Friedman's k-percent rule
Encyclopedia
Friedman's k-percent rule is the monetarist proposal that the money supply
should be increased by the central bank
by a constant percentage
rate every year, irrespective of business cycles.
Milton Friedman coauthored a book with Anna Schwartz to summarise a historical analysis of monetary policy, called "Monetary History of the United States 1867-1960". The book attributed inflation to excess money supply generated by a central bank. It attributed deflationary spirals to the reverse effect of a failure of a central bank to support the money supply during a liquidity crunch.Friedman proposed a fixed monetary rule, called Friedman's k-percent rule, where the money supply would be calculated by known macroeconomic and financial factors, targeting a specific level or range of inflation. Under this rule, there would be no leeway for the central reserve bank as money supply increases could be determined "by a computer", and business could anticipate all monetary policy decisions.
"The stock of money [should be] increased at a fixed rate year-in and year-out without any variation in the rate of increase to meet cyclical
needs." (Friedman 1960) Friedman was of the view that the main policy to be avoided is countercyclical
monetary policy, the standard Keynesian policy recommendation at the time. He belived giving governments any flexibility in setting money growth would lead to inflation and therefore, the central bank should follow a procyclical
monetary policy and expand the money supply at a constant rate, equivalent to the rate of growth of real GDP.
Framing the monetary policy is a very complicated and difficult task as balance has to be maintained between different economic variables and a trade off usually has to be made between these economic variables.Policy makers thus often make use of Monetary Rules like the Friedman's k-percent rule
or Taylor rule
etc , to design more effective monetary policies.
are inclined towards using rules rather than discretion. Taylor has said "You do not prevent bailouts by giving the government more power to intervene in a discretionary manner. You prevent bailouts by requiring adequate capital based on simple, enforceable rules and by making it possible for failing firms to go through bankruptcy without causing disruption to the financial system and the economy" indicating a clear preference over rules rather than discretion in monetary policies.
Economists and policy makers strive to formulate monetary policies using Rules but allowing scope for discretion so as to adjust the policies appropriate to the current economic situation so as to make these policies more effective.
The Friedman's k-percent rule
however does not allow any interference from central banks in framing the monetary policy, as Friedman belived that discretion would be counter productive and could lead to increased levels of inflation instead of controling it.The K-percent rule does not allow any discretion in framing of monetary policies and belives in strict adherence to the proposed rule. This has caused many economists to criticise Freidmans k-percent rule.
The k-percent rule is considered as a no feedback rule, which does not allow central banks to alter monetary policy to adjust to current economic situations, thus not being effective in the short run.
It does not help in the short term neither
does it allow central banks to respond to financial and economic turmoils occuring at present in the economy thus totally ignoring the current economic situation.
This is not to be confused with the Friedman Rule
, which is a policy of zero nominal interest rates.
Money supply
In economics, the money supply or money stock, is the total amount of money available in an economy at a specific time. There are several ways to define "money," but standard measures usually include currency in circulation and demand deposits .Money supply data are recorded and published, usually...
should be increased by the central bank
Central bank
A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in a country. Central banks often also oversee the commercial banking system of their respective countries...
by a constant percentage
Percentage
In mathematics, a percentage is a way of expressing a number as a fraction of 100 . It is often denoted using the percent sign, “%”, or the abbreviation “pct”. For example, 45% is equal to 45/100, or 0.45.Percentages are used to express how large/small one quantity is, relative to another quantity...
rate every year, irrespective of business cycles.
Milton Friedman coauthored a book with Anna Schwartz to summarise a historical analysis of monetary policy, called "Monetary History of the United States 1867-1960". The book attributed inflation to excess money supply generated by a central bank. It attributed deflationary spirals to the reverse effect of a failure of a central bank to support the money supply during a liquidity crunch.Friedman proposed a fixed monetary rule, called Friedman's k-percent rule, where the money supply would be calculated by known macroeconomic and financial factors, targeting a specific level or range of inflation. Under this rule, there would be no leeway for the central reserve bank as money supply increases could be determined "by a computer", and business could anticipate all monetary policy decisions.
Definition
According to Milton FriedmanMilton Friedman
Milton Friedman was an American economist, statistician, academic, and author who taught at the University of Chicago for more than three decades...
