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Chapter 26: Problem 1

What is a monetary rule, as opposed to a monetary policy? What monetary rule would Milton Friedman have liked the Fed to follow? Why has support for a monetary rule of the kind Friedman advocated declined since \(1980 ?\)

Short Answer

Expert verified
A monetary rule is a policy guideline venture that commits the monetary authority to a certain course of action based on set rules, unlike a monetary policy that adjusts according to economic conditions. Milton Friedman favored a constant growth rate rule, conducting monetary policy by increasing the money supply with a fixed percentage each year. The support for this monetary rule has declined since 1980 due to the advancement of technology affecting economic indicators and the prominence of the theory favoring discretionary monetary policies for stabilizing real economic variables.

Step by step solution

01

Understanding Monetary Rule and Monetary Policy

A monetary rule refers to a normative policy guideline venture to regulate the flow of money within a national or global economy. It functions under an established set of rules that commits the monetary authority towards a certain course of action. On the other hand, monetary policy refers to the actions undertaken by a monetary authority, like the Fed, to control the supply of money and interest rates. While the monetary policy may be adjusted regularly according to economic conditions and financial indicators, the monetary rule operates by strict regulations without modifications.
02

Milton Friedman's Monetary Rule

Milton Friedman was a strong supporter of monetary rule over discretionary monetary policy. His preferred rule was a constant growth rate rule, where the money supply would be increased by a fixed percentage annually. This rule was aimed to prevent erratic changes in the money supply, and to reduce unpredictability, enhancing economic stability and growth.
03

Declining Support post-1980 for Friedman's Monetary Rule

The decreasing support for Friedman's monetary rule post-1980 can be reasoned by two factors. Firstly, the advancement of technology and evolution of financial systems made monetary aggregates less reliable indicators of economic conditions. Secondly, increasing acceptance of the theory that monetary policy had a role to play in stabilizing real economic variables, such as unemployment rate and output, led many to favor discretionary monetary policies over hard rules.

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