What is the monetary rule of Milton Friedman and why did he propose it?

The monetary rule proposed by Milton Friedman, a renowned economist, is a prescription for the conduct of monetary policy. According to this rule, the central bank should aim to increase the money supply at a constant annual rate, regardless of economic fluctuations. Specifically, Friedman suggested that the money supply should grow at a rate equal to the growth of real GDP, in order to achieve stable prices and avoid inflation or deflation.

Friedman proposed the monetary rule to address several issues. Firstly, he believed that adopting the rule would help stabilize inflation and promote long-term economic growth. By keeping the money supply growth consistent with real GDP growth, central banks can avoid creating inflationary or deflationary pressures in the economy. Secondly, Friedman argued that monetary policy is prone to errors when central banks attempt to "fine-tune" the economy by reacting to short-term economic fluctuations. The monetary rule is designed to reduce the risk of policy errors, as it provides a clear and consistent guideline for central banks to follow. Lastly, the monetary rule is a response to the flaws in Keynesian demand management policies, which called for active government intervention in the economy. Friedman believed that a more predictable monetary policy would reduce uncertainty and promote stability in markets, resulting in better long-term decision-making by businesses and individuals.

In conclusion, the monetary rule of Milton Friedman suggests that central banks should target a constant annual growth of the money supply, in line with the growth of real GDP. The main reasons for Friedman's proposal are: stabilizing inflation and promoting long-term economic growth, reducing the risk of policy errors, and addressing the flaws in active government intervention. By following this rule, central banks can achieve greater predictability and stability in monetary policy, fostering a more stable economic environment.