Monetarism
Monetarism is the branch or branch of economic thought that deals with the effects of money on the economy in general. Despite not constituting a school of economic thought as such, monetarism is recognized as a trend that has exerted a great influence on numerous economists. Currently, there is a school of economic thought—the Chicago School of Economics—which is generally credited with dealing with "monetarist" thought, and especially when the term "monetarist" is used, it is understood to refer to the doctrine defended by Milton Friedman and the Chicago School. However, the definition of said expression is more complex among economists.
The (not necessarily problematic) situation that prevents calling monetarism a school is that there are at least two general economic interpretations or models of how the money supply affects other variables, such as prices, output, and employment.. These two approaches can be seen, on the one hand, in the work of Knut Wicksell, and, on the other, in that of Irving Fisher (see below). In addition, monetarism (or versions of it) is present in the work of authors considered representatives of other schools. Since all economists have at least some version of how money affects economic variables, they could all be called "monetarists."
Monetarists generally accept the idea that monetary policy can at least have short-run effects on output (increasing it) and longer-run prices (increasing them).On the other hand, if monetarists simply assert that there is a proportional relationship between the money supply and the general long-run price level, most economics would accept this idea, provided that the long-run period is long enough and other variables—such as the type of financial institutions in existence—were held constant. Consequently, monetarism has been defined as «the tendency that emphasizes the role of the government in controlling the amount of money in circulation. It is the view in monetary economics that variations in the money supply have a great influence on the national product in the short run and on the price level in the long run, and that the objectives of monetary policy are best achieved through control. of the money supply.
Monetarism originated from neoclassical economics and was one of its strands, had great influence on later developments (see below) and became one of the main sources of New Classical economics. However, it is necessary keep in mind that there is not just one approach that can be called monetarist.
Origins
Monetarism has a long tradition in the history of economic thought. There are detailed and highly sophisticated explanations of how an increase in the quantity of money affects prices, and short-run output, in the mid-18th-century writings of the Irish economist Richard Cantillon and the Scottish philosopher and economist David Hume (see Quantity Theory of Money).
However, the origins of modern monetarism can be found in John Stuart Mill's proposal of the general dependence of prices on the quantity of money in circulation, which suggests that the general level of prices is related to the quantity of money. multiplied by its circulation speed.
Stuart Mill himself, although he generally accepts the quantity theory, suggests that what is important or relevant is not so much the physical amount of money in circulation, but credit and purchases (or demand) (Stuart Mill considered that only cash was money as such. The banknotes are promissory notes and, together with other promissory notes—bank or individual, either at sight (or on demand") or term—such as checks, credit "on the books" or on account,etc., constitute credit.): “But now we have found that there are other things, such as bank notes, bills of exchange and checks, which circulate like money, and perform all the functions of money: and the question arises: do these operate? substitutes on prices in the same way as money itself? Does an increase in the quantity of transferable paper tend to increase prices, in the same manner and degree as an increase in the quantity of money...?” There has been a great deal of debate and argument over the question of whether some of these forms of credit and, in particular, whether banknotes should be considered money. The matter is so purely verbal that it is hardly worth raising, and one would have some difficulty in understanding why so much importance is attached to it, if there were not some authorities who believe - still adhering to the doctrine of the infancy of society and political economy - that the quantity of money in comparison with that of commodities determines prices in general, and that it is It is important to show that banknotes and not other forms of credit are money, in order to support the inference that banknotes and not other forms of credit influence prices. It is obvious, however, that prices do not depend on money, but on purchases. Money deposited in a bank and against which no debits are created, or which is debited for purposes other than the purchase of goods, has no effect on prices, in the same way as credit that is not used. Credit used to purchase products affects prices in the same way as money. Money and credit are thus exactly on a par in their effect on prices; and if we choose to classify the banknotes in one way or the other, it is in this sense completely indifferent.
