T h e Ame rican Economic R e v ie w

Volume LVIII MAR CH 1968 Numbe r 1

T HE R OLE OF MONET AR Y POLICY*
By
MILT ON FR IEDMAN**
T h e re is w ide agre e me nt about th e major goals of e conomic policy:
h igh e mployme nt, stable price s, and rapid grow th . T h e re is le ss agre e -
me nt th at th e se goals are mutually compatible or, among th ose w h o re -
gard th e m as incompatible , about th e te rms at w h ich th e y can and
sh ould be substitute d for one anoth e r. T h e re is le ast agre e me nt about
th e role th at v arious instrume nts of policy can and sh ould play in
ach ie v ing th e se v e ral goals.
My topic for tonigh t is th e role of one such instrume nt-mone tary
policy. Wh at can it contribute ? And h ow sh ould it be conducte d to con-
tribute th e most? Opinion on th e se que stions h as fluctuate d w ide ly. In
th e first flush of e nth usiasm about th e ne w ly cre ate d Fe de ral R e se rv e
Syste m, many obse rv e rs attribute d th e re lativ e stability of th e 1920s to
th e Syste m's capacity for fine tuning-to apply an apt mode rn te rm. It
came to be w ide ly be lie v e d th at a ne w e ra h ad arriv e d in w h ich busi-
ne ss cycle s h ad be e n re nde re d obsole te by adv ance s in mone tary te ch -
nology. T h is opinion w as sh are d by e conomist and layman alike ,
th ough , of course , th e re w e re some dissonant v oice s. T h e Gre at Con-
traction de stroye d th is naiv e attitude . Opinion sw ung to th e oth e r e x-
tre me . Mone tary policy w as a string. You could pull on it to stop infla-
tion but you could not push on it to h alt re ce ssion. You could le ad a
h orse to w ate r but you could not make h im drink. Such th e ory by
aph orism w as soon re place d by Ke yne s' rigorous and soph isticate d
analysis.
Ke yne s offe re d simultane ously an e xplanation for th e pre sume d im-
pote nce of mone tary policy to ste m th e de pre ssion, a nonmone tary in-
te rpre tation of th e de pre ssion, and an alte rnativ e to mone tary policy
*
Pre side ntial addre ss de liv e re d at th e Eigh tie th Annual Me e ting of th e Ame rican Eco-
nomic Association, Wash ington, D.C., De ce mbe r 29, 1967.
** I am inde bte d for h e lpful criticisms of e arlie r drafts to Arme n Alch ian, Gary
Be cke r,
Martin Bronfe nbre nne r, Arth ur F. Burns, Ph illip Cagan, Dav id D. Frie dman, Law re nce
Harris, Harry G. Joh nson, Home r Jone s, Je rry Jordan, Dav id Me ise lman, Allan H.
Me ltze r, T h e odore W. Sch ultz, Anna J. Sch w artz, He rbe rt Ste in, Ge orge J. Stigle r, and
Jame s T obin.
2 T HE AMER ICAN ECONOMIC R EVIEW
for me e ting th e de pre ssion and h is offe ring w as av idly acce pte d. If li-
quidity pre fe re nce is absolute or ne arly so-as Ke yne s be lie v e d like ly
in time s of h e av y une mployme nt-inte re st rate s cannot be low e re d by
mone tary me asure s. If inv e stme nt and consumption are little affe cte d
by inte re st rate s-as Hanse n and many of Ke yne s' oth e r Ame rican dis-
ciple s came to be lie v e -low e r inte re st rate s, e v e n if th e y could be
ach ie v e d,
w ould do little good. Mone tary policy is tw ice damne d. T h e
contraction, se t in train, on th is v ie w , by a collapse of inv e stme nt or by
a sh ortage of inv e stme nt opportunitie s or by stubborn th riftine ss, could
not, it w as argue d, h av e be e n stoppe d by mone tary me asure s. But th e re
w as av ailable an alte rnativ e -fiscal policy. Gov e rnme nt spe nding could
make up for insufficie nt priv ate inv e stme nt. T ax re ductions could un-
de rmine stubborn th riftine ss.
T h e w ide acce ptance of th e se v ie w s in th e e conomics profe ssion
me ant th at for some tw o de cade s mone tary policy w as be lie v e d by all
but a fe w re actionary souls to h av e be e n re nde re d obsole te by ne w e co-
nomic know le dge . Mone y did not matte r. Its only role w as th e minor
one of ke e ping inte re st rate s low , in orde r to h old dow n inte re st pay-
me nts in th e gov e rnme nt budge t, contribute to th e "e uth anasia of th e
re ntie r," and maybe , stimulate inv e stme nt a bit to assist gov e rnme nt
spe nding in maintaining a h igh le v e l of aggre gate de mand.
T h e se v ie w s produce d a w ide spre ad adoption of ch e ap mone y poli-
cie s afte r th e w ar. And th e y re ce iv e d a rude sh ock w h e n th e se policie s
faile d in country afte r country, w h e n ce ntral bank afte r ce ntral bank
w as force d to giv e up th e pre te nse th at it could inde finite ly ke e p "th e "
rate of inte re st at a low le v e l. In th is country, th e public de noue me nt
came w ith th e Fe de ral R e se rv e -T re asury Accord in 1951, alth ough th e
policy of pe gging gov e rnme nt bond price s w as not formally abandone d
until 1953. Inflation, stimulate d by ch e ap mone y policie s, not th e
w ide ly h e ralde d postw ar de pre ssion, turne d out to be th e orde r of th e
day. T h e re sult w as th e be ginning of a re v iv al of be lie f in th e pote ncy
of mone tary policy.
T h is re v iv al w as strongly foste re d among e conomists by th e th e ore ti-
cal de v e lopme nts initiate d by Habe rle r but name d for Pigou th at
pointe d out a ch anne l-name ly, ch ange s in w e alth -w h e re by ch ange s
in th e re al quantity of mone y can affe ct aggre gate de mand e v e n if th e y
do not alte r inte re st rate s. T h e se th e ore tical de v e lopme nts did not un-
de rmine Ke yne s' argume nt against th e pote ncy of orth odox mone tary
me asure s w h e n liquidity pre fe re nce is absolute since unde r such cir-
cumstance s th e usual mone tary ope rations inv olv e simply substituting
mone y for oth e r asse ts w ith out ch anging total w e alth . But th e y did
sh ow h ow ch ange s in th e quantity of mone y produce d in oth e r w ays
could affe ct total spe nding e v e n unde r such circumstance s. And,
more
FR IEDMAN: MONET AR Y POLICY 3
fundame ntally, th e y did unde rmine Ke yne s' ke y th e ore tical proposi-
tion, name ly, th at e v e n in a w orld of fle xible price s, a position of e qui-
librium at full e mployme nt migh t not e xist. He nce forth , une mployme nt
h ad again to be e xplaine d by rigiditie s or impe rfe ctions, not as th e nat-
ural outcome of a fully ope rativ e marke t proce ss.
T h e re v iv al of be lie f in th e pote ncy of mone tary policy w as foste re d
also by a re -e v aluation of th e role mone y playe d from 1929 to 1933.
