Monetarism and Money supply

8/12/2019 Monetarism and Money supply

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Milton Friedman ( 1912 - 2006 )The Revival of the Equation of Exchange

and the Quantity Theory of Money

A Great Economist And a Product of his Times

Roger W. Garrison 2011


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CPICONSUMER PRICE INDEX

(1982-1984 = 100)

220 221

100


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220

221CPI(1982-1984 = 100)

Last five years

211


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Printing Moneyand Spending it.

The Equation of Exchangeand the Quantity Theory of Money

CFO Chapter 18, pp. 341-343:Monetarism

CFO Chapter 10:The Money Supply

and the Federal Reserve System


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How much moneyis there, anyway?

But first. What do we mean by money?


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Tim Hudson earns a lot ofmoney.

Bill Gates has a lot ofmoney.

Its better to buy a housewhen money is cheap.

I need to cash a check to

get some money.Money facilitates theexchange of goods andservices.


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Tim Hudson earns a lot ofmoney.

Bill Gates has a lot ofmoney.

Its better to buy a housewhen money is cheap.

I need to cash a check to

get some money.Money facilitates theexchange of goods andservices.

CURRENCY

CREDIT

MONEY

INCOME

WEALTH


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How much money is there, anyway?

(Money is the medium of exchange.)

$ 1,861,000,000,000
http://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=M1http://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=M1http://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=M1http://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=M1


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Checking deposits: $ 941 billion

C&C/M1 = 0.494, or about 49.4%

M1 = $ 1,861 billion

Currency and coin: $ 920 billion
http://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=CURRSLhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=CURRSLhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=CURRSLhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=CURRSLhttp://research.stlouisfed.org/fred2/graph/?s%5b1%5d%5bid%5d=CURRSL


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Currency and coin: $ 920 billion

US Population: 311,000,000

Per capita C&C: $ 2,958

Per family of four: $ 11,833

Just whos holding all this C&C?



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M is the money supply.

M1 = $ 1,861 billionInquiring minds want to know:

Has M1 always been $1,861 billion?How does more MI get created?Who makes the decisions?Is more money always a good thing?

Are there some politics in play?

Did Keynes actually ignore M?


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MonetarismFriedman was a Marshallian,but he was a macroeconomist.He had his own research

Agenda: Money and Inflation.

And he was out to counterKeynesian theory and policy.

MILTON FRIEDMAN


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M stands for the Money supply.


GDP = Y = $ 14,870 billion

V = Y/M = 14,870 / 1,861 = 7.99


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MMV = Y



V = Y/M = 14,870 / 1,861 = 7.99


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MV = Y = E



V = Y/M = 14,870 / 1,861 = 7.99


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MV = Y = E = PQ



V = Y/M = 14,870 / 1,861 = 7.99


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MV = Y = E = PQ2008: V = 10.182009: V = 9.092010: V = 8.22

2011: V = 7.99

Dating from the beginning of the most recent

contraction, the velocity of money has declined.


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MV = Y = E = PQ2008: V = 10.182009: V = 9.092010: V = 8.22

2011: V = 7.99

Dating from the beginning of the most recent

contraction, the velocity of money has declined.

2008 2009 2010 2011 2012

5.0

6.0

7.0

8.0

9.0

10.0

11.0

V E L O

C I T Y


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MV = PQM is the money supply(outside the banking system).

V is moneys velocity of circulation. P is the price level.Q is the economys output. PQ is total expenditures (E).

MV is total income (Y)


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How much money is there, anyway? A. M1 is a little under $1.861 billion.

B. M1 is a little under $6.168 billion.C. M1 is a little under $1.861 trillion.

D. M1 is a little under $6.168 trillion.

Ask FRED. (FRED means Federal Reserve Economic Data.)

Click on Ben to go there.

A SAMPLE QUESTION
http://research.stlouisfed.org/fred2/


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Keynes believed that the velocity ofmoney was subject to dramatic andunpredictable change.