The situation that made Mill's suggestion relevant was that, in the late 19th and early 20th centuries, the old monetary system (based on precious metal coins, mainly gold) was falling into disuse. As well as from the economy itself, they demanded a monetary expansion that the amount of precious metals held by the banks in most countries could not satisfy (although in some, mainly England, there was a great accumulation of the metal).), which, in turn, gave rise to the expansion of "paper circulation". But even in England, with that great accumulation of gold, there was not enough at the beginning of the 20th century to back all of that currency, including paper money, checks, promissory notes, and other forms of "bank money" or "bank money" with gold and silver. outstanding credit. PH Wicksteed (a marginal economist) writing in 1910, describes the situation thus:"The pool of metallic reserves held by all the banks constitutes a very small fraction of the total collective responsibility of the banks to pay for gold on demand,...(each depositor)...therefore, he will be entitled to withdraw the full amount of its balance in gold, and anyone can make it happen, as long as the machinery is running smoothly, but it would be impossible for everyone to do it (at the same time), because the vast majority of property does not exist in the form of [ gold coins] at all, consists of all kinds of goods and obligations, of a value equivalent, in the marginal terms of trade, to the total sum that the public has the theoretical right to extract in gold.Everything exists, however... the total amount of deposits in banks together, represents real property,and all that property is in the possession of the banks at all times, at full amount... The clients' property, represented by their bank balances, is real property and is doing real work,... ( To perceive that) the banking system of England consists of a cunning device to make Golden Sovereigns who exist only as entries in a book do the work of real sovereigns, is a fundamental mistake."(Perceiving that) England's banking system consists of a cunning device to make Golden Sovereigns who exist only as entries in a book do the work of real sovereigns, is a fundamental mistake."(Perceiving that) England's banking system consists of a cunning device to make Golden Sovereigns who exist only as entries in a book do the work of real sovereigns, is a fundamental mistake."
Consequently, paper money began to acquire more and more importance. At the same time, the situation, which has been called chaotic created by the free issuance of notes by private banks, was being replaced with notes issued and backed by the State through the Central Bank. (see also Fractional Reserve System and Banks central).
In that situation two phenomena became apparent. First, the general population accepted the notes without demanding their immediate transformation into precious metals. Second, monetary expansion - especially credit expansion - without real cash backing did not lead to runaway inflation, as feared. At the same time —and at the level of the discipline— the rise of the marginalist school —which happened at that time— implied the abandonment of the classic suggestions about The question of the quantity of money in circulation. This gave rise to doubts about the validity of the "quantity theory" (or at least, the previous interpretations),and certainly demanded exploration and explanation. (A. Leijonhufvud, op. cit) (See also Chartalism). Consequently, a variety of so-called "monetarist" approaches were formulated.
Formulation of the monetarist approach
The monetarists share the conception of classical and neoclassical economics of economic equilibrium; specifically, the proposition that if the money supply matches the demand for liquidity, prices will be stable. They also share the perception of a free market but with the proviso that the government (or monetary authorities) have an obligation to maintain economic stability (however, see "Lerner's Contribution", etc., below). Unlike the rest of the neoclassicists (and marginalists) they do not use methodological individualism: the monetarist interest focuses on aggregates (monetary, demand, etc.).
The basic monetarist idea is to analyze total money demand and money supply together. It is assumed that the economic authorities have the capacity and power to set the nominal money supply (without taking into account the effects of prices) since they control both the amount that is printed or minted as well as the creation of bank money; But individuals and businesses are free to make decisions about how much real cash they want to get plus goods and services.