Ke yne s and most oth e r e conomists of th e time be lie v e d th at th e Gre at
Contraction in th e Unite d State s occurre d de spite aggre ssiv e e xpansion-
ary policie s by th e mone tary auth oritie s-th at th e y did th e ir be st but
th e ir be st w as not good e nough .' R e ce nt studie s h av e de monstrate d
th at th e facts are pre cise ly th e re v e rse : th e U.S. mone tary auth oritie s
follow e d h igh ly de flationary policie s. T h e quantity of mone y in th e
Unite d State s fe ll by one -th ird in th e course of th e contraction. And it
fe ll not be cause th e re w e re no w illing borrow e rs-not be cause th e h orse
w ould not drink. It fe ll be cause th e Fe de ral R e se rv e Syste m force d or
pe rmitte d a sh arp re duction in th e mone tary base , be cause it faile d to
e xe rcise th e re sponsibilitie s assigne d to it in th e Fe de ral R e se rv e Act to
prov ide liquidity to th e banking syste m. T h e Gre at Contraction is
tragic te stimony to th e pow e r of mone tary policy-not, as Ke yne s and
so many of h is conte mporarie s be lie v e d, e v ide nce of its impote nce .
In th e Unite d State s th e re v iv al of be lie f in th e pote ncy of mone tary
policy w as stre ngth e ne d also by incre asing disillusionme nt w ith fiscal
policy, not so much w ith its pote ntial to affe ct aggre gate de mand as
w ith th e practical and political fe asibility of so using it. Expe nditure s
turne d out to re spond sluggish ly and w ith long lags to atte mpts to ad-
just th e m to th e course of e conomic activ ity, so e mph asis sh ifte d to
taxe s. But h e re political factors e nte re d w ith a v e nge ance to pre v e nt
prompt adjustme nt to pre sume d ne e d, as h as be e n so graph ically illus-
trate d in th e month s since I w rote th e first draft of th is talk. "Fine tun-
ing" is a marv e lously e v ocativ e ph rase in th is e le ctronic age , but it h as
little re se mblance to w h at is possible in practice -not, I migh t add, an
unmixe d e v il.
It is h ard to re alize h ow radical h as be e n th e ch ange in profe ssional
opinion on th e role of mone y. Hardly an e conomist today acce pts v ie w s
th at w e re th e common coin some tw o de cade s ago. Le t me cite a f e w
e xample s.
In a talk publish e d in 1945, E. A. Golde nw e ise r, th e n Dire ctor of th e
R e se arch Div ision of th e Fe de ral R e se rv e Board, de scribe d th e pri-
mary obje ctiv e of mone tary policy as be ing to "maintain th e v alue of
Gov e rnme nt bonds.... T h is country" h e w rote , "w ill h av e to adjust to
'In [2],
I
h av e argue d th at He nry Simons sh are d th is v ie w w ith Ke yne s, and th at it
accounts for th e policy ch ange s th at h e re comme nde d.
4 T HE AMER ICAN ECONOMIC R EVIEW
a 212 pe r ce nt inte re st rate as th e re turn on safe , long-time mone y, be -
cause th e time h as come w h e n re turns on pione e ring capital can no
longe r be unlimite d as th e y w e re in th e past" [4, p. 1 17].
In a book on Financing A me rican Prospe rity, e dite d by Paul Homan
and Fritz Mach lup and publish e d in 1945, Alv in Hanse n de v ote s nine
page s of te xt to th e "sav ings-inv e stme nt proble m" w ith out finding any
ne e d to use th e w ords "inte re st rate " or any close facsimile th e re to
[5,
pp. 218-27]. In h is contribution to th is v olume , Fritz Mach lup
w rote ,
"Que stions re garding th e rate of inte re st, in particular re garding its
v ariation or its stability, may not be among th e most v ital proble ms of
th e postw ar e conomy, but th e y are ce rtainly among th e pe rple xing
one s" [5, p. 466]. In h is contribution, Joh n H. Williams-not only
profe ssor at Harv ard but also a long-time adv ise r to th e Ne w York
Fe de ral R e se rv e Bank- w rote , "I can se e no prospe ct of re v iv al of a
ge ne ral mone tary control in th e postw ar pe riod" [5, p. 383].
Anoth e r of th e v olume s de aling w ith postw ar policy th at appe are d at
th is time , Planning and Paying for Full Employme nt, w as e dite d by
Abba P. Le rne r and Frank D. Grah am
[6]
and h ad contributors of all
sh ade s of profe ssional opinion-from He nry Simons and Frank Gra-
h am to Abba Le rne r and Hans Ne isse r. Ye t Albe rt Halasi, in h is e xce l-
le nt summary of th e pape rs, w as able to say, "Our contributors do not
discuss th e que stion of mone y supply. . . . T h e contributors make no
spe cial me ntion of cre dit policy to re me dy actual de pre ssions.... Infla-
tion ... migh t be fough t more e ffe ctiv e ly by raising inte re st rate s....
But . . . oth e r anti-inflationary me asure s . . . are pre fe rable " [6, pp.
23-24]. A Surv e y of Conte mporary Economics, e dite d by How ard Ellis
and publish e d in 1948, w as an "official" atte mpt to codify th e state of
e conomic th ough t of th e time . In h is contribution, Arth ur Smith ie s
w rote , "In th e fie ld of compe nsatory action, I be lie v e fiscal policy must
sh oulde r most of th e load. Its ch ie f riv al, mone tary policy, se e ms to be
disqualifie d on institutional grounds. T h is country appe ars to be com-
mitte d to some th ing like th e pre se nt low le v e l of inte re st rate s on a
long-te rm basis"
[1,
p. 208
].
T h e se quotations sugge st th e flav or of profe ssional th ough t some tw o
de cade s ago. If you w ish to go furth e r in th is h umbling inquiry, I re c-
omme nd th at you compare th e se ctions on mone y-w h e n you can find
th e m-in th e Principle s te xts of th e e arly postw ar ye ars w ith th e
le ngth y se ctions in th e curre nt crop e v e n, or e spe cially, w h e n th e e arly
and re ce nt Principle s are diffe re nt e ditions of th e same w ork.
T h e pe ndulum h as sw ung far since th e n, if not all th e w ay to th e po-
sition of th e late 1920s, at le ast much close r to th at position th an to th e
position of 1945. T h e re are of course many diffe re nce s be tw e e n th e n
and now , le ss in th e pote ncy attribute d to mone tary policy th an in th e
FR IEDMAN: MONET AR Y POLICY 5
role s assigne d to it and th e crite ria by w h ich th e profe ssion be lie v e s
mone tary policy sh ould be guide d. T h e n, th e ch ie f role s assigne d mone -
tary policy w e re to promote price stability and to pre se rv e th e gold
standard;
th e ch ie f crite ria of mone tary policy w e re th e state of th e
"mone y marke t," th e e xte nt of "spe culation" and th e mov e me nt of
gold. T oday, primacy is assigne d to th e promotion of full e mployme nt,
w ith th e pre v e ntion of inflation a continuing but de finite ly se condary
obje ctiv e . And th e re is major disagre e me nt about crite ria of policy,
v aryino from e mph asis on mone y marke t conditions, inte re st rate s, and
th e quantity of mone y to th e be lie f th at th e state of e mployme nt itse lf
sh ould be th e proximate crite rion of policy.
