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The Economic Thermostat

 

            Milton Friedman's main argument in the article "The Fed's Thermostat" is that the Federal Reserve has performed poorly in the attempt to control inflation. The Fed is suppose to help with price stability but this has not been achieved in the past, particularly before the mid 1980's. The Fed controls the high-powered money or the base in the economy. By controlling the base, the Fed can also control M1, M2, or M3 and can make them rise or fall at a rate of 2%, 5%, or 10%. Prior to the mid 1980's, the Fed got into trouble for generating wide fluctuations in the monetary growth per unit of output. But since that time, the Fed has controlled the money supply in a way to offset changes in output and velocity. Friedman believes Alan Greenspan was the new thermostat in the economy. His ideas of controlling inflation are unattainable. Many central banks adopted a policy of inflation targeting which specified a small target range for inflation. But this did nothing to control inflation. Friedman believes the Central Banks have done poorly in the past because they have pursued the wrong goals according to the wrong theory. The Keynes theory taught them that the quantity of money did not matter but what mattered was free spending and the money multiplier. According to the Keynesian theory, inflation resulted from high pressures on cost. The Keynesian theory has now been replaced by New Keynesian economics, which believes monetary policy has substantial effects in the short run but not in the long run. Friedman concludes his article by stating that the equation MV=PY was there all along and was the key to a good thermostat in the economy. .
             The American Consensus reported in "Rocky Mountain High" is the view that our improved economy that has shorter recessions has been a result of improved monetary policy. The Central Bank has received much applause on their success of lowering recession and improving the economy.


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