Re: The Fed

Date: Sat Feb 19 2000 - 15:01:08 MST

On Sat, 19 Feb 2000 12:55:00 -0500 "John Clark" <>
> Years ago I read an article about Milton Friedman (David's father),
> he didn't like
> the Federal Reserve Board, he didn't like its unpredictability and
> he didn't like
> its futile attempts to fine tune the economy and second guess the
> market.
> He suggested the Fed be abolished and the money supply be regulated
> by a
> computer with all its programs made a matter of public record. I
> can't
> remember the details or even where I read it, does anybody know
> anything?
> John K Clark

Milton Friedman, a Nobel Prize-winning economist, is a 'monetarist',
meaning that he believes the rate of overall price inflation tends to be
determined by the difference between the rate of increase of the money
stock (sometimes called money supply), and the rate of increase of the
physical volume of production and provision of services (net of capital
consumption). To put it another way, monetarism says that the overall
price index tends to be in proportion to the ratio of the money stock
divided by the physical volume of goods and services produced per unit of

To give a simple example, suppose there is an economy in which the only
activities are that people raise potatoes and apples, which they buy and
sell amongst themselves for dollars, and that all the potatoes and apples
which are produced are eaten within a short time of when they are
produced. Monetarism would say (in this example) that if potato and
apple production each go up by 10%, and the money stock increases by 15%,
the prices of potatoes and apples will go up by about 5%.

In the 1960s, Friedman put forth the idea that if the Fed tinkers with
the rate of growth of the money supply (money stock, more properly) in a
well-meaning attempt to stabilize the business cycle and promote healthy,
sound economic growth, that policy is likely to result in more economic
instability than if the money supply is simply increased steadily at a
moderate fixed rate, regardless of what the momentary economic conditions
may be. Friedman recommended picking a money supply growth rate between
3% and 5%, and sticking with that as a strict guide for monetary policy.
That way, overall price inflation would be modest, say about 0% to 2%,
assuming that the population grows at 1% per year and the real
productivity of labor grows by 2% per year. Individual prices could of
course vary up and down.

Possible problems with implementing Friedman's recommendation in practice
is that in a credit-based money system the definition of the money stock
is somewhat arbitrary, and the velocity of circulation of money could
change. At any given time, M1, M2, and M3 might each be growing at
different rates. In theory, a free market credit-based money system (no
Fed, no bank reserve requirements) would result in overall average price
stability, due to the natural corrective feedback between market interest
rates and the overall rate of change of prices.

Ron Kean




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