Thus, the monetarist problem becomes how to establish economic balance or stability, in the absence of an obvious system of regulation of money in circulation (including credit). Specifically, what is the monetary policy that a government must follow in order to obtain and maintain stability and what are the mechanisms that the monetary authority has for that purpose, given that, on the one hand, whether the private banks, at that time, and the State in general can, taking credit into account, issue almost freely and in fact is issuing above the theoretical parity required either by the gold standard or, more recently, any other, and, on the other, since As Stuart Mill observes, no matter what the authority does, if someone wants or finds it convenient to use credit, they will use it. This of course
Support by Wicksell
The suggestions we are interested in from Knut Wicksell are mainly found in his "Geldzins und Güterpreise" (1889 ). In general Wicksell sought to defend the suggestion of the quantity theory. From his point of view, there is a certain amount of money in circulation that keeps prices stable. That quantity is determined by the relationship between the interest rate and the capital gain rate. Note that this suggestion implies that the interest rate is the ultimate determinant of the quantity of money in circulation and, consequently, of prices. This position can be traced to Stuart Mill's attempt to preserve both the quantity theory and the classical dichotomy.
Wicksell's thesis can be summarized as follows: the amount of currency that maintains price stability is what the market naturally demands, and it is the obligation of the banks, in general, and of the state, in particular, to provide it. through the state (Central Bank or equivalent) printing enough money and making it available to the public. It doesn't matter if the state overprints (oversupply), as long as that audience or market only uses what it naturally needs. That condition (that is, that both money supply and demand equalize) will be satisfied if the interest rate is the natural one. If the interest rate at which the bank (or banks) grant loans is not the natural one, there will be either an excess or a shortage of money in circulation and prices will not be in equilibrium.
Wicksell establishes a fundamental difference between the normal rateor natural interest and what can be called banking or financial. The normal or natural rate is the rate at which savings equal investment. In other words, it is that rate of interest on capital that would exist if the economy were in equilibrium and there were not even banks or other financial institutions (indeed, in Wicksell's opinion, even if the loans or investments were not in money but in capital goods). That is, it is equivalent to the rate of profit in a situation of economic equilibrium. But, as is obvious, banks neither pay for deposits nor lend at that rate, which introduces an element of instability. Additionally, the natural rate is not permanent. If banks lend at a lower rate, savings will fall, there will be excess demand and prices will rise. Vice versa,
The above seems to suggest the need to establish what this natural rate is, which, at least in Wicksell's time, was complex (especially since the real conditions are in constant flux). However, Wicksell suggests a practical solution that is simple:"This does not mean that banks must actually determine the natural rate before setting their own interest rates. That would, of course, be impractical and also unnecessary. Since the current price of commodities provides a reliable measure of agreement or disagreement of both rates. The procedure is rather simple: as long as prices remain unchanged, the bank interest rate must remain unchanged. If prices rise, the bank interest rate must rise, and if prices fall, the rate of interest must be lowered and thereafter maintained at that new level until a new change in prices demands a new change in interest in one direction or the other as explained in the texts of a book" ( K. Wickell, op cit).
That is, the monetary authorities should practice what is now called Inflation Targeting.
Since, in fact, the economy (and the population) is growing, that growth is financed by credit or money created out of thin air by financial authorities and banks. As long as that money is loaned out at the same normal interest rate, prices will stay the same.
This general argument came to have great subsequent influence both at a general level in macroeconomic theory and practice and in two schools that are generally considered opposed, constituting, on the one hand, one of the bases of the Austrian theory of the business cycle and, on the other, one of the foundations of Keynesianism.
Later Fisher called the normal or natural rate the real rate and the bank rate the nominal rate.
Fisher famously disputed Wicksell's suggestion that it is the interest rate that determines prices, which has given rise to one of the deepest divisions in the approach to financial problems in macroeconomics (For other aspects and implications of these differences, see ) which culminated in the Two Cambridge Debate. Wicksell's position, already outlined influencing the schools mentioned, Fisher's influenced Milton Friedman, and through him the New Classics. This has led some to suggest the existence of two types of monetarism.
Cambridge Group Contribution
The so-called "Cambridge Group" represents the conceptions of a group of neoclassical economists who belonged to the University of Cambridge —made up mainly of Alfred Marshall, Pigou, John Maynard Keynes when he was young, etc.— in financial matters and, therefore, of considerable importance in monetarism. Its best-known representative on monetary matters is Ralph George Hawtrey.
