far more likely to influence the economy than simply reflect it.

Friedman was wrong in the mid-1980s because he based his forecasts on M1, and Chicago-trained monetarists were wrong in 2009–10 because they relied on the monetary base and M1 when warning of imminent inflation and currency debasement. 

For all its shortcomings, broad-money monetarism fared well during the inflationary surge of the 2020s, as both its peak and eventual soft landing in 2022 were strongly correlated with shifts in broad-money growth.

I have described my latest book, without apology, as a manifesto for broad-money monetarism. 

Economics needs a theory that explains not only how changes in the quantity of money affect inflation, but also how banks and their customers create money and how that process influences aggregate demand, real output, and the prices of financial and real assets.

Fifty years after Friedman was awarded the Nobel Prize in Economics, he and his Chicago School colleagues deserve to be recognized for their extraordinary contributions to economic thought. 

But monetarism cannot survive on Friedman’s achievements alone. 

If it is to remain relevant, it must learn from its past shortcomings, develop new ideas, and adapt to the monetary and financial realities of the 21st century.

Tim Congdon is Founder and Chair of the Institute of International Monetary Research.