Is There An Optimum Quantity of Money?

November 24th, 2012
in econ_news, syndication


Follow up:

The Friedman Rule from Wikipedia:

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 additional fiat money. It is assumed that the marginal cost of creating additional money is zero (or approximated by zero). Therefore, nominal rates of interest should be zero. In practice, this means that the central bank should seek a rate of deflation equal to the real interest rate on government bonds and other safe assets, to make the nominal interest rate zero.

The result of this policy is that those who hold money don't suffer any loss in the value of that money due to inflation. The rule is motivated by long-run efficiency considerations.

The abstract of a recent paper published by the Philly Fed:

A central premise of monetary policy in the U.S. throughout the first decade of the 21st century has been a firm commitment to avoid deflation. Indeed, it is the consensus view of policymakers and most economists. Nonetheless, Nobel laureate Milton Friedman proposed that optimal monetary policy should lead to a steady rate of deflation. For some economists, the Friedman rule is mainly a benchmark for thinking clearly about the assumptions underlying our models and a systematic guide for deciding how to modify our models, that is, a way of making scientific progress. However, it is not an exaggeration to say that most of the work in the field of monetary theory has focused on identifying situations in which Friedman’s insight does not apply. In “The Optimum Quantity of Money,” PDF (408 KB, 8 pages) Daniel Sanches discusses the Friedman rule and the main arguments that have been made against it.

The conclusion of the paper:

Many economists have criticized Friedman’s notion of the optimum quantity of money, despite its being a fairly robust conclusion across a wide range of models. Although Friedman proposed a monetary policy that leads to steady deflation, subsequent researchers have shown alternative ways to get the same result. In addition, models that take explicit account of how households and firms use money for both transactions and insurance and models in which firms are slow to adjust prices show that Friedman’s insights need to be supplemented. While few economists or policymakers would prescribe the Friedman rule as a literal guide to policy, this does not mean that Friedman’s insight is irrelevant. The rule has been useful in spurring serious thoughts about the role of money in the economy and has helped economists make scientific progress in the search for more accurate models of the economy.

Read the entire paper.






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