For the members of the group (and those influenced by it), the function of money is not only to serve as a trade facilitator or medium of exchange, but also as a mechanism for preserving value between transactions. This implies that individuals (including companies, etc.) may find it convenient to hold a certain amount of money as a liquid (monetary) reserve.
The above introduces the so-called Cambridge Equation that formalizes the concept of "propensity to keep money in the pockets" and represents it by the letter k:
{displaystyle M^{textit {d}}={textit {k}}cdot Pcdot Y}
In which,{displaystyle M^{textit {d}}}
Note that in this view the demand for money (quantity of currency) corresponds not so much to interest rates, as Wicksell suggests, but rather to the ratio of total sales volume or trade volume (PY) plus the amount held as reserves. But that reserve amount depends in turn on interest rates. That situation was directly examined by Hawtrey.
Hawtrey's contribution
Hawtrey's central concern, in his many works, was to identify the tools available to monetary authorities. In order to determine these, Hawtrey was one of the first to propose a monetary interpretation of the business cycle, drawing on the work of both the other members of the Cambridge group and Wicksell's, thus serving as a bridge. between those ideas and the later work of Keynes. (Keynes and Hawtrey were friends, despite which they did not share proposals ).
Additionally, he supported what was later called the Treasury View — the suggestion that fiscal policy has no effect on the total amount of economic activity and/or unemployment, even in times of economic recession. He also advanced in 1931 the concept that came to be known as the multiplier effect (or simply "the multiplier"), a coefficient showing the effect of a change in total national investment on the amount of total national income.
His proposal in relation to the cycles can be summarized as follows: The main actors in the economic cycle are the wholesalers or other intermediaries that base their activities on bank credit and therefore are very sensitive to interest rates. Any injection of money that reduces the interest rate induces these intermediaries to increase their inventories; what they do by increasing their indebtedness to the banks and demanding increases in production from companies. But the increase in production takes time, consequently, the money supply is at least momentarily excessive in relation to real income (made up of wages). This leads to increased demand for investment products by investors (who anticipate increased sales), additional demand which, in turn, reduces the inventories of these wholesale intermediaries. Realizing their inventories are running low, those wholesalers will once again demand that companies increase production and borrow the money to do so. But this once again leads to an "excess" of money in circulation, etc. Eventually the banks will reduce the level of their loans – seeing that their liquid reserves are approaching the limit. Wholesalers are forced to reduce their inventories and demand from companies, these reduce production, and the cycle now enters a recessive phase. This may, in Hawtrey's opinion, lead to a dead end: If sales decline faster than wholesalers anticipated, their inventories may rise rather than fall. In that situation, no supply of money, no matter how low the interest rate, it will induce them to go into debt to buy from the producers, consequently the demand falls indefinitely. In Hawtrey's opinion, that was the situation that led to the Great Depression.
The solution that Hawtrey proposed came to be known as Active or Discretionary Monetary Policy.. This is based on the proposal that the monetary authorities should have a proactive attitude, intervening in order to prevent the appearance of situations that could degenerate into crises: "it is much better to constantly regulate credit in such a way that neither of the two vicious circles ( inflation or deflation) can take a serious hold. In practice, an active monetary policy means that the central bank (or monetary authority) must participate in the financial markets (for example, buying or selling foreign currency); varying interest rates and bank reserve requirements, etc. with the intention of modifying both the amount of currency and interest rates in order to maintain stable national income.
Note that the mechanisms that this proposal suggests are exclusively monetary, thus differing from Keynes' later proposal about an active fiscal policy.
Fisher's contribution
The work of Irving Fisher (who has been described as the best economist the US has ever produced ), can be found in his "The Theory of Interest" (1930).
