Friedman rule

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The Friedman rule is a monetary policy rule proposed by Milton Friedman.[1] Friedman advocated monetary policy that would result in the nominal interest rate being at or very near zero. His rationale was that the opportunity cost of holding money faced by private agents should equal the social cost of creating additional fiat money. Assuming that the marginal cost of creating additional money is zero (or approximated by zero), nominal rates of interest should also be zero. In practice, this means that a central bank should seek a rate of inflation or deflation equal to the real interest rate on government bonds and other safe assets, to make the nominal interest rate zero.

The result of this policy is that those who hold money do not suffer any loss in the value of that money due to

efficiency
considerations.

This is not to be confused with Friedman's k-percent rule which advocates a constant yearly expansion of the monetary base.

Friedman's argument

The

inefficiency
, and by doing so, raise the mean of output.

Use in economic theory

The Friedman rule has been shown to be the welfare maximizing monetary policy in many

U.S. dollars are held overseas, the optimal rate of inflation is found to be anywhere from 2 to 10%, whereas the Friedman rule would call for deflation of almost 4%.[6]

Recent results have also suggested that in order to achieve the goal of the Friedman rule, namely to reduce the

credit spreads are taken into account, the welfare optimality implied by the Friedman rule can instead be achieved by eliminating the interest rate differential between the policy nominal interest rate and the interest rate paid on reserves by assuring that the rates are identical at all times.[7]

Experimental evaluation

While no central bank has explicitly implemented the Friedman rule, experimental economists have evaluated the Friedman rule in a laboratory setting with paid human subjects.[8] Contrary to theoretical predictions, the Friedman rule was not found to be welfare-improving, performing no better than a constant money supply regime. By one welfare measure, Friedman's k-percent rule performed best.

See also

References

  1. ^ M. Friedman (1969), The Optimum Quantity of Money, Macmillan
  2. ^
  3. ^ a b Curdi, Vasco; Woodford, Michael (2010), "The Central-Bank Balance Sheet as an Instrument of Monetary Policy", NBER Working Paper No. 16208