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Friedman’s Restatement of the Quantity Theory of Money
1. Introduction
📌 Milton Friedman, a leading monetarist economist, restated the Quantity Theory of Money (QTM) in the 1950s and 1960s. Unlike classical economists, who viewed money as only affecting prices, Friedman argued that money influences output in the short run but remains neutral in the long run.
🚀 Why is it important?
✔ Shifted the focus from Keynesian demand management to monetary policy as the key to economic stability.
✔ Challenged the idea that fiscal policy is more effective than monetary policy.
✔ Laid the foundation for modern central bank policies, including inflation targeting.
2. Key Features of Friedman’s Restatement
🔹 1. Money Demand is a Stable Function
✔ Friedman argued that money demand is predictable and primarily depends on:
- Income level (higher income → higher demand for money).
- Interest rates (higher rates → lower demand for money).
- Inflation expectations (high inflation → lower demand for money).
✔ Unlike Keynes, who emphasized liquidity preference and speculation, Friedman saw money demand as a long-term, stable function.
🔹 2. Permanent Income Hypothesis
✔ Instead of focusing on short-term changes in income, Friedman argued that people base their spending on permanent income (long-term average income).
✔ This means that temporary changes in money supply have little effect on spending.
🔹 3. Long-Run Neutrality of Money
✔ Friedman agreed with classical economists that money is neutral in the long run—it only affects prices, not real GDP.
✔ However, in the short run, changes in money supply can impact employment and output.
🔹 4. Rejection of the Phillips Curve Trade-Off
✔ The Phillips Curve suggested a trade-off between inflation and unemployment.
✔ Friedman rejected this, arguing that in the long run, unemployment returns to its “natural rate,” regardless of inflation.
✔ High inflation caused by excessive money growth leads to stagflation (inflation + unemployment rising together).
🔹 5. Money Supply Growth Rule
✔ Instead of active monetary intervention, Friedman recommended a fixed money supply growth rate (e.g., 3-5% per year).
✔ This would prevent inflation while allowing steady economic growth.
3. Friedman’s Quantity Equation
📌 Friedman modified the Quantity Equation: MV=PYM V = P Y
Where:
- MM = Money supply
- VV = Velocity of money
- PP = Price level
- YY = Real GDP
🔹 Key Differences from Classical QTM:
✔ Velocity (V) is not constant but predictable.
✔ Changes in money supply influence output in the short run.
✔ In the long run, money supply growth only affects inflation.
4. Policy Implications
🔹 1. Monetary Policy is More Effective Than Fiscal Policy
✔ Friedman argued that monetary policy has a stronger effect on economic stability than government spending.
✔ Keynesians believed in using government intervention, but Friedman emphasized controlling money supply growth.
🔹 2. Inflation is Always a Monetary Phenomenon
✔ Excessive money supply growth leads to inflation.
✔ Governments should avoid printing too much money, as seen in cases like hyperinflation in Zimbabwe and Venezuela.
🔹 3. No Long-Run Trade-Off Between Inflation and Unemployment
✔ Attempts to reduce unemployment using inflationary policies will fail.
✔ Instead, the economy will return to the natural rate of unemployment while inflation remains high.
🔹 4. Rule-Based Monetary Policy
✔ Instead of discretionary policies (changing interest rates frequently), Friedman suggested a fixed rule for money growth to avoid economic instability.
5. Criticisms of Friedman’s Restatement
🔸 1. Short-Run Instability of Money Demand
✔ Critics argue that money demand is not as stable as Friedman claimed.
✔ Financial innovations (e.g., credit cards, online payments) change how people use money.
🔸 2. Underestimation of Fiscal Policy
✔ Keynesians argue that government spending can stabilize the economy during recessions, while Friedman saw it as ineffective.
🔸 3. The 2008 Financial Crisis Challenge
✔ Friedman’s approach worked well in controlling inflation, but during the 2008 financial crisis, monetary policy alone was not enough to restore growth.
✔ Governments had to use fiscal stimulus (spending programs), contradicting Friedman’s views.
6. Conclusion
✔ Friedman’s restatement of QTM revived monetarism and shifted focus to controlling money supply growth.
✔ His ideas led to inflation targeting policies used by modern central banks.
✔ However, recent economic crises show that a combination of monetary and fiscal policies may be necessary.