Like Wicksell, Fisher draws on and tries to defend the Quantity Theory (but implicitly abandons the dichotomy). In that defense of the quantity theory, Fisher updates it, introducing the so-called Equation of Exchange, which is usually presented as follows:{displaystyle Mcdot V=Pcdot Q}
in which{displaystyle M,}
For example; PQ is the nominal cost (or price) of everything sold/purchased in a given economy in a given period. Fisher's V is the inverse of the k of the "Cambridge equation".
Fisher argues that the velocity of money is relatively stable. Consequently, assuming equilibrium and full employment, what is fundamental is the amount of money in circulation. If that amount increases, the PQ result will increase. But since Q cannot change unless technical variables change, the only thing that can really change is P, that is, prices. (If there is not full employment, it is possible that an increase in M will lead to an increase in Q).
It follows that changes in prices are due to changes in money in circulation. Conversely, in order to control prices (avoid inflation or deflation), the amount of money in circulation must be controlled. From the above, Fisher proposed a plan to stabilize the currency. However, to understand it, it is necessary to have a more general view of his position.
Fisher began by trying to establish the basis on which the balance is established. From the monetary point of view, this is equivalent to establishing how the situation in which savings equals investment is reached. (Which implies that prices will be stable. Fisher believed, like monetarists generally, that it is price fluctuations that cause crises). Initially, Fisher did not give greater importance in calculating the amount of money in circulation to that which originates in checking accounts (checks, credit cards, etc.), considering that such deposits constitute a stable and smaller fraction of money in circulation. Another way of saying that is that only the total volume of currency printed and/or minted counts for the calculations. After the great crisis of the 1930s, Fisher changed his mind.
Fisher originally suggested that the profit rate (or real interest rate) depends on two factors: society's willingness to save or "postpone consumption" and the "investment opportunity rate" (which depends on the technological levels and natural resources available ). At one extreme, all resources are used to consume in the present. In the other, they are all used to invest (consume in the future). Equilibrium is established at that point at which both tendencies equalize. The real interest rate (or rate of profit) can then be conceived as the prize that individuals demand in order to postpone their consumption. Since each extra unit of present consumption decreases his "profit margin" but so does each additional unit of investment or future consumption,
However, the foregoing does not solve the problem of the expansion of working capital and how to establish, in a practical way, what is the appropriate level of it. Fisher's proposal to achieve this was the abandonment of the gold standard (including the use of precious metal coins) and its replacement with paper money freely exchangeable for gold but at a variable rate in order to maintain the purchasing power of the unit. monetary. For example, if prices vary by 1%, the amount of gold that a monetary unit "buys" would also vary by 1%, in this way, prices would remain stable in relation to the "legal currency".Note that this implies that someone (the State or Government) is responsible for "producing" the gold necessary to maintain that stability. That is, the function of the State is to maintain monetary stability. For example, if the amount of gold in existence increases (producing inflation) the State must reduce the gold that each monetary unit represents (reduce the price of gold). This leads individuals to change their banknotes for gold, reducing the currency and increasing prices, thus reestablishing equilibrium, etc.
After the beginning of the Great Crisis, Fisher extended his theory of interest, adding another factor: the bank credits that originate in the loans of the money deposited in current accounts, which at the same time is available to the owners of the accounts. ; which means that money in circulation expands rapidly (banks “create money out of thin air”). Such excesses of credit lead to excess liquidity that increases prices. In the presence of inflation, individuals demand, in return for their investments, not only the real interest rate but also a fraction that compensates for the loss of purchasing power. of your money. This "nominal interest rate" then equals the real interest rate plus the expected rate of inflation.
For example, assume that the real interest rate (or rate of profit) is 5% and the rate of inflation, say, 3%. Investors will demand approximately 8% return on their investments, in order to obtain not only the expected profit, but also the return on the purchasing power of the sums invested. The effect that the anticipated rate of inflation has on interest rates is known as the Fisher Effect.