I stre ss none th e le ss th e similarity be tw e e n th e v ie w s th at pre v aile d in
th e late 'tw e ntie s and th ose th at pre v ail today be cause I fe ar th at, now
as th e n, th e pe ndulum may w e ll h av e sw ung too far, th at, now as th e n,
w e are in dange r of assigning to mone tary policy a large r role th an it
can pe rform, in dange r of asking it to accomplish tasks th at it cannot
ach ie v e , and, as a re sult, in dange r of pre v e nting it from making th e
contribution th at it is capable of making.
Unaccustome d as I am to de nigrating th e importance of mone y, I
th e re fore sh all, as my first task, stre ss w h at mone tary policy cannot do.
I sh all th e n try to outline w h at it can do and h ow it can be st make its
contribution, in th e pre se nt
state of our
know le dge -or ignorance .
I. Wh at Mone tary Policy Cannot Do
From th e infinite w orld of ne gation, I h av e se le cte d tw o limitations
of mone tary policy to discuss: (1) It cannot pe g inte re st rate s for more
th an v e ry limite d pe riods; (2) It cannot pe g th e rate of une mployme nt
for more th an v e ry limite d pe riods. I se le ct th e se be cause th e contrary
h as be e n or is w ide ly be lie v e d, be cause th e y corre spond to th e tw o main
unattainable tasks th at are at all like ly to be assigne d to mone tary pol-
icy, and be cause e sse ntially th e same th e ore tical analysis cov e rs both .
Pe gging of Inte re st R ate s
History h as alre ady pe rsuade d many of you about th e first limita-
tion. As note d e arlie r, th e failure of ch e ap mone y policie s w as a major
source of th e re action against simple -minde d Ke yne sianism. In th e
Unite d State s, th is re action inv olv e d w ide spre ad re cognition th at th e
w artime and postw ar pe gging of bond price s w as a mistake , th at th e
abandonme nt of th is policy w as a de sirable and ine v itable ste p, and
th at it h iad none of th e disturbing and disastrous conse que nce s th at
w e re so fre e ly pre dicte d at th e time .
T h e li'mitation de riv e s from a much misunde rstood fe ature of th e re -
lation be tw e e n mone y and inte re st rate s. Le t th e Fe d se t out to ke e p
6 T HE AMER ICAN ECONOMIC R EVIEW
inte re st rate s dow n. How w ill it try to do so? By buying se curitie s.
T h is raise s th e ir price s and low e rs th e ir yie lds. In th e proce ss, it also
incre ase s th e quantity of re se rv e s av ailable to banks, h e nce th e amount
of bank cre dit,
and,
ultimate ly th e total quantity of mone y. T h at
is w h y ce ntral banke rs in particular, and th e financial community
more broadly, ge ne rally be lie v e th at an incre ase in th e quantity of
mone y te nds to low e r inte re st rate s. Acade mic e conomists acce pt th e
same conclusion, but for diffe re nt re asons. T h e y se e , in th e ir mind's
e ye ,
a ne gativ e ly sloping liquidity pre fe re nce sch e dule . How can pe ople
be induce d to h old a large r quantity of mone y? Only by bidding dow n
inte re st rate s.
Both are righ t, up to a point. T h e initial impact of incre asing th e
quantity of mone y at a faste r rate th an it h as be e n incre asing is to
make inte re st rate s low e r for a time th an th e y w ould oth e rw ise h av e
be e n. But th is is only th e be ginning of th e proce ss not th e e nd. T h e
more rapid rate of mone tary grow th w ill stimulate spe nding, both
th rough th e impact on inv e stme nt of low e r marke t inte re st rate s and
th rough th e impact on oth e r spe nding and th e re by re lativ e price s of
h igh e r cash balance s th an are de sire d. But one man's spe nding is an-
oth e r man's income . R ising income w ill raise th e liquidity pre fe re nce
sch e dule and th e de mand for loans; it may also raise price s, w h ich
w ould re duce th e re al quantity of mone y. T h e se th re e e ffe cts w ill
re v e rse th e initial dow nw ard pre ssure on inte re st rate s fairly prompt-
ly, say, in some th ing le ss th an a ye ar. T oge th e r th e y w ill te nd, afte r
a some w h at longe r inte rv al,
say, a ye ar or tw o, to re turn inte re st
rate s to th e le v e l th e y w ould oth e rw ise h av e h ad. Inde e d, giv e n th e te n-
de ncy for th e e conomy to ov e rre act, th e y are h igh ly like ly to raise in-
te re st rate s te mporarily be yond th at le v e l, se tting in motion a cyclical
adjustme nt proce ss.
A fourth e ffe ct, w h e n and if it be come s ope rativ e , w ill go e v e n far-
th e r, and de finite ly me an th at a h igh e r rate of mone tary e xpansion w ill
corre spond to a h igh e r, not low e r, le v e l of inte re st rate s th an w ould
oth e rw ise h av e pre v aile d. Le t th e h igh e r rate of mone tary grow th pro-
duce rising price s, and le t th e public come to e xpe ct th at price s w ill
continue to rise . Borrow e rs w ill th e n be w illing to pay and le nde rs w ill
th e n de mand h igh e r inte re st rate s-as Irv ing Fish e r pointe d out de c-
ade s ago. T h is price e xpe ctation e ffe ct is slow to de v e lop and also slow
to disappe ar. Fish e r e stimate d th at it took se v e ral de cade s for a full ad-
justme nt and more re ce nt w ork is consiste nt w ith h is e stimate s.
T h e se subse que nt e ffe cts e xplain w h y e v e ry atte mpt to ke e p inte re st
rate s at a low le v e l h as force d th e mone tary auth ority to e ngage in suc-
ce ssiv e ly large r and large r ope n marke t purch ase s. T h e y e xplain w h y,
h istorically, h igh and rising nominal inte re st rate s h av e be e n associate d
FR IEDMAN: MONET AR Y POLICY 7
w ith rapid grow th in th e quantity of mone y, as in Brazil or Ch ile or in
th e Unite d State s in re ce nt ye ars, and w h y low and falling inte re st
rate s h av e be e n associate d w ith slow grow th in th e quantity of mone y,
as in Sw itze rland now or in th e Unite d State s from 1929 to 1933. As an
e mpirical matte r, low inte re st rate s are a sign th at mone tary policy h as
be e n tigh t-in th e se nse th at th e quantity of mone y h as grow n slow ly;
h igh inte re st rate s are a sign th at mone tary policy h as be e n e asy-in
th e se nse th at th e quantity of mone y h as grow n rapidly. T h e broade st
facts of e xpe rie nce run in pre cise ly th e opposite dire ction from th at
w h ich th e financial community and acade mic e conomists h av e all ge ne r-
ally take n for grante d.
Paradoxically, th e mone tary auth ority could assure low nominal rate s
of inte re st-but to do so it w ould h av e to start out in w h at se e ms like
th e opposite dire ction, by e ngaging in a de flationary mone tary policy.