He believed that people hoard money,

more so some times than others.(increased hoarding means a decreasein velocity.)

In extreme episodes, people may beovercome by the fetish of liquidity,the fetish often accompanying thewaning of animal spirits.


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MV = PQSo, what happens when M isdoubled say, from $ 1,861billion to $ 3,722 billion?

P would also double.

But the doubling of P takes time.


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MV = PQIn the long run and with a constant V, theprice level (P) moves in proportion to themoney supply (M) in a no-growth (i.e.,constant-Q) economy.

This is The Quantity Theory of Money. A more descriptive name would be: The Quantity of Money Theory of the Price Level.


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MV = PQMore generally,

In the long run, money-supply growth in excess of real economic growth impingeswholly on the price level (P) and not at allon the level of real output.

Put bluntly: you cant create real wealth

by slapping green ink on paper.


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MonetarismMV = PQ

This is the unadorned tautologythat we call the Equation of Exchange


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This is the Quantity Theory of Money.

(The Quantity of Money Theory of the Price Level)

MV = PQIn the long run, increases in M

affect nothing but P (and W).

18-30 months

Monetarism


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A. Ben Bernanke.

B. Tim Geithner.

Keynesianism is to Keynes as Monetarism is to MonetarismC. Claude Monet.

D. Milton Friedman.


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Milton Friedman (1912 - 2006)

MV = PQ Inflation is always

and everywhere

a monetaryphenomenon!!!


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C. has written a parody to the popularY.M.C.A to memorialize the equation insong.

The equation of exchange is so near and dear

to Milton Friedmans heart that he

B. has had it spelled out in pansies in theflower garden at Stanfords HooverInstitution.

D. has adopted it as his vanity license platenumber for his Cadillac Eldorado. A. has made his wife Rose promise that it

will make a tasteful appearance on hishead stone.


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GREG MANKIWS BLOG


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Gregory MankiwFormer ChairmanCouncil of Economic AdvisorsGeorge W. Bush Administration

GREG MANKIW S BLOG Random Observations for Students of Economics

September 16, 2006:Curious question from Mankiw:How can you identify my car?

mvpy writes:


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mvpy writes:

You know, I hate to spoil things, but I must say, I think MiltonFriedman has a better plate. This is from an article I came across:

"Years ago, trying to find the Friedmans apartment in SanFrancisco, I knew I was in the right location when I spotted a carwith the number plate MV = PT."

A. Delaique writes:

Milton Friedman's license plate was MV = PQ, not MV = PT.Picture here : http://gribeco.free.fr/article.php3?id_article=12

Anonymous writes:

That's pretty ridiculous. .

Cane writes:

I love economists.
http://gribeco.free.fr/article.php3?id_article=12http://gribeco.free.fr/article.php3?id_article=12


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Normally, a healthy economy willexperience real economic growthamounting to 2% or 3% per year.

MV = PQPolicy implication: Increase M at aslow, steady rate (2% or 3%) tomatch the long-run rate of growth.

Monetarist PolicyFOR A GROWING ECONOMY


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MV = PQWith this Monetarist Rule in effect,there will be no inflation and no deflation.

Price-level stability is the hallmark ofmacroeconomic stability.

Monetarist PolicyFOR A GROWING ECONOMY


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MonetarismSome diagnostics:

With the Monetarist Rule in effect(2 or 3%) and a constant V, the rate

of inflation would be zero or veryclose to zero.

Has the rate of inflation been zero?


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MonetarismSome diagnostics:CPI for 1982-1984 = 100

CPI for January 2010 = 216

That is, prices on average are morethan double now what they were in

the early 1980s. (See FRED .)
http://research.stlouisfed.org/fred2/series/CPIAUCSL/9/5yrshttp://research.stlouisfed.org/fred2/series/CPIAUCSL/9/5yrs


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CPICONSUMER PRICE INDEX

(1982-1984 = 100)Last five years of the CPI


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MonetarismSome diagnostics:

Has Q been falling for the past 25 years?

