After seven decades of poor performance, says Milton Friedman, the U.S. Federal Reserve has improved markedly over the past 15 years. It has done much better at achieving price stability, he says, because it has abandoned Keynesian theory.
The economist John M. Keynes had taught that the quantity of money did not matter, that what mattered was spending and the turnover of money in the economy. The role of monetary policy was to keep interest rates low to promote investment and thereby full employment. Inflation, he claimed, was produced primarily by pressures on cost that could best be restrained by direct controls on prices and wages.
Now central bankers accept the proposition that inflation is always and everywhere a monetary phenomenon: inflation is the expansion of the money supply. They accept that the crucial function of a central bank is to produce price stability, interpreted as a low and relatively steady recorded rate of inflation. Once the banks adopted price stability as their primary goal, they were able to improve their performance drastically.
This is being called the “New Keynesian Economics.”
Source: Milton Friedman (Hoover Institution), The Fed’s Thermostat, Wall Street Journal, August 19. 2003.
For text http://online.wsj.com/article/0,,SB106125694925954100-search,00.html
For more on Inflation and Prices http://www.ncpa.org/iss/eco/
FMF Policy Bulletins/ 26 August 2003
