Question

Discuss Milton Friedman’s views on what monetary policy can and cannot do.

Answer 1

Solution-

Discuss Milton Friedman’s views on what monetary policy can and cannot do.

Friedman discussed what monetary policy cannot do, what it can do, and how monetary policy should be conducted. Regarding what monetary policy cannot do, he noted that it cannot in the long run control real variables such as unemployment and GDP; in the long run it can only control nominal variables, such as the exchange rates, the price level, or monetary aggregates. These insights were not obvious at the time, but they are now part of the conventional wisdom.

Regarding what monetary policy can do, Friedman emphasized three things: First, monetary policy can avoid being a major source of disturbance. It can avoid major mistakes. Second, monetary policy can provide a stable background for the economy, preferably by achieving price stability. Finally, monetary policy can contribute to offsetting major disturbances in the economy that arise from other sources than monetary policy itself.