Has V been rising for the past 25 years?

Has M been rising for the past 25 years?

MV = PQ


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MonetarismQ rose by 88.5%, which is 2.80% per year.

V rose by 23.7%, which is 0.90% per year.

Suppose M had increased (in accordancewith the monetary rule) at the rate of2.5% per year.

MV = PQ


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Monetarism

MV PQ

2.50% 2.80%

0.90% 0.60%


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MonetarismIf M had risen at the rate of 2.5% overthe period 1983 2008 and P had risen atthe rate of 0.60%, the current CPI wouldbe 115.0 instead of 216.

That is, prices in general wouldve beenonly 15% higher than they were in 1983.


45/78MV PQ

5.0%

2.80%

0.90%

3.1%

Monetarism


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MonetarismQ rose by 88.5%, which is 2.80% per year.

V rose by 23.7%, which is 0.90% per year.

M actually increased by 5.0% per year.

M, which rose from $450 billion to $1,383billion (in 2008), more than tripled.

P more than doubles (from 100 to 216


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T H E N T U R L R T E

O F U N E M P L O Y M E N T


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S E P T 1 1 2 0 0 1


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S E P T 1 1 2 0 0 1


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S E P T 1 1 2 0 0 1


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Sidewalk Survey on Dexter Avenue:

Whats the cause of inflation? Greed.

Oil companies.Medical industry.

Home-building industry.Labor unions.


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The Jane Fonda bull-by-the-hornapproach to ending inflation.

Identify major groups of productswhose prices have risen the most:

energy, medical, housing, food.

Enact pricing policies that hold theprices in these areas down andthereby counter the inflationarypressures.


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What about the major groups ofproducts whose prices have fallenthe most:

computers, cameras, electronics.

Is the economic activity in theseareas creating deflationary

pressures?


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The P in the equation of exchangeis measured by the CPI (or the

WPI or GPI), which is a priceindex. The index tracks theaverage of all prices.

MV = PQCPI = avg.(p 1 , p 2 , p 3 , p 4 , p gasoline , p n )


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?

Good arithmetic; bad economics.

MV = PQ

CPI = avg.(p 1 , p 2 , p 3 , p 4 , p gasoline , p n )


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Many other prices go down.

-- the price of complements (RVs)

--the price of so- called normalgoods generally (restaurant meals).

CPI = avg.(p 1 , p 2 , p 3 , p 4 , p gasoline , p n )

Some other prices go up, too.

--the price of substitutes (firewood).

--the price of goods and services for whichoil in a substantial input (airfares).


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Suppose that unrest in the Middle East causes areduction in the supply of oil flowing to the U.S., whichleads to a 20% increase in the price of oil. Economistswho accept the quantity theory of money will claim that A. prices in general will rise because everything

depends upon (is related to) oil.B. the Federal Reserve should increase the moneysupply so that people can pay the higher gas prices.

C. whatever the Federal Reserve does, there will besubstantial inflation although not a 20% inflation rate.D. there will be no inflation in the U.S. so long as theFederal Reserve does not increase the money supply.

Bubbalonia


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a. Increasing Q.b. Decreasing Q

c. Increasing V.d. Decreasing V.

e. Increasing M.

f. Decreasing M.

Bubbaloniais experiencing inflation.

Prices in general are rising.What are the log ica lly po ss ib le causes,

as implied by the Equation of Exchange?What is the actual ( em pir ica lly demo ns t rated )

cause according to the Quantity Theory?g. Increasing gas prices.

h. Credit-card mania.i. Labor unions.

j. Greed.

MV = PQINFLATION

IS ALWAYS AND EVERYWHEREA MONETARY PHENOMENON.

--- Milton Friedman


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Suppose that new taxes on tobacco products causethe tax-included price of cigarettes to double.Microeconomists would predict that the quantity oftobacco products bought will fall only slightly andthat total spending on cigarettes will nearly double.

