Search This Blog

Thursday, October 28, 2010

Milton Friedman and Today's Monetary Policy

I wrote on March 3

It seems inconsistent to me that the same people that argue the most that the US economy is headed the way of Europe seem to think inflation is coming soon. I think they forget the quantity theory of money equation from the monetary from their macoeconomics 101 class (or never took it) This is despite the fact that many who think inflation is coming around the corner are arch conservatives and the major advocate of this view in recent history was Milton Friedman. The basic equaltion is this:

 MV= PT (the Fisher Equation)

Each variable denotes the following:
M = Money Supply
V = Velocity of Circulation (the number of times money changes hands)
P = Average Price Level
T = Volume of Transactions of Goods and Services  

.... merely raising the money supply by taking interest rates low is not sufficient to cause inflation.

David Wessel in the wsj has a great piece  which  finds that Friedman, on balance would likely be a supporter of  quantititative easing by the Fed. Wessel reviews several parts of the Freidman "dashboard" (see graphic) and concludes on balance Prof Friedman would have been comfortable with QE2.

On velocity Wessel notes:

He would look at velocity, the number of times a dollar turns over in a given year, to gauge demand for money. "To keep prices stable, the Fed must see to it that the quantity of money changes in such a way to offset movements in velocity and output," he wrote in this newspaper in 2003.
When velocity is stable, the Fed should keep money growth steady. When velocity swings widely, the Fed shouldn't be passive. Velocity rose sharply from 1990 to 1997 and then plummeted; the Fed offset that and kept inflation stable, he said with praise. Velocity has been falling—which means each dollar the Fed prints has less oomph. POINT: For QE.

A recent op ed in Investors Business Daily makes similar points about Friedman and current monetary policy and is even less ambiguous in its conclusions

...were Friedman alive today, he would balk at the notion that the Fed is out of ammunition. He would remind us that in the early-to-mid-1930s, when the economic environment was far worse and short-term interest rates were near the zero bound, monetary policy easily generated a recovery. Therefore, the Fed could do likewise today.Friedman would likely make the case today for more aggressive monetary action. It is time for "Helicopter Ben" to earn his nickname.

No comments: