Question

Use the framework of the QTM as we developed it in class to do the following: Explain why Friedman argued that the FED should follow a monetary policy rule and what that rule is, why Friedman argued such a rule might have lessened the impact of the Great Depression and the inflation of the 1970’s.

What are the critical assumptions that Friedman must use to make the QTM work? Based on Friedman’s stated criteria, is it possible to provide a warranted critique of Friedman’s assumptions? Explain either way.

Answer 1

1. Monetarism is a challenge to Keynesian economics where its (Monetarism) theory was followed by the Federal Reserve in 1979 which was found by the economist Milton Friedman during oil shocks.

2. According to this theory the then high rates of inflation were due to the rapid increase in the supply of money and its measure is to control the supply of money to outsource a good policy.

3. Markets work well when they are left to themselves and more government interventions leads to destabilisation of the economy according to him.

4. Quantity theory of money is the foundation to the aforesaid theory. Money markets, mutual funds and some other assets were altered by the people from traditional bank deposits.

5. Monetarists find long-run money growth rule as useful measure and argues that FED should fix rules in monetary policy conduction and they should not discrete in conducting policy as it could make economy worse.