MILTON FRIEDMAN SAID THE FEDERAL RESERVE SHOULD RAISE INTEREST RATES 2% EACH YEAR.BUT HE WAS AGAINST INFLATION IT DOESN'T MAKE SENSE?HOW CAN MILTON FRIEDMAN BE AGAINST INFLATION IF HE SAID HE WANTS...

MILTON FRIEDMAN SAID THE FEDERAL RESERVE SHOULD RAISE INTEREST RATES 2% EACH YEAR.BUT HE WAS AGAINST INFLATION IT DOESN'T MAKE SENSE?

HOW CAN MILTON FRIEDMAN BE AGAINST INFLATION IF HE SAID HE WANTS THE FED TO RAISE INTEREST RATES ISNT THAT A CONTRADICTION?

Asked on by jkjhgbh

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pohnpei397's profile pic

pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted on

I'd be astonished if he said he wanted the Fed to raise interest rates that much each year.  Are you sure you're not thinking about how he wants the money supply to go up by a certain amount each year?

Assuming that you are asking about the increase in the money supply...  The main reason why this would not cause inflation is that (Friedman assumes) the REAL GDP would rise by at least that 2% each year.  If this is the case, then there's no inflation because along with the increase in money supply there's an increase in the value of available goods.  If inflation is caused by too much money chasing too few goods, then increasing the value of available goods will make it so there's no inflation.

Another (related) argument is that the increase in money supply could also lead to an increase in aggregate supply in the economy.  An increase in AS would offset any potential increase in aggregate demand and the price level would not rise.

 

 

krishna-agrawala's profile pic

krishna-agrawala | College Teacher | (Level 3) Valedictorian

Posted on

I do not know what Milton Friedman said, but it is quite unlikely that he suggested raising interest rate 2% each year. Particularly the bit about "each year" makes no sense. However we can still consider the relationship between interest rate and inflation.

The prices of economic are dependent on the total demand. More the demand for a good, higher its prices are likely to be in the short run. When the the general demand for a wide variety goods increases the simultaneously the prices of all these increase also. We call a condition like this as inflation.

Inflation implies that the total demand in the market for all the goods in the economy has risen faster than the actual availability of goods. This mismatch in variations in supply and demand of goods happens due to several reason including the following.

  • The part of the goods produced representing creation of additional capital goods, that are not available for immediate production of consumable goods. The people receive wages for the efforts put in by them for producing such capitals. They also receive price for other factors of production used in this way. But there are no consumer goods created in short run corresponding to such additional purchasing power available with people.
  • People may spend more or less than they earn on buying and consuming goods immediately. This happens because people may save money for future,spend money saved earlier, or borrow money. The inflation is caused by the total purchasing power in this way exceeding the total goods available for purchase.

Interest rates impacts the economy in a complex way, One of the effect is to influence the tendency of people to save and borrow. A higher interest rates encourages people to save more and borrow less. In this way increase in interest rates tends to reduce the total spending in the economy and bring down the inflation.

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