Monetarists would claim that the tax will A. result in a slightly higher rate of inflation.B. cause the Federal Reserve to undertake

compensatory policy actions.C. have no effect on the general price level.D. result in a slightly higher velocity of money.

C l i il i t


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Can you apply similar reasoning toshow that none of the other oft-

mentioned culprits are responsiblefor inflation?

Greed.

Oil companies.

Medical industry.Home-building industry.

Labor unions.


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Do labor unions cause inflation?

Labor unions can call a strike or just threaten to call a strike inorder to get higher wages.

And higher wages get translatedinto higher prices.

Thats inflation, isnt it?


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W

N

S

D

Union labor


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W

N

S

D

ND

S

S

W

Union labor

Non-union labor


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W

N

S

D

ND

S

S

W

Q

D

SS P

Product market

Non-union labor

Union labor


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W

N

S

D

ND

S

S

W

Q

D

S

S

P

Q

D

SS P

Non-union labor

Union labor

Product market

Product market


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Do labor unions cause inflation?

No. But they can cause the prices ofgoods made by unionized labor torise and the prices of goods made

by non-unionized labor to fall.However, if the central bank

increases the money supply in anattempt to neutralize the effects oflabor unions, the general price level

will rise


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A Ceiling on Your Home (1945)

By the Office of Price Administration(OPA)

Synopsis: [This 12 minute film] showsthe economic factors affectingpostwar inflation and an appeal forpublic cooperation, an appeal to thepublic to assist in retail price control,and the difficulties veterans faced inlocating jobs and housing.

CLICK ON POSTER GIRL TO SEE VIDEO
http://www.archive.org/details/Ceilingo1945


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Reviewer: ERD -- March 7, 2006Subject: "Ceiling on Your Home" does a good job

This 1945 film does a good job explaining about thepurpose of rent control after World War II. Excellentnarrative script and filming.


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Reviewer: Christine Hennig -- December 9, 2003Subject: No Rentals Today, But Keep in Touch!

This post-WWII film advocates rent control as a way tocontrol inflation as a result of the post-war housingshortage. It portrays young couples struggling to find adecent place to live and start their families, and findingNO RENTALS signs everywhere. This is an interestingslice of life from the post-WWII era, before the problemwould be eventually solved by huge housingdevelopments in the suburbs.


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Reviewer: Spuzz -- February 26, 2003Subject: Rent Rant.

As the boys were coming home from war, much concern(I guess) was made about the lack of affordable housingfor the soldiers and their new families. Luckily, the Officeof Price Administration (whatever that is) was there tosee that there was rent fixing, and that everyone wouldpay the same price. A persuasive film with plenty of greatimages.


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Is it possible to increase the moneysupply without causing inflation?

Suppose that the velocity ofmoney can (somehow) be made to

fall as the money supply was beingincreased?

Couldnt an increased M and adecreased V combine to allow for aconstant price level?

Th A ti i fl ti i


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The Anti-inflation campaignof the Ford Administration

WIN

WhipInflationNow

Th A ti i fl ti i


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MV=PQPeople should weartheir WIN buttons.

They should look forbargains

holding on to theirmoney while theylook.Dont spend it.

Just hold it.

Th A ti i fl ti ig


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MV=PQThe Federal Reserveis increasing themoney supply.

That means thatprices will be rising.

Its called inflation.

What can you do tokeep inflation fromoccurring?

Th A ti i fl ti ig


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You can earn moneyand then just holdon to it.

Holding on to moneymeans a decrease invelocity.

The decreased V willoffset our increasingM, keeping P fromrising.

In other words, thegovernment cancreate money andspend it, and thatwont cause inflation

if you are willing toearn money and notspend it.


MV=PQ

Th A ti i fl ti ig


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MV=PQ: Its alwaysright, but there areno votes in it.


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Milton Friedman (1912- 2006)

MV = PQ

Inflation isalways andeverywhere

a monetary phenomenon!!!

Monetarism and Money supply

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