The obvious solution, in Fisher's opinion, is to require checking account deposits to be 100% backed: banks could only lend their own money (from the sale of bank shares, etc.) or that in deposit accounts. This would eliminate bank runs but at the same time many of the profits of the banks, which would have to charge for the money kept in checking accounts.
Another effect of the great crisis was the abandonment of the gold standard as a measure of currency value. This required Fisher to modify his active monetary policy proposal. Instead of buying/selling gold, the state should participate in the market for monetary assets (stocks, bonds, etc.), buying such assets if prices fall and selling them if prices rise. In other words, financial assets in the stock market would replace gold.
Note that, through all of the above, the fundamental thing is, unlike Wicksell, the amount of money in circulation, not the interest rate. It is the excess of money, in this view, that leads to an increase in prices and that inflation leads, due to the Fisher effect, to the increase in the nominal or bank interest rate (which eventually affects the real interest rate). or profit). The function of the state, in order to maintain stable prices, is to control money in circulation, both by limiting its printing and by modifying reserve requirements and, in general, with an active participation in the financial markets.
However, mainly due to a prediction generally perceived as seriously wrong, Fisher's contribution fell into obscurity until after World War II, when it was revived through the work of Clark Warburton (who was described as "the first monetarist in the period following World War II ) and who served as a bridge between Fisher's work and Friedman's.
A controversial point is the proposal of some that Keynes was not so much influenced by Wicksell's vision but rather that of Fisher, being consequently, monetarily closer to the group of so-called "quantitative" theories, represented by, among others, Fisher, Milton Friedman and Don Patinkin (This is a complex area. For an introduction, see Roger W. Garrison (1993): Is Milton Friedman a Keynesian?).
Lerner's contribution
The proposals of Abba Lerner, which date back to 1943 and gave rise to the so-called Functional Finance, are too complex to present here more than a general and simplistic summary. Although it is possible to trace many of these suggestions to the proposals of the authors already outlined, they are stated in such a way that they are generally surprising at first glance to non-specialists. From this point of view, Lerner's contribution can be seen as a systematization of previous positions. There is, however, one suggestion that is genuinely revolutionary: the abandonment of the attempt to maintain economic balance (equated as the goal of sound financesof the previous proposals) and its replacement with the proposal that the main objective of state economic policies is to promote growth and development. (note the change of emphasis: from just monetary policy to economic policies ).
Lerner's position can be seen as prefiguring or introducing modern monetary conceptions. A succinct exposition of his proposals could be:
- Any monetary policy or fiscal policy should only be judged in relation to the effects relevant to the main function of the State: promoting economic growth. In relation to this objective, the search for balance is, at most, secondary. Given that the State has the power to issue money, it makes no sense that instead of doing so it either collects taxes or goes into debt. (The functions of these mechanisms are not to finance the State). Additionally, government spending generates income for the private sector, while taxes reduce disposable private income. When government spending exceeds tax revenue (there is a budget deficit), there is a net addition to household and business disposable income. Some of that extra wealth is deposited in banks, that pay interest (see Risk-free rate and Public debt as an instrument of the fixed-income securities market). Thus, the private sector becomes richer by an amount at least equal to the government deficit. that pay interest (see Risk-free rate and Public debt as an instrument of the fixed-income securities market). Thus, the private sector becomes richer by an amount at least equal to the government deficit.
- However, the state cannot force individuals to accept the extra money (and even if it could, such "distribution" would have no other result than inflation). Money can only enter circulation through other mechanisms (for example, the State authorizes banks to reduce their reserves, which means that the level of loans potentially increases). This implies, in Lerner's opinion, that the main tools that the State possesses to achieve its objectives are those mechanisms, and not the printing of money (to which, however, the State must resort without hesitation if it is convenient or necessary). ). In his words: “All important decisions are made when deciding to apply the fiscal instruments... If one of those instruments involves the payment of money...It follows that the state has various mechanisms at its disposal to achieve its goal. Lerner suggests that there are three "pairs" of financial instruments:
- Collection of taxes and fiscal expenses.
