The Monetarist Rule and the Fed
Lately, there have been a slew of articles about Milton Friedman. Most of those articles discuss Friedman’s importance in terms of promulgating monetarism, but they don’t actually provide a definition of monetarism.
I’ve heard several definitions of monetarism and monetarists. Perhaps the broadest is that a monetarist is someone who thinks that changes in the money supply affect the economy. But by that definition, just about everyone is a monetarist. Most of us, whether we have an economic education or not, can noodle out that if you increase the money supply by enough, you will have runaway inflation, and if you shrink it by enough, you will have liquidity problems.
A better definition might be that a monetarist is one who believes in the monetarist rule. The monetarist rule states that the Federal Reserve should increase the money supply by a slow steady rate every year. This prevents disruptions due to too much or too little money sloshing around, and also prevents people from trying to game the system. Friedman put the desired rate of increase at about 3% or 5% a year. (The increase is necessary to accommodate both increasing population and the increasing complexity of the economy. More people need more money, but each person also engages in more transactions now than, say, 100 years ago.)
So has the Fed been following these policies? The table below shows the average percentage rate of growth of M1 and M2 since 1960, by presidency (through 2005):
1960 – 1980______5.0%______8.0%
(BTW… since I keep messing up when I do this, its worth pointing out I think I got it right this time… M1 in 1980 was 387.3…. then 387.3*[(1+0.05)^26] = 1377.12. Actual M1 in 2005 was 1382… the difference is due to rounding… when don’t round off the percentage I get the 2005 figure, spot on.)
Clearly, neither M1 nor M2 is increasing at a slow, steady rate. But… perhaps after adjusting for inflation and population growth?
________real M1 per cap_______real M2 per cap
1960 – 1980_____-1.1%______1.8%
Adjusting for inflation and population growth, it doesn’t seem like M1 or M2 became any slower or more stable as the sample progressed. The Fed may have done many things, but it doesn’t seem to have pursued anything resembling the monetarist rule.
Is there anything we can learn about the Fed behavior? I dunno… all I get this from this is that since 1980, the Fed has seemed to be rooting for the practitioners of what GHW once called Voodoo economics, since those boys sure seemed to get the Fed wind at their backs. Anyone surprised?
M1 and M2 , not seasonally adjusted, for June of each year.
Year’s midpoint population from NIPA Table 7.1
As usual, my spreadsheet is available to anyone who wants it.