Business Economics · Recent macroeconomic history

Monetarism and the Neoliberal Turn: Friedman, Thatcher and Reagan

Updated 11 October 2026 · Fact-checked

Monetarism is the view, led by Milton Friedman, that inflation is caused by excessive growth in the money supply and that governments should control money growth by rule. The neoliberal turn of the 1980s paired this with supply-side policies: tax cuts, deregulation, privatisation and weaker unions. Thatcher and Reagan applied them.

Understand Monetarism and the Neoliberal Turn

Start with the problem. In the 1970s, many economies had high inflation and high unemployment together (stagflation). Keynesian demand management had no clear answer. If you boost demand to cut unemployment, inflation rises further. This opened the door to new ideas.

Monetarism was the main new idea. Milton Friedman argued that inflation is always and everywhere a monetary phenomenon. In the long run, faster growth in the money supply raises prices, not output. This links to the quantity theory of money: MV = PT. If V (velocity) and T (output) are fairly stable, then growth in M feeds through to P.

Friedman also challenged the Phillips curve. He and Edmund Phelps argued there is a natural rate of unemployment. Governments can cut unemployment below it only briefly, by surprising people with inflation. Once people adjust their expectations, unemployment returns to the natural rate but inflation stays higher. So the long-run Phillips curve is vertical. Monetarists therefore preferred rules (for example a target for money growth) over discretionary fine-tuning.

The neoliberal turn extended this to the supply side. The view was that long-run growth depends on incentives and efficient markets, not demand management. Policies included lower marginal tax rates, deregulation (for example of financial markets), privatisation of state firms, weaker trade union power, and freer trade and capital flows. Thatcher in the UK (from 1979) and Reagan in the US (from 1981) are the classic examples. Both tightened monetary policy to fight inflation, and both pursued supply-side reform.

Keep the contrast clear. Keynesians stress demand, see wages and prices as sticky, and accept an active role for fiscal policy. Monetarists stress money supply, expect markets to clear in the long run, and favour rules and a limited government role. Be ready to give evaluation too. Inflation did fall in the 1980s, but unemployment rose sharply first, money targets proved hard to hit because velocity was unstable, and inequality widened.

Key rules to remember

Equation of exchange: M × V = P × T; M is money supply, V is velocity of circulation, P is the price level and T is the volume of transactions (often replaced by real output Y). It is an identity. It becomes the quantity theory only if V and T are assumed stable.
Quantity theory (growth form): % change in M + % change in V ≈ % change in P + % change in Y; If V is stable and Y grows at its trend rate, inflation ≈ money growth minus real growth. This is an approximation.
Expectations-augmented Phillips curve: π = πe + f(U − Un); Inflation π depends on expected inflation πe and on the gap between actual unemployment U and the natural rate Un. At U = Un, inflation equals expected inflation, so the long-run curve is vertical.

How to solve Monetarism and the Neoliberal Turn questions

Use this method for any question on monetarism, Friedman, Thatcher, Reagan or the neoliberal turn.

1Identify the command word: describe, explain, compare or evaluate. This sets how much analysis you need.
2Set the context in one or two lines: 1970s stagflation and the perceived failure of Keynesian demand management.
3State the core monetarist argument: inflation comes from money supply growth, MV = PT, natural rate of unemployment, vertical long-run Phillips curve, preference for rules.
4Link to the policy: money supply targets, higher interest rates, reduced budget deficits, plus supply-side measures such as tax cuts, privatisation and deregulation.
5Use the country example asked for. Name the leader and the type of policy, but do not invent figures.
6Contrast with the Keynesian view where relevant: demand focus, sticky prices, active fiscal policy.
7Evaluate: benefits (lower inflation, efficiency) against costs (higher unemployment in the short run, unstable velocity, inequality, financial risk from deregulation).
8Finish with a short conclusion that answers the exact question.

Quickest way: The 4-point Keynes vs Monetarist grid

When to use it: Use for multiple-choice questions and short comparison questions where time is tight.

Cause of inflation: Keynesian says excess demand or cost push; monetarist says excess money growth.
Best tool: Keynesian says fiscal policy and demand management; monetarist says control of money supply by rules.
Labour market: Keynesian allows persistent unemployment; monetarist says unemployment returns to the natural rate.
Government role: Keynesian says active; monetarist and neoliberal say limited, with supply-side reform.
Match the option to the school using these four cues and eliminate the rest.