- Purchase and sales by the State.
- Loans and fiscal indebtedness.
Note that some of these mechanisms are more appropriate to promote expansion, others to reduce it (when, for example, the economy "overheats" or, in other words, expands too quickly).
Lerner's contribution, although currently considered simplistic, was applied in the United States in the period from the end of World War II to the early 1970s, and has had a great influence on conceptions is generally considered to have been responsible for a shift from the perception of the "need", suggested by earlier monetarists, to maintain a balanced budget to that what really matters is the size of such deficits as a percentage of the GDP, which was used as justification for an alleged tendency in that country to maintain budget deficits(and to increase the amount of dollars in circulation - See United States debt ceiling crisis of 2011).
Some have interpreted the above as suggesting that the State can print unlimitedly. It is necessary to note that functional finance does not suggest permanent deficits or surpluses. Functional finance is not a proposal or policy about permanent financial measures as such, but rather a system or approach that suggests that the proper way to measure or evaluate any proposal is in relation to results, not in relation to some general principle. or some ideal system, etc. Note (graph on the left) that the public debt of the US — the country in which these proposals were applied between 1950-1980 — decreased both in total and as a percentage of GDP in that period.
It has also been suggested that Lerner's proposals are the basis of the so-called monetary stimulus policy or Quantitative Easing that has been used in numerous countries as a consequence of the 2008 Financial Crisis), being, in that sense, generally accepted. However, this perception is not entirely correct. If nothing else, subsequent practice seems to have watered down Lerner's proposal of one in which money printing can be resorted to if necessary in order to finance a fiscal instrument. to one in which it is enough and more than enough to make money available to the public or, more recently, to banks in order to stabilize their reserves, but not to finance demand.
Lerner's suggestions have also had great influence on what is called Modern Monetary Theory (a position that developed from Lerner's work and Chartalism ), both approaches having similar or complementary assumptions.
Friedman's contribution
Milton Friedman's contribution is too vast to offer more than a simplistic point. Friedman is considered the founder of modern monetarism, as exemplified by the Chicago School of Economics, and one of the major influences on economic thought in the second half of the 20th century and even later, through his influence on the New World. classical economics.
Friedman introduced what is generally considered the current (late 20th and early 21st century) conception or interpretation of quantity theory. Friedman can be seen as synthesizing the approach of previous monetarists, drawing primarily on the suggestions of Fisher and Lerner. For example: "What we should be considering and what is being considered is legislation that limits taxes and fiscal spending from year to year to no more than population growth and inflation. I don't think there is a need for that to be in the form of a balanced budget, but (that proposal) could be a way to achieve it. " "Inflation is always and everywhere a monetary phenomenon.""The surest path to a healthy economic recovery is to increase the rate of monetary growth, to change scarce money to easy money...but without going back to hype. That would make much-needed economic and financial reforms much easier to get.
According to Friedman's interpretation of the quantity theory, both the velocity of circulation and the demand for money are, assuming that the economic variables are in their relationships or "natural levels", stable in the short term,reflecting individual or institutional preferences about how much to save or consume. Variations in the quantity of money in circulation then lead to attempts by companies and individuals to maintain those preferences, for example, by getting rid of excess money (which means an increase in demand). But, crucially, a society cannot, as a whole, rid itself of such a monetary surplus, especially if the society is at its natural levels of production and employment. Consequently, prices will increase. A new break-even point will eventually be reached, but that point will be at the new prices. Shortages of circulating will give rise to the opposite process.
Friedman famously exemplified this in his monumental A monetary history of the United States, 1867-1960. In that work Friedman argues that the main cause of the Great Crisis was the restriction that the US monetary authorities would have imposed in 1930 following a relatively long period of expansionary monetary policies.