Similarly, it could assure h igh nominal inte re st rate s by e ngaging in an
inflationary policy and acce pting a te mporary mov e me nt in inte re st
rate s in th e opposite dire ction.
T h e se conside rations not only e xplain w h y mone tary policy cannot
pe g inte re st rate s; th e y also e xplain w h y inte re st rate s are such a mis-
le ading indicator of w h e th e r mone tary policy is "tigh t" or "e asy." For
th at, it is far be tte r to look at th e rate of ch ange of th e quantity of
mone y.'
Employme nt as a Crite rion of Policy
T h e se cond limitation I w ish to discuss goe s more against th e grain
of curre nt th inking. Mone tary grow th , it is w ide ly h e ld, w ill te nd to
stimulate e mployme nt; mone tary contraction, to re tard e mployme nt.
Wh y, th e n, cannot th e mone tary auth ority adopt a targe t for e mploy-
me nt or une mployme nt-say, 3 pe r ce nt une mployme nt; be tigh t w h e n
une mployme nt is le ss th an th e targe t; be e asy w h e n une mployme nt is
h igh e r th an th e targe t; and in th is w ay pe g une mployme nt at, say, 3
pe r ce nt? T h e re ason it cannot is pre cise ly th e same as for inte re st
rate s-th e diffe re nce be tw e e n th e imme diate and th e de laye d conse -
que nce s of such a policy.
T lh anks to Wickse ll, w e are all acquainte d w ith th e conce pt of a
"natural" rate of inte re st and th e possibility of a discre pancy be tw e e n
th e "natural" and th e "marke t" rate . T h e pre ce ding analysis of inte re st
rate s can be translate d fairly dire ctly into Wickse ]lian te rms. T h e mon-
e tary auth ority can make th e marke t rate le ss th an th e natural rate
2
T h is is partly an e mpirical not th e ore tical judgme nt. In principle , "tigh tne ss" or "e ase "
de pe nds on th e rate of ch ange of th e quantity of mone y supplie d compare d to th e rate of
ch ange of th e quantity de mande d e xcluding e ffe cts on de mand from mone tary policy itse lf.
How e v e r, e mpirically de mand is h igh ly stable , if w e e xclude th e e ffe ct of mone tary policy,
so it is ge ne rally sufficie nt to look at supply alone .
8 T HE AMER ICAN ECONOMIC R EVIEW
only by inflation. It can mnake th e marke t rate h igh e r th an th e natural
rate only by de flation. We h av e adde d only one w rinkle to Wickse ll-
th e Irv ing Fish e r distinction be tw e e n th e nominal and th e re al rate of
inte re st. Le t th e mone tary auth ority ke e p th e nominal marke t rate for a
time be low th e natural rate by inflation. T h at in turn w ill raise th e
nominal natural rate itse lf, once anticipations of inflation be come w ide -
spre ad, th us re quiring still more rapid inflation to h old dow n th e mar-
ke t rate . Similarly, be cause of th e Fish e r e ffe ct, it w ill re quire not
me re ly de flation but more and more rapid de flation to h old th e marke t
rate abov e th e initial "natural" rate .
T h is analysis h as its close counte rpart in th e e mployme nt marke t. At
any mome nt of time , th e re is some le v e l of une mployme nt w h ich h as
th e prope rty th at it is consiste nt w ith e quilibrium in th e structure of
re al w age rate s. At th at le v e l of une mployme nt, re al w age rate s are
te nding on th e av e rage to rise at a "normal" se cular rate ,
i.e .,
at a rate
th at can be inde finite ly maintaine d so long as capital formation, te ch -
nological improv e me nts, e tc., re main on th e ir long-run tre nds. A low e r
le v e l of une mployme nt is an indication th at th e re is an e xce ss de mand
for labor th at w ill produce upw ard pre ssure on re al w age rate s. A
h igh e r le v e l of une mployme nt is an indication th at th e re is an e xce ss
supply of labor th at w ill produce dow nw ard pre ssure on re al w age
rate s. T h e "natural rate of une mployme nt," in oth e r w ords, is th e le v e l
th at w ould be ground out by th e Walrasian syste m of ge ne ral e quilib-
rium e quations, prov ide d th e re is imbe dde d in th e m th e actual struc-
tural ch aracte ristics of th e labor and commodity marke ts, including
marke t impe rfe ctions, stoch astic v ariability in de mands and supplie s,
th e cost of gath e ring information about job v acancie s and labor av ail-
abilitie s, th e costs of mobility, and so on.'
You w ill re cognize th e close similarity be tw e e n th is state me nt and
th e ce le brate d Ph illips Curv e . T h e similarity is not coincide ntal. Ph il-
lips' analysis of th e re lation be tw e e n une mployme nt and w age ch ange is
de se rv e dly ce le brate d as an important
and original contribution. But,
unfortunate ly, it contains a basic de fe ct-th e failure to distinguish be -
tw e e n nominal w age s and re al w age s-just as Wickse ll's analysis faile d
to distinguish be tw e e n nominal inte re st rate s and re al inte re st rate s.
Implicitly, Ph illips w rote h is article for a w orld in w h ich e v e ryone an-
ticipate d th at nominal price s w ould be stable and in w h ich th at antici-
pation re maine d unsh ake n and immutable w h ate v e r h appe ne d to actual
price s and w age s. Suppose , by contrast,
th at e v e ryone anticipate s
th at
price s w ill rise at a rate of more th an 75 pe r ce nt a ye ar-as, for e xam-
3It is pe rh aps w orth noting th at th is "natural" rate ne e d not corre spond to e quality
be tw e e n th e numbe r une mploye d and th e numbe r of job v acancie s. For any giv e n structure
of th e labor mnarke t, th e re w ill be some e quilibrium re lation be tw e e n th e se tw o magnitude s,
but th e re is no re ason w h y it sh ould be one of e quality.
FR IEDMAN: MONET AR Y POLICY 9
ple , Brazilians did a fe w ye ars ago. T h e n w age s must rise at th at rate
simply to ke e p re al w age s unch ange d. An e xce ss supply of labor w ill be
re fle cte d in a le ss rapid rise in nominal w age s th an in anticipate d
price s,4 not in an absolute de cline in w age s. Wh e n Brazil e mbarke d
on
a policy to bring dow n th e rate of price rise , and succe e de d in bringing
th e price rise dow n to about 45 pe r ce nt a ye ar, th e re w as a sh arp ini-
tial rise in une mployme nt be cause unde r th e influe nce of e arlie r antici-
pations, w age s ke pt rising at a pace th at w as h igh e r th an th e ne w rate
of price rise , th ough low e r th an e arlie r. T h is is th e re sult e xpe rie nce d,
and to be e xpe cte d, of all atte mpts to re duce th e rate of inflation be low
th at w ide ly anticipate d.5
T o av oid misunde rstanding, le t me e mph asize th at by using th e te rm
"natural" rate of une mployme nt, I do not me an to sugge st th at it is im-
mutable and unch ange able . On th e contrary, many of th e marke t ch ar-
acte ristics th at de te rmine its le v e l are man-made and policy-made . In
th e Unite d State s, for e xample , le gal minimum w age
rate s,
th e Walsh -
He aly and Dav is-Bacon Acts, and th e stre ngth of labor unions all make
th e natural rate of une mployme nt h igh e r th an it w ould oth e rw ise be .