"The stock of money [should be] increased at a fixed rate year-in and year-out without any variation in the rate of increase to meet cyclical
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...
needs." (Friedman 1960) Friedman was of the view that the main policy to be avoided is countercyclical
Countercyclical
Countercyclical is a term used in economics to describe how an economic quantity is related to economic fluctuations. It is the opposite of procyclical. However, it has more than one meaning.-Meaning in policy making:...
monetary policy, the standard Keynesian policy recommendation at the time. He belived giving governments any flexibility in setting money growth would lead to inflation and therefore, the central bank should follow a procyclical
Procyclical
Procyclical is a term used in economics to describe how an economic quantity is related to economic fluctuations. It is the opposite of countercyclical. However, it has more than one meaning.-Meaning in business cycle theory:...
monetary policy and expand the money supply at a constant rate, equivalent to the rate of growth of real GDP.
Monetary Policy
Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability.The official goals usually include relatively stable prices and low unemployment.Framing the monetary policy is a very complicated and difficult task as balance has to be maintained between different economic variables and a trade off usually has to be made between these economic variables.Policy makers thus often make use of Monetary Rules like the Friedman's k-percent rule
Friedman's k-percent rule
Friedman's k-percent rule is the monetarist proposal that the money supply should be increased by the central bank by a constant percentage rate every year, irrespective of business cycles....
or Taylor rule
Taylor rule
In economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the...
etc , to design more effective monetary policies.
Rules versus Discretion in Monetary Policies
Many economists have argued whether using Rules in framing monetary policies is better than the discretion of the policy maker and vice versa.The Rules vs. Dicretion debate was the mainstream argument of monetary policy framing in the 1960's - 1980's and there is still no single opinion on what is better.However some economists like TaylorTaylor
- People :* Taylor , a Scottish/English surname* Taylor , the given name of a male or female* See also List of people with surname Taylor* Taylor Lautner star of Twilight- Australia :* Electoral district of Taylor, state electoral district...
are inclined towards using rules rather than discretion. Taylor has said "You do not prevent bailouts by giving the government more power to intervene in a discretionary manner. You prevent bailouts by requiring adequate capital based on simple, enforceable rules and by making it possible for failing firms to go through bankruptcy without causing disruption to the financial system and the economy" indicating a clear preference over rules rather than discretion in monetary policies.
Economists and policy makers strive to formulate monetary policies using Rules but allowing scope for discretion so as to adjust the policies appropriate to the current economic situation so as to make these policies more effective.
The Friedman's k-percent rule
Friedman's k-percent rule
Friedman's k-percent rule is the monetarist proposal that the money supply should be increased by the central bank by a constant percentage rate every year, irrespective of business cycles....
however does not allow any interference from central banks in framing the monetary policy, as Friedman belived that discretion would be counter productive and could lead to increased levels of inflation instead of controling it.The K-percent rule does not allow any discretion in framing of monetary policies and belives in strict adherence to the proposed rule. This has caused many economists to criticise Freidmans k-percent rule.
Modified K-percent Rule
Economists and policy makers have modified Friendmans k-percent rule and have developed more sophiscticated rules for framing monetary policy, using the K-percent rule as a base. Joachim Scheide, head of the Forecasting Center at the Kiel Institute for the World Economy in Germany has modiefied the k-percent rule to make it more applicable in context of Germany's economy.He uses three new variables "nominal domestic demand","central bank money", "error term with the standard characteristics" to give a more suitable model.The k-percent rule is considered as a no feedback rule, which does not allow central banks to alter monetary policy to adjust to current economic situations, thus not being effective in the short run.
Criticisms
No feedback is considered in this policy,as it belives in no interference of the central bank.It does not help in the short term neither
does it allow central banks to respond to financial and economic turmoils occuring at present in the economy thus totally ignoring the current economic situation.
This is not to be confused with the Friedman Rule
Friedman rule
The Friedman rule is a monetary policy rule proposed by Milton Friedman. Essentially, Friedman advocated setting the nominal interest rate at zero. According to the logic of the Friedman rule, the opportunity cost of holding money faced by private agents should equal the social cost of creating...
, which is a policy of zero nominal interest rates.
See also
- Taylor ruleTaylor ruleIn economics, a Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the...
- Monetary policyMonetary policyMonetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment...
- Inflation targetingInflation targetingInflation targeting is an economic policy in which a central bank estimates and makes public a projected, or "target", inflation rate and then attempts to steer actual inflation towards the target through the use of interest rate changes and other monetary tools.Because interest rates and the...
- McCallum ruleMcCallum ruleIn monetary policy, the McCallum rule specifies a target for the monetary base which could be used by a central bank. The McCallum rule was proposed by Bennett T. McCallum at Carnegie Mellon University's Tepper School of Business. It is an alternative to the well known Taylor rule.-Rule:The rule...
- Exchange Rate Targeting Rule