This gave rise to the perception that the crisis could have been avoided if the US central bank - the Federal Reserve - had expanded the amount of money in circulation, given that money functions as a monetary multiplier Friedman argued, for example in an interview with Peter Jaworski, that "although the Federal Reserve did not cause the 1929 crisis, it did make it worse by reducing the money supply at a time when more liquidity was needed" (which has become the more general theoretical basis for "the monetary stimulus" as implemented). Paul Krugman comments on this: “A central theme of Keynes's General Theory was the impotence of monetary policy under depression-type conditions. But Milton Friedman and Anna Shwartz, in their magisterial monetary history of the US, propose that the Federal Bank could have prevented the Great Depression – a proposal that later, in popular writings, including Friedman himself, transmuted into the proposal that the Federal Bank caused the depression–. Now, what the Bank really controlled was the monetary base –currency plus bank reserves–. As the figure shows, that base actually expanded during the Great Depression, so it's hard to make the case that the Fed caused the depression. But it can be argued that the depression could have been prevented if the Federal Bank had done more—if it had expanded the monetary base more rapidly and done more to bail out troubled banks. and “So, here we are (2008), looking at a crisis reminiscent of the 1930s. And this time the Federal Bank has been spectacularly aggressive about increasing the monetary base…and guess what happens? doesn't seem to be working."
Friedman went on to try to elucidate the role that both economic and monetary forces play in the economy in general and in employment in particular. Friedman suggests that economic equilibrium does not necessarily imply price stability, as previous conceptions assumed, but rather that economic stability depends on anticipated variations that allow maintaining "natural relationships" between the variables. For example, the natural level of unemployment (NAIRU) is the level at which observed inflation equals expected inflation.
Consequently, Friedman proposes the abandonment of monetary policies and their replacement with the monetary rule : The state must increase the amount of money in circulation at a regular and stable annual rate, which Friedman proposes is between 3% and 5% (but which is generally interpreted as corresponding to the rate of economic growth) (note that for Friedman the fundamental thing is that this rate be stable and predictable by the public - see op. cit) Given that this growth rate is not absolutely predictable, and given that the increase if it is, that could give rise to a certain level of inflation, but, to the extent that this inflation is anticipated, the result will not be problematic. The economy will remain "stable."In any case, the monetary rule does not prohibit the use of interest rates in order to control variations in demand within the limits allowed by the rule.
Taylor's contribution
Based on the above, an interest in the development of possible monetary rules has been observed. Of particular interest in this area is the contribution of John B. Taylor.
In 1977, Taylor and Edmund Phelps showed that monetary policy is useful in stabilizing the economy if wages are sticky, even when all workers and firms have rational expectations. This showed that some of the suggestions of Keynesian economics hold under the assumption of rational expectations. This is important because Thomas Sargent and Neil Wallace had argued that rational expectations make macroeconomic policy useless for achieving economic stability. Taylor and Phelps' results showed that Sargent and Wallace's assumption was not fundamentally rational expectations, but perfectly flexible prices.Consequently, Taylor's Temporal Superposition Model of wage contracts became one of the pillars of New Keynesian Economics.
Taylor went on to explore what kind of monetary policy rules are most effective in reducing the Welfare cost of business cycles: should central banks try to control the money supply, the price level, or the interest rate, and in Which changes should these instruments react to: changes in output, unemployment, asset prices, or inflation rates? Taylor showed that there was a trade-off—later called the Taylor curve—between the volatility of inflation and that of output. Taylor proposedA policy that he considers simple and effective: central banks should manipulate short-term interest rates, raising rates to cool the economy when inflation or output growth becomes excessive, and lowering those rates when one of those measures falls too low. This has come to be known as Taylor's Rule.
A key provision of the Taylor rule — sometimes called the Taylor Principle — is that the nominal interest rate must overreact, for example, by increasing more than one percentage point for every one percent increase in inflation. and vice versa, decreasing by more than one point for each point that prices or production declines).
The Taylor rule has become a generally accepted position as the basis for monetary decisions, constituting one of the main aspects to consider in discussions about monetary policies both in the United States and in the European Union.
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