Improv e me nts in e mployme nt e xch ange s, in av ailability of information
about job v acancie s and labor supply, and so on, w ould te nd to low e r
th e natural rate of une mployme nt. I use th e te rm "natural" for th e
same re ason Wickse ll did-to try to se parate th e re al force s from mon-
e tary force s.
Le t us assume th at th e mone tary auth ority trie s to pe g th e "marke t"
rate of une mployme nt at a le v e l be low th e "natural" rate . For de finite -
ne ss, suppose th at it take s 3 pe r ce nt as th e targe t rate and th at th e
"natural" rate is h igh e r th an 3 pe r ce nt. Suppose also th at w e start out
at a time w h e n price s h av e be e n stable and w h e n une mployme nt is
h igh e r th an 3 pe r ce nt. Accordingly,
th e auth ority incre ase s th e rate of
mone tary grow th . T h is w ill be e xpansionary. By making nominal cash
4 Strictly spe aking, th e rise in nominal w age s w ill be le ss rapid th an th e rise in antici-
pate d nominal w age s to make allow ance for any se cular ch ange s in re al w age s.
'State d in te rms of th e rate of ch ange of nominal w age s, th e Ph illips Curv e can be
e xpe cte d to be re asonably stable and w e ll de fine d for any pe riod for w h ich th e av e rage
rate of ch ange of price s, and h e nce th e anticipate d rate , h as be e n re lativ e ly stable . For
such pe riods, nominal w age s and "re al" w age s mov e toge th e r. Curv e s compute d for diffe r-
e nt pe riods or diffe re nt countrie s for e ach of w h ich th is condition h as be e n satisfie d w ill
diffe r in le v e l, th e le v e l of th e curv e de pe nding on w h at th e av e rage rate of price ch ange
w as. T h e h igh e r th e av e rage rate of price ch ange , th e h igh e r w ill te nd to be th e le v e l of
th e curv e . For pe riods or countrie s for w h ich th e rate of ch ange of price s v arie s conside r-
ably, th e Ph illips Curv e w ill not be w e ll de fine d. My impre ssion is th at th e se state me nts
accord re asonably w e ll w ith th e e xpe rie nce of th e e conomists w h o h av e e xplore d e mpirical
Ph illips Curv e s.
R e state Ph illips' analysis in te rms of th e rate of ch ange of re al w age s-and e v e n more
pre cise ly, anticipate d re al w age s-and it all falls into place . T h at is w h y stude nts of
e mpirical Ph illips Curv e s h av e found th at it h e lps to include th e rate of ch ange of th e
price le v e l as an inde pe nde nt v ariable .
10 T HE AMER ICAN ECONOMIC R EVIEW
balance s h igh e r th an pe ople de sire , it w ill te nd initially to low e r inte re st
rate s and in th is and oth e r w ays to stimulate spe nding. Income and
spe nding w ill start to rise .
T o be gin w ith , much or most of th e rise in income w ill take th e form
of an incre ase in output and e mployme nt rath e r th an in price s. Pe ople
h av e be e n e xpe cting price s to be stable , and price s and w age s h av e be e n
se t for some time in th e future on th at basis. It take s time for pe ople to
adjust to a ne w state of de mand. Produce rs w ill te nd to re act to th e
initial e xpansion in aggre gate de mand by incre asing
output,
e mploye e s
by w orking longe r
h ours,
and th e une mploye d, by taking jobs now of-
fe re d at forme r nominal w age s. T h is much is pre tty standard doctrine .
But it de scribe s only th e initial e ffe cts. Be cause se lling price s of
products typically re spond to an unanticipate d rise in nominal de mand
faste r th an price s of factors of production, re al w age s re ce iv e d h av e
gone dow n-th ough re al w age s anticipate d by e mploye e s w e nt up, since
e mploye e s implicitly e v aluate d th e w age s offe re d at th e e arlie r price
le v e l. Inde e d, th e simultane ous fall e x post in re al w age s to e mploye rs
and rise e x ante in re al w age s to e mploye e s is w h at e nable d e mploy-
me nt to incre ase . But th e de cline e x post in re al w age s w ill soon come
to affe ct anticipations. Employe e s w ill start to re ckon on rising price s
of th e th ings th e y buy and to de mand h igh e r nominal w age s for th e fu-
ture . "Marke t" une mployme nt is be low th e "natural" le v e l. T h e re is an
e xce ss de mand for labor so re al w age s w ill te nd to rise tow ard th e ir ini-
tial le v e l.
Ev e n th ough th e h igh e r rate of mone tary grow th continue s, th e rise
in re al w age s w ill re v e rse th e de cline in une mployme nt, and th e n le ad
to a rise , w h ich w ill te nd to re turn une mployme nt to its forme r le v e l. In
orde r to ke e p une mployme nt at its targe t le v e l of 3 pe r ce nt, th e mone -
tary auth ority w ould h av e to raise mone tary grow th still more . As in
th e inte re st rate case , th e "marke t" rate can be ke pt be low th e "natu-
ral" rate onaly by inflation. And, as in th e inte re st rate case , too, only by
acce le ratin(g inflation. Conv e rse ly, le t th e mone tary auth ority ch oose a
targe t rate of une mployme nt th at is abov e th e natural rate , and th e y w ill
be le d to produce a de flation, and an acce le rating de flation at th at.
Wh at if th e mone tary auth ority ch ose th e "natural" rate -e ith e r of
inte re st or une mployme nt-as its targe t? One proble m is th at it cannot
know w h at th e "natural" rate is. Unfortunate ly, w e h av e as ye t de -
v ise d no me th od to e stimate accurate ly and re adily th e natural rate of
e ith e r inte re st or une mployme nt. And th e "natural" rate w ill itse lf
ch ange from time to time . But th e basic proble m is th at e v e n if th e
mone tary auth ority kne w th e "natural" rate , and atte mpte d to pe g th e
marke t rate at th at le v e l, it w ould not be le d to a de te rminate policy.
T h e "marke t" rate w ill v ary from th e natural rate for all sorts of re a-
sons oth e r th an mone tary policy. If th e mone tary auth ority re sponds to
FR IEDMAN: MONET AR Y POLICY I I
th e se v ariations, it w ill se t in train longe r te rm e ffe cts th at w ill make
any mone tary grow th path it follow s ultimate ly consiste nt w ith th e rule
of policy. T h e actual course of mone tary grow th w ill be analogous to a
random w alk, buffe te d th is w ay and th at by th e force s th at produce
te mporary de parture s of th e marke t rate from th e natural rate .
T o state th is conclusion diffe re ntly, th e re is alw ays a te mporary
trade -off be tw e e n inflation and une mployme nt; th e re is no pe rmane nt
trade -off. T h e te mporary trade -off come s not from inflation pe r se , but
from unanticipate d inflation, w h ich ge ne rally me ans, from a rising rate
of inflation. T h e w ide spre ad be lie f th at th e re is a pe rma ie nt trade -off
is a soph isticate d v e rsion of th e confusion be tw e e n "h igh " and "rising"
th at w e all re cognize in simple r forms. A rising rate of inflation may
re duce une mployme nt, a h igh rate w ill not.
