8.4 The Money Multiplier

the monetary authorities should be replaced by a robot programmed to increase the money supply at a low, constant rate a controversial prescription known as the monetarist rule.
The Rules-Versus-Discretion Debate
Monetarists advocate their rule for several reasons:
1. It guarantees a low long-run rate of inflation. This creates a stable economic environment conducive to long-term investment projects, a necessary ingredient in the promotion of long-term growth.
2. It creates automatic stabilizing forces. As the economy moves into recession, income and thus the demand for money grow more slowly. If money-supply growth is kept steady, the slowdown in money-demand growth causes an excess money supply that begins to stimulate the economy and pushes it out of recession. If the economy overheats and begins to experience high inflation, the higher prices increase the demand for money, and an excess demand for money develops. This cuts back aggregate demand (as people stop spending to accumulate more money), which puts a damper on the inflationary forces.
3. It insulates monetary policy from politics. Just before an election, politicians are tempted to pump up the money supply, letting the later fallout of higher inflation appear after the election.
4. It prevents the Fed from making mistakes. History has shown that the Fed makes many mistakes in its efforts to use discretionary monetary policy to improve the economy. Although major mistakes such as its failure to serve as a lender of last resort during the Great Depression and its overly expansionary monetary policy during the Vietnam war have become less and less frequent over time as the Fed has learned, monetarists argue that even a clever and well-intentioned Fed is doomed to make mistakes continually because of the extreme complexity of the economy. For example, the magnitude of the income multiplier with respect to the money supply is uncertain and changing; the lags of monetary policy in affecting the economy are long, variable, and unpredictable; and forecasting the economy's behavior is difficult.
However, those who believe in the use of discretionary monetary policy offer cogent criticisms of this monetarist prescription:
1. Unstable velocity. Although most economists concur with the general logic of the inflation equation, they note that to make it operational, a specific measure of the money supply must be chosen in particular one for which velocity is constant, or at least growing at a constant rate. As a result of banking innovations and financial deregulations, M1 velocity and, to a lesser extent, M2 velocity have behaved irregularly at times, as illustrated in figure 9.4. This objection is summarized in amusing fashion by Goodhart's law: what-


Macroeconomic Essentials. Understanding Economics in the News 2000
Macroeconomic Essentials - 2nd Edition: Understanding Economics in the News
ISBN: 0262611503
EAN: 2147483647
Year: 2004
Pages: 152

Similar book on Amazon

flylib.com © 2008-2017.
If you may any questions please contact us: flylib@qtcs.net