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MV = Py
Friedman lauds Fed!
 For most of his academic life (he is still going strong in his late eighties) Milton Friedman has been a relentless critic of the Federal Reserve Board.
Way back in 1969 he wrote, "the inflation is made in Washington, in that stately and impressive Grecian temple on Constitutional Avenue that houses Board of Governors of the Federal Reserve System. 18 years ago he returned to the media to renew the attack with redoubled vigour. Therefore it was surprising that he all of a sudden came up with a clean chit for the central bank, which he despised for years. Why the change of heart?
It is because Fed has mended its ways, says Friedman. It is a different Fed now in office. The turning point was in the mid-80s. Since then, it has been doing every thing right. Gone is its attachment to Lord Keynes. The focus now is on money supply and its growth. So far so good, he recently wrote in Wall Street Journal. Friedman claims Fed is closely following the formula MV = Py. It fine-tunes the quantity of money to offset the movements in velocity and output. It is as though it has the thermostat in place.
With what results? Unlike the case earlier, Fed keep in view price stability. It did so even when velocity witnessed a bubble in the 90s. Then it rose by 20% before dropping sharply. Fed then took that admirable step of keeping the monetary growth down to 2.3% a year when velocity got out of hand. When it declined, it boosted monetary growth to 7.5%. Inflation thus was under check. Friedman points out that quite a few governments are also doing the same thing though not all of them are inflation targeting.
The lesson to be learned here is that the governments are free from Keynesian. Keynes saw autonomous spending coupled with low interest rates and the multiplier effect taking care of investments and employment.
It may be recalled that in his 'General Theory' Keynes wrote that the term "income-velocity of money" (V) could be misleading because there is a demand only for a part of the money proportional to income. His disciple Alvin Hansen wrote: "I think we should do well to eliminate, once and for all, the phrase the 'velocity of circulation' from our vocabulary" because the actual role of this parameter remained unclarified. At the same time another protégé of Keynes declared that the "velocity of money is a discredited subject".
In Friedman's view neo-Keynesians know better. Their analyses take note of the key propositions in quantity theory of money. The central banks across the world have also realised that the price stability is more important. |