But h ow long, you w ill say, is "te mporary"? For inte re st rate s, w e
h av e some syste matic e v ide nce on h ow long e ach of th e se v e ral e ffe cts
take s to w ork itse lf out. For une mployme nt, w e do not. I can at most
v e nture a pe rsonal judgme nt, base d on some e xamination of th e h istori-
cal e v ide nce , th at th e initial e ffe cts of a h igh e r and unanticipate d rate
of inflation last for some th ing like tw o to fiv e ye ars; th at th is initial
e ffe ct th e n be gins to be re v e rse d; and th at a full adjustme nt to th e ne w
rate of inflation take s about as long for e mployme nt as for inte re st
rate s, say, a couple of de cade s. For both inte re st rate s and e mployme nt,
le t me add a qualification. T h e se e stimate s are for ch ange s in th e rate
of inflation of th e orde r of magnitude th at h as be e n e xpe rie nce d in th e
Unite d State s. For much more sizable ch ange s, such as th ose e xpe ri-
e nce d in South Ame rican countrie s, th e w h ole adjustme nt proce ss is
gre atly spe e de d up.
T o state th e ge ne ral conclusion still diffe re ntly, th e mone tary auth or-
ity controls nominal quantitie s-dire ctly, th e quantity of its ow n liabil-
itie s. In principle , it can use th is control to pe g a nominal quantity-an
e xch ange rate , th e price le v e l, th e nominal le v e l of national income , th e
quantity of motne y by one or anoth e r de finition-or to pe g th e rate of
ch ange in a nominal quantity-th e rate of inflation or de flation, th e
rate of grow th or de cline in nominal national income , th e rate of grow th
of th e quantity of mone y. It cannot use its control ov e r nominal quanti-
tie s to pe g a re al quantity-th e re al rate of inte re st, th e rate of une m-
ployme nt, th e le v e l of re al national income , th e re al quantity of mone y,
th e rate of grow th of re al national income , or th e rate of grow th of th e
re al quantity of mone y.
II. Wh at Mone tary Policy Can Do
Mone tary policy cannot pe g th e se re al magnitude s at pre de te rmine d
le v e ls. But mone tary policy can and doe s h av e important e ffe cts on
th e se re al magnitude s. T h e one is in no w ay inconsiste nt w ith th e oth e r.
12 T HE AMER ICAN ECONOMIC R EVIEW
My ow n studie s of mone tary h istory h av e made me e xtre me ly sym-
path e tic to th e oft-quote d, much re v ile d, and as w ide ly misunde rstood,
comme nt by Joh n Stuart Mill. "T h e re cannot . .. ," h e w rote , "be in-
trinsically a more insignificant th ing, in th e e conomy of socie ty, th an
mone y; e xce pt in th e ch aracte r of a contriv ance for sparing time and
labour. It is a mach ine for doing quickly and commodiously, w h at
w ould be done , th ough le ss quickly and commodiously, w ith out it: and
like many oth e r kinds of mach ine ry, it only e xe rts a distinct and inde -
pe nde nt influe nce of its ow n w h e n it ge ts out of orde r" [7, p. 488].
T rue , mone y is only a mach ine , but it is an e xtraordinarily e fficie nt
mach ine . With out it, w e could not h av e be gun to attain th e astounding
grow th in output and le v e l of liv ing w e h av e e xpe rie nce d in th e past
tw o ce nturie s-any more th an w e could h av e done so w ith out th ose
oth e r marv e lous mach ine s th at dot our countryside and e nable us, for
th e most part, simply to do more e fficie ntly w h at could be done w ith out
th e m at much gre ate r cost in labor.
But mone y h as one fe ature th at th e se oth e r mach ine s do not sh are .
Be cause it is so pe rv asiv e , w h e n it ge ts out of orde r, it th row s a mon-
ke y w re nch into th e ope ration of all th e oth e r mach ine s. T h e Gre at
Contraction is th e most dramatic e xample but not th e only one . Ev e ry
oth e r major contraction in th is country h as be e n e ith e r produce d by
mone tary disorde r or gre atly e xace rbate d by mone tary disorde r. Ev e ry
major inflation h as be e n produce d by mone tary e xpansion-mostly to
me e t th e ov e rriding de mands of w ar w h ich h av e force d th e cre ation of
mone y to supple me nt e xplicit taxation.
T h e first and most important le sson th at h istory te ach e s about w h at
mone tary policy can do-and it is a le sson of th e most profound impor-
tance -is th at mone tary policy can pre v e nt mone y itse lf from be ing a
major source of e conomic disturbance . T h is sounds like a ne gativ e
proposition: av oid major mistake s. In part it is. T h e Gre at Contraction
migh t not h av e occurre d at all, and if it h ad, it w ould h av e be e n far le ss
se v e re , if th e mone tary auth ority h ad av oide d mistake s, or if th e mone -
tary arrange me nts h ad be e n th ose of an e arlie r time w h e n th e re w as no
ce ntral auth ority w ith th e pow e r to make th e kinds of mistake s th at th e
Fe de ral R e se rv e Syste m made . T h e past fe w ye ars, to come close r to
h ome , w ould h av e be e n ste adie r and more productiv e of e conomic w e ll-
be ing if th e Fe de ral R e se rv e h ad av oide d drastic and e rratic ch ange s of
dire ction, first e xpanding th e mone y supply at an unduly rapid pace ,
th e n, in e arly 1966, ste pping on th e brake too h ard, th e n, at th e e nd of
1966, re v e rsing itse lf and re suming e xpansion until at le ast
Nov e mbe r,
1967, at a more rapid pace th an can long be maintaine d w ith out appre -
ciable inflation.
Ev e n if th e proposition th at mone tary policy can pre v e nt mone y it-
FR IEDMAN: MONET AR Y POLICY 13
se lf from be ing a major source of e conomic disturbance w e re a w h olly
ne gativ e proposition, it w ould be none th e le ss important for th at. As it
h appe ns, h ow e v e r, it is not a w h olly ne gativ e proposition. T h e mone -
tary mach ine h as gotte n out of orde r e v e n w h e n th e re h as be e n no ce n-
tral auth ority w ith anyth ing like th e pow e r now posse sse d by th e Fe d.
In th e Unite d State s, th e 1907 e pisode and e arlie r banking panics are
e xample s of h ow th e mone tary mach ine can ge t out of orde r large ly on
its ow n. T h e re is th e re fore a positiv e and important task for th e mone -
tary auth ority-to sugge st improv e me nts in th e mach ine th at w ill re -
duce th e ch ance s th at it w ill ge t out of orde r, and to use its ow n pow e rs
so as to ke e p th e mach ine in good w orking orde r.
