What was Milton Friedman's reasoning behind the 3% growth rule for money supply?
a) monetary neutrality
b) increasing long run economic growth rates
c) minimization of negative supply shocks
d) price stability
Of the choices given here, the best is A. A major reason why Milton Friedman thought that the 3% rule would be a good idea was the fact that he believed in monetary neutrality.
Monetary neutrality is the idea that a central bank cannot really do anything to affect the “real” economy. Instead, it only affects the “nominal” economy. What that means is that monetary policy only affects nominal things such as prices and wages in an economy. It does not affect the real variables such as output and employment.
Today, central banks typically try to manipulate the money supply in response to fluctuations in the business cycle. Friedman believed that these attempts were a bad thing because they could not really improve the real economy. Therefore, he argued that the Fed should simply increase the money supply by a given percent each year. This would allow businesses to know what was going to happen and to plan accordingly. This would make real growth in the economy more likely.
Thus, Friedman’s rule is based on the idea of monetary neutrality.