Nobel Prize winner: Friedman part 2 (The modern quantity theory of money (…
Nobel Prize winner: Friedman part 2
The demand for money
Demand for money = demand for cash balances
Determinants of demand for money:
Cost of holding money (interest rate, expected inflation, price level)
The modern quantity theory of money
Older quantity theory of money: velocity is constant
Modern quantity theory of money: demand for money is stable
--> Inflation results from money supply growth
Demand for money stable in the SR. Increase in money supply increases demand for goodsincrease in pricesincrease in demand for money ￼ equilibrium
The cause of the Great Depression
“Monetary policy is responsible for causing the Great Depression
The long-run vertical Philips curve
--> Natural rate of unemployment: when actual rate of inflation = expected rate of inflation
=> Actual U < natural U if actual inflation > expected inflation
The monetary rule
Central banks should abandon its use of discretionary monetary policy and adhere to the monetary rule:
“Increase the money supply annually at a steady rate roughly corresponding to the long-run rate of growth of capacity to avoid the risk of high inflation or recession”
No evidence during 1983-1984 policy of Federal Reserve Bank
--> Model that won Friedman the NP let him down.
Friedman monetary theory
Relation to Chicago School / Classicals:
Limited to no government intervention
Relation to Keynes:
Contrary to Keynes no fiscal policy (to counteract cyclical effects in consumption) but monetary policy according to monetary rule.
We now know that the Philips curve is not stable.
Positive vs normative economics
no one doubts that uncontrolled monetary expansion can have devastating economic consequences.
Friedman was most influential critic of Keynes
His policy recommendations have had a strong influence on policymakers in many countries, particularly during the last quarter of the 20th century.