A se cond th ing mone tary policy can do is prov ide a stable back-
ground for th e e conomy-ke e p th e mach ine w e ll
oile d,
to continue Mill's
analogy. Accomplish ing th e first task w ill contribute to th is obje ctiv e ,
but th e re is more to it th an th at. Our e conomic syste m w ill w ork be st
w h e n produce rs and consume rs, e mploye rs and e mploye e s, can proce e d
w ith full confide nce th at th e av e rage le v e l of price s w ill be h av e in a
know n w ay in th e future -pre fe rably th at it w ill be h igh ly stable .
Unde r any conce iv able institutional arrange me nts, and ce rtainly unde r
th ose th at now pre v ail in th e Unite d State s, th e re is only a limite d
amount of fle xibility in price s and w age s. We ne e d to conse rv e th is fle xi-
bility to ach ie v e ch ange s in re lativ e price s and w age s th at are re quire d
to adjust to dynamic ch ange s in taste s and te ch nology. We sh ould not
dissipate it simply to ach ie v e ch ange s in th e absolute le v e l of price s
th at se rv e no e conomic function.
In an e arlie r e ra, th e gold standard w as re lie d on to prov ide confi-
de nce in future mone tary stability. In its h e yday it se rv e d th at function
re asonably w e ll. It cle arly no longe r doe s, since th e re is scarce a coun-
try in th e w orld th at is pre pare d to le t th e gold standard re ign un-
ch e cke d-and th e re are pe rsuasiv e re asons w h y countrie s sh ould not do
so. T h e mone tary auth ority could ope rate as a surrogate for th e gold
standard, if it pe gge d e xch ange rate s and did so e xclusiv e ly by alte ring
th e quantity of mone y in re sponse to balance of payme nt flow s w ith out
"ste rilizing" surpluse s or de ficits and w ith out re sorting to ope n or con-
ce ale d e xch ange control or to ch ange s in tariffs and quotas. But again,
th ough many ce ntral banke rs talk th is w ay, fe w are in fact w illing to
follow th is course -and again th e re are pe rsuasiv e re asons w h y th e y
sh ould not do so. Such a policy w ould submit e ach country to th e v a-
garie s not of an impe rsonal and automatic gold standard but of th e pol-
icie s-de libe rate or accide ntal-of oth e r mone tary auth oritie s.
In today's w orld, if mone tary policy is to prov ide a stable back-
ground for th e e conomy it must do so by de libe rate ly e mploying its
pow e rs to th at e nd. I sh all come late r to h ow it can do so.
14 T HE AMER ICAN ECONOMIC R EVIEW
Finally, mone tary policy can contribute to offse tting major distur-
bance s in th e e conomic syste m arising fromi oth e r source s. If th e re is an
inde pe nde nt se cular e xh ilaration-as th e postw ar e xpansion w as de -
scribe d by th e propone nts of se cular stagnation-mone tary policy can
in principle h e lp to h old it in ch e ck by a slow e r rate of mone tary
grow th th an w ould oth e rw ise be de sirable . If, as now , an e xplosiv e fe d-
e ral budge t th re ate ns unpre ce de nte d de ficits, mone tary policy can h old
any inflationary dange rs in ch e ck by a slow e r rate of mone tary grow th
th an w ould oth e rw ise be de sirable . T h is w ill te mporarily me an h igh e r
inte re st rate s th an w ould oth e rw ise pre v ail-to e nable th e gov e rnme nt
to borrow th e sums ne e de d to finance th e de ficit-but by pre v e nting th e
spe e ding up of inflation, it may w e ll me an both low e r price s and low e r
nominal inte re st rate s for th e long pull. If th e e nd of a substantial w ar
offe rs th e country an opportunity to sh ift re source s from w artime to
pe ace time production, mone tary policy can e ase th e transition by a
h igh e r rate of mone tary grow th th an w ould oth e rw ise be de sirable -
th ough e xpe rie nce is not v e ry e ncouraging th at it can do so w ith out
going too far.
I h av e put th is point last, and state d it in qualifie d te rms-as re fe r-
ring to major disturbance s-be cause I be lie v e th at th e pote ntiality of
mone tary policy in offse tting oth e r force s making for instability is far
more limite d th an is commonly be lie v e d. We simply do not know
e nough to be able to re cognize minor disturbance s w h e n th e y occur or
to be able to pre dict e ith e r w h at th e ir e ffe cts w ill be w ith any pre cision
or w h at mone tary policy is re quire d to offse t th e ir e ffe cts. We do not
know e nough to be able to ach ie v e state d obje ctiv e s by de licate ,
or e v e n
fairly coarse , ch ange s in th e mix of mone tary and fiscal policy. In th is
are a particularly th e be st is like ly to be th e e ne my of th e good. Expe ri-
e nce sugge sts th at th e path of w isdom is to use mone tary policy e xplic-
itly to offse t oth e r disturbance s only w h e n th e y offe r a "cle ar and pre s-
e nt dange r."
III. How Sh ould Mone tary Policy Be Conducte d?
How sh ould mone tary policy be conducte d to make th e contribution
to our goals th at it is capable of making? T h is is cle arly not th e occa-
sion for pre se nting a de taile d "Program for Mone tary Stability"-to
use th e title of a book in w h ich I trie d to do so [3]. I sh all re strict
myse lf h e re to tw o major re quire me nts for mone tary policy th at follow
fairly dire ctly from th e pre ce ding discussion.
T h e first re quire mre nt is th at th e mone tary auth ority sh ould guide it-
se lf by magnitude s th at it can control, not by one s th at it cannot con-
trol. If, as th e auth ority h as ofte n done , it take s inte re st rate s or th e
curre nt une mployme nt pe rce ntage as th e imme diate crite rion of policy,
FR IEDMAN: MONET AR Y POLICY 15
it w ill be like a space v e h icle th at h as take n a fix on th e w rong star. No
matte r h ow se nsitiv e and soph isticate d its guiding apparatus, th e space
v e h icle w ill go astray. And so w ill th e mone tary auth ority. Of th e v ar-
ious alte rnativ e magnitude s th at it can control, th e most appe aling
guide s for policy are e xch ange rate s, th e price le v e l as de fine d by some
inde x, and th e quantity of a mone tary total-curre ncy plus adjuste d
de mand de posits, or th is total plus comme rcial bank time de posits, or a
still broade r total.
For th e Unite d State s in particular, e xch ange rate s are an unde sira-
ble guide . It migh t be w orth re quiring th e bulk of th e e conomy to ad-
just to th e tiny pe rce ntage consisting of fore ign trade if th at w ould
guarante e fre e dom from mone tary
irre sponsibility-as
it migh t unde r a
re al gold standard. But it is h ardly w orth doing so simply to adapt to
th e av e rage of w h ate v e r policie s mone tary auth oritie s in th e re st of th e
w orld adopt. Far be tte r to le t th e marke t, th rough floating e xch ange
rate s, adjust to w orld conditions th e 5 pe r ce nt or so of our re source s
de v ote d to inte rnational trade w h ile re se rv ing mone tary policy to pro-
mote th e e ffe ctiv e use of th e 95 pe r ce nt.
