Controlling inflation is simple, we simply control the money supply

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“Controlling inflation is simple, we simply control the money supply”. What do you think of this opinion? This opinion expresses the monetarist’s stance, emphasizing the power of the Central Bank policy to control the economy by preserving the stability of the financial markets. This, in effect means maintaining an equilibrium between the supply and demand for money. Money, when used as a technical economic term is defined as: the stock of assets readily available to make transactions. Currency held by people is the asset with the greatest ease of transaction, and it constitutes one measure of money (C). However, there are also a multitude of deposits and bonds that have varying degrees of liquidity. Therefore, there are three further measures of money M1, M2 and M3 which include deposits and bonds depending on what counts as ‘readily available’, for that context. The measure referred to in this discussion will be M1, which is currency plus demandable deposits. This essay starts by explaining the model which forms the basis of the the monetarist’s opinion, which gives it some justification. However, empirical evidence showing disparity between inflation and money supply, hence reducing this view’s credibility. The essay identifies its two major flaws. Firstly, the failure to recognise variation in other factors which influence the supply of money and are beyond the Central Bank’s control, namely, the banks’ and consumers’ behaviour. Secondly, and perhaps more crucially, the assumption that demand for money remains constant is simply too great to be justified. Significant fluctuations in the demand for money do occur, and inflation is affected by both supply and demand of money. Hence, monetary policy does not have full power over inflation. The monetarist’s point of view is the outcome of the quantity theory of money, a model showing the relationship

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