diet coke for breakfast

Tuesday, August 19, 2003

Posted by Tanstaafl - The Fed's Thermostat:

"Central banks the world over performed badly prior to the '80s not because they lacked the capacity to do better, but because they pursued the wrong goals according to a wrong theory. Keynes had taught them that the quantity of money did not matter, that what mattered was autonomous spending and the multiplier, that the role of monetary policy was to keep interest rates low to promote investment and thereby full employment. Inflation, according to this vision, was produced primarily by pressures on cost that could best be restrained by direct controls on prices and wages.

That Keynesian vision was thoroughly discredited by experience in the '70s and '80s. It has since been replaced by what has become known as New Keynesian Economics, which incorporates some key quantity theory (monetarist) propositions: that inflation is always and everywhere a monetary phenomenon; that monetary policy has important effects on real magnitudes in the short run but no important effects in the long run (the long run Phillips curve is vertical), 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." -Milton Friedman Aug 19th 2003. WSJ

Unfortunately, this link requires a subscription, but picking up a copy of today's Journal might be worth the dollar, for this article alone. I'm not sure how much of this article will make sense to someone without an Economics degree, but a decent understanding of mathematics should suffice. Friedman is a bit modest. I would rewrite the phrase "the Keynesian vision was thoroughly discredited by experience in the '70s and '80s," as "Friedman's research and theories thoroughly discredited Keynesian notions throughout the '70s and '80s." Also, his description of Open Market Operations, the big-stick of monetary policy, is clear and concise.


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