Of th e th re e guide s liste d, th e price le v e l is cle arly th e most impor-
tant in its ow n righ t. Oth e r th ings th e same , it w ould be much th e be st
of th e alte rnativ e s-as so many distinguish e d e conomists h av e urge d in
th e past. But oth e r th ings are not th e same . T h e link be tw e e n th e pol-
icy actions of th e mone tary auth ority and th e price le v e l, w h ile unque s-
tionably pre se nt, is more indire ct th an th e link be tw e e n th e policy ac-
tions of th e auth ority and any of th e se v e ral mone tary totals. More -
ov e r, mone tary action take s a longe r time to affe ct th e price le v e l th an
to affe ct th e mone tary totals and both th e time lag and th e magnitude
of e ffe ct v ary w ith circumstance s. As a re sult, w e cannot pre dict at all
accurate ly just w h at e ffe ct a particular mone tary action w ill h av e on
th e price le v e l and, e qually important, just w h e n it w ill h av e th at e ffe ct.
Atte mpting to control dire ctly th e price le v e l is th e re fore like ly to make
mone tary policy itse lf a source of e conomic disturbance be cause of
false stops and starts. Pe rh aps, as our unde rstanding of mone tary ph e -
nome na adv ance s, th e situation w ill ch ange . But at th e pre se nt stage of
our unde rstanding, th e long w ay around se e ms th e sure r w ay to our ob-
je ctiv e . Accordingly, I be lie v e th at a mone tary total is th e be st cur-
re ntly av ailable imme diate guLide or crite rion for mone tary policy-and
I be lie v e th at it matte rs much le ss w h ich particular total is ch ose n th an
th at one be ch ose n.
A se cond re quire me nt for mone tary policy is th at th e mone tary au-
th ority av oid sh arp sw ings
in
policy.
In th e
past, mone tary
auth oritie s
h av e on occasion mov e d in th e w rong dire ction-as in th e e pisode
of
th e Gre at Contraction th at I h av e stre sse d. More
fre que ntly, th e y h av e
16 T HE AMER ICAN ECONOMIC R EVIEW
mov e d in th e righ t dire ction, albe it ofte n too late , but h av e e rre d by
mov ing too far. T oo late and too much h as be e n th e ge ne ral practice .
For e xample , in e arly 1966, it w as th e righ t policy for th e Fe de ral R e -
se rv e to mov e in a le ss e xpansionary dire ction-th ough it sh ould h av e
done so at le ast a ye ar e arlie r. But w h e n it mov e d, it w e nt too far, pro-
ducing th e sh arpe st ch ange in th e rate of mone tary grow th of th e post-
w ar e ra. Again, h av ing gone too far, it w as th e righ t policy for th e Fe d
to re v e rse course at th e e nd of 1966. But again it w e nt too far, not only
re storing but e xce e ding th e e arlie r e xce ssiv e rate of mone tary grow th .
And th is e pisode is no e xce ption. T ime and again th is h as be e n th e
course follow e d-as in 1919 and 1920, in 1937 and 1938, in 1953 and
1954, in 1959 and 1960.
T h e re ason for th e prope nsity to ov e rre act se e ms cle ar: th e failure of
mone tary auth oritie s to allow for th e de lay be tw e e n th e ir actions and
th e subse que nt e ffe cts on th e e conomy. T h e y te nd to de te rmine th e ir
actions by today's conditions-but th e ir actions w ill affe ct th e e conomy
only six or nine or tw e lv e or fifte e n month s late r. He nce th e y fe e l im-
pe lle d to ste p on th e brake , or th e acce le rator, as th e case may be , too
h ard.
My ow n pre scription is still th at th e mone tary auth ority go all th e
w ay in av oiding such sw ings by adopting publicly th e policy of ach ie v -
ing a ste ady rate of grow th in a spe cifie d mone tary total. T h e pre cise
rate of grow th , like th e pre cise mone tary total, is le ss important th an
th e adoption of some state d and know n rate . I myse lf h av e argue d for a
rate th at w ould on th e av e rage ach ie v e rough stability in th e le v e l of
price s of final products, w h ich I h av e e stimate d w ould call for some -
th ing like a 3 to 5 pe r ce nt pe r ye ar rate of grow th in curre ncy plus all
comme rcial bank de posits or a sligh tly low e r rate of grow th in curre ncy
plus de mand de posits only.6 But it w ould be be tte r to h av e a fixe d rate
th at w ould on th e av e rage produce mode rate inflation or mode rate de -
flation, prov ide d it w as ste ady, th an to suffe r th e w ide and e rratic pe r-
turbations w e h av e e xpe rie nce d.
Sh ort of th e adoption of such a publicly state d policy of a ste ady
rate of mone tary grow th , it w ould constitute a major improv e me nt if
th e mone tary auth ority follow e d th e se lf-de nying ordinance of av oiding
w ide sw ings. It is a matte r of re cord th at pe riods of re lativ e stability in
th e rate of mone tary grow th h av e also be e n pe riods of re lativ e
stability
in e conomic activ ity, both in th e Unite d State s and oth e r countrie s.
Pe riods of w ide sw ings in th e rate of mone tary grow th h av e also be e n
pe riods of w ide sw ings in e conomic activ ity.
a In an as ye t unpublish e d article on "T h e Optimum Quantity of Mone y," I conclude
th at a still low e r rate of grow th , some th ing like 2 pe r ce nt for th e broade r de finition,
migh t be be tte r ye t in orde r to e liminate or re duce th e diffe re nce be tw e e n
priv ate
and
total costs of adding to re al balance s.
FR IEDMAN: MONET AR Y POLICY 17
By se tting itse lf a ste ady course and ke e ping to it, th e mone tary au-
th ority could make a major contribution to promoting e conomic stabil-
ity. By making th at course one of ste ady but mode rate grow th in th e
quantity of mone y, it w ould make a major contribution to av oidance of
e ith e r inflation or de flation of price s. Oth e r force s w ould still affe ct th e
e conomy, re quire ch ange and adjustme nt, and disturb th e e v e n te nor of
our w ays. But ste ady mone tary grow th w ould prov ide a mone tary cli-
mate fav orable to th e e ffe ctiv e ope ration of th ose basic force s of e nte r-
prise , inge nuity, inv e ntion, h ard w ork, and th rift th at are th e true
springs of e conomic grow th . T h at is th e most th at w e can ask from
mone tary policy at our pre se nt stage of know le dge . But th at much -
and it is a gre at de al-is cle arly w ith in our re ach .
R EFER ENCES
1. H. S. ELLIS, e d., A Surv e y of Conte mporary Economics. Ph ilade lph ia 1948.
2. MILT ON FR IEDMAN, "T h e Mone tary T h e ory and Policy of He nry Simons,"
Jour. Law and Econ.,
Oct. 1967, 10, 1-13.
3. , A Program for Mone tary Stability. Ne w York 1959.
4. E. A. GOLDENWEISER , "Postw ar Proble ms and Policie s," Fe d. R e s. Bull.,
Fe b. 1945, 31, 112-21.
5. P. T . HOMAN AND FR IT Z MACHLUP, e d., Financing Ame rican Prospe rity.
Ne w York 1945.
6. A. P. LER NER AND F. D. GR AHAM, e d., Planning and Paying for Full Em-
ployme nt. Prince ton 1946.
7. J. S. MILL, Principle s of Political Economy, Bk. III, Ash le y e d. Ne w York
1929.