What does MV = PQ Mean for America?
As prices rise and economic uncertainty becomes a daily reality, many Americans are left grappling with the question: how did we get here? With inflation eating away at purchasing power, the need for a sound monetary policy has never been more pressing. In these turbulent times, the insights of Nobel laureate Milton Friedman shine brightly. His monetarist approach, which emphasizes the importance of controlling the money supply, offers a path towards restoring economic stability and prosperity—one that current policies have largely overlooked.
Friedman’s central insight was simple yet profound: “Inflation is always and everywhere a monetary phenomenon.” This statement, made in 1970, encapsulates the core of monetarist theory. It asserts that the primary driver of inflation is an excessive increase in the money supply relative to economic growth. This principle stands in stark contrast to prevailing Keynesian approaches that downplay the role of monetary factors in inflation.
The foundation of Friedman’s monetarism is the Quantity Theory of Money, expressed in the equation MV = PQ, where M is the money supply, V is velocity (how often money changes hands), P is the price level, and Q is the quantity of goods and services. Friedman argued that velocity remains relatively stable over time, meaning changes in the money supply directly impact prices and economic output.
Based on this equation, Friedman emphasized the importance of controlling the money supply to manage inflation. He proposed a “k-percent rule,” suggesting that the central bank should increase the money supply by a fixed percentage each year, regardless of the economy’s position in the business cycle. This rule would remove the central bank’s discretionary power and allow businesses to anticipate monetary policy, limiting changes to the velocity of money.
He also highlighted the role of expectations in inflation. He argued that individuals would expect higher wages if inflation increased, leading to a self-fulfilling cycle. This insight underscores the importance of maintaining credible, consistent monetary policy to anchor inflation expectations.
Friedman’s work also demonstrated the long-term neutrality of money. While changes in the money supply can affect output and employment in the short run, in the long run, they primarily impact prices. This principle emphasizes the importance of focusing on long-term price stability rather than short-term economic manipulation.
Friedman’s ideas gained prominence in the 1970s and early 1980s when the Federal Reserve, under Paul Volcker’s leadership, adopted monetarist principles to combat high inflation. The Fed began targeting monetary aggregates and gradually reduced money supply growth, successfully bringing inflation down from double digits to around 4 percent by late 1983.
It’s important to note that Friedman’s monetarism is not a rigid doctrine. In fact, Friedman himself was open to alternative approaches that achieved the same goals. However, implementing Friedman’s monetarist approach would require a significant shift in our current monetary policy framework. The Federal Reserve would need to focus more explicitly on controlling the money supply rather than manipulating short-term interest rates. This could involve setting clear targets for money supply growth and communicating these targets transparently to the public.
Moreover, adopting Friedman’s approach would necessitate a reevaluation of our fiscal policy. Friedman argued that fiscal policy adjustments do not have an immediate effect on the economy and that market forces are more efficient in making economic determinations. This suggests a more limited role for government intervention in the economy, allowing market mechanisms to play a larger role in resource allocation.
The current economic landscape, characterized by persistent inflation concerns and economic uncertainty, demands a reevaluation of our monetary policy approach. Friedman’s monetarist framework offers a path to greater stability and prosperity. By focusing on controlling the money supply and maintaining long-term price stability, we can substantially improve our current economy. This approach offers a clear path to managing inflation and restoring confidence in our monetary system, a change long overdue.