Common mistakes in Monetarism and the Neoliberal Turn

Saying monetarists believe money supply never affects output.
Students over-simplify the long-run result.
Fix: Say money growth can affect output briefly, but in the long run it mainly affects prices.
Treating MV = PT as proof that money causes inflation.
The equation looks like a law.
Fix: Remember it is an identity. It supports the causal claim only if V and T are stable.
Mixing up demand-side and supply-side policies.
Both are linked with the 1980s and tax cuts.
Fix: Monetarism is about controlling money. Supply-side policy is about raising productive capacity through incentives, deregulation and privatisation. Say how they were combined.
Describing the 1980s turn as a complete success with no costs.
Answers copy the policy aims without evaluating.
Fix: Always add costs: rising unemployment early on, difficulty of money targeting, wider inequality and risks from financial deregulation.
Drawing the long-run Phillips curve as downward sloping.
Students recall only the original short-run curve.
Fix: Draw the long-run curve as vertical at the natural rate of unemployment and the short-run curves shifting with expectations.

Worked examples

Example 1

Explain how monetarists and Keynesians differ in their views on controlling inflation and unemployment. (Written question)

Show the solution

Define the monetarist view: inflation is caused by excess growth in the money supply, as in MV = PT with V and T stable.
On unemployment, monetarists say there is a natural rate. Using demand to push unemployment below it only raises inflation once expectations adjust, so the long-run Phillips curve is vertical.
Policy implication: control money growth by a rule and use supply-side policy to lower the natural rate.
Define the Keynesian view: output and employment depend on aggregate demand, and wages and prices are sticky, so an economy can stay below full employment.
Policy implication: governments should use fiscal policy, and monetary policy where needed, to manage demand.
Conclude: the schools differ on the cause of inflation, the long-run trade-off and the role of government. The 1970s stagflation strengthened the monetarist case.

Answer: Monetarists blame money growth for inflation, accept a natural rate of unemployment and favour rules and supply-side reform. Keynesians stress demand, sticky prices and active demand management.

Example 2

In an economy, velocity is constant, real output grows 3% a year and money supply grows 8% a year. Using the quantity theory, estimate annual inflation, and state one reason the estimate may be wrong.

Show the solution

Use the growth form: % change in M + % change in V ≈ % change in P + % change in Y.
Substitute: 8% + 0% ≈ % change in P + 3%.
Solve: % change in P ≈ 8% − 3% = 5%.
Comment on reliability: velocity is often unstable, for example when financial innovation or deregulation changes how people hold money, so actual inflation may differ.

Answer: Estimated inflation is about 5% a year. It is only approximate because the assumption of constant velocity may fail.

Exam tips

Know the exact link: stagflation, then loss of faith in Keynesian demand management, then monetarism and supply-side policy.
Use the command word. For 'evaluate', give at least one benefit and one cost, then a judgement.
Quote Thatcher and Reagan as examples of policy direction, and avoid specific statistics you cannot verify.
In MCQs, watch for options that attribute Keynesian ideas to Friedman or confuse supply-side with demand-side policy.
If you draw a Phillips curve, label axes, short-run curves and the vertical long-run curve at the natural rate.

Practice questions from Recent macroeconomic history

Monetarism and the Neoliberal Turn: frequently asked questions

What is the main difference between monetarism and Keynesianism?

Monetarists say inflation comes from excess money growth and that markets self-correct in the long run, so governments should follow rules. Keynesians say demand drives output, prices and wages are sticky, and governments should manage demand actively.

What is supply-side economics?

It focuses on raising an economy's productive capacity rather than managing demand. Typical policies are lower tax rates, deregulation, privatisation and labour market reform. Thatcher and Reagan both used such policies.

What does neoliberalism mean in 1980s economic policy?

It means a shift towards free markets and a smaller state role. In practice it covered deregulation, privatisation, lower taxes on income and business, tighter control of inflation, and greater openness to trade and capital flows.

Why did monetary targeting often fail in practice?

Monetarist targeting assumed velocity of money was stable. In the 1980s, financial innovation and deregulation made it unstable, so money growth did not reliably predict inflation. Many central banks later moved to interest rate and inflation targets.