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Bright Promises, Dismal Performance: An Economist's Protest
by Milton Friedman
The Case for a Monetary Rule - February 7, 1972

I and most other monetarists have long favored a policy of a steady and moderate rate of growth of the quantity of money. We have strongly opposed the Fed’s trying to fine-tune the economy.

Recent policy conformed to our prescription only in 1970.

Critics ask why we are so modest. Why not use the powerful instrument of monetary policy to offset other forces pushing the economy toward inflation or recession? Why tie the hands of the Fed? Why not trust their discretion in adapting changing circumstances?

We favor the rule of steady monetary growth for several reasons.

1. The Past Performance of the Fed.
Throughout its history, the Fed has proclaimed that it was using its powers to promote economic stability. But the record does not support the claim. On the contrary, the Fed has been a major source of instability.

The Fed was responsible for converting what would have been a serious recession after 1929 into a major catastrophe by permitting the quantity of money to decline by one-third from 1929 to 1933, even though it had ample power to vent the decline.

In recent years, the Fed set off the accelerating inflation that President Nixon inherited by expanding the money supply too rapidly in 1967 and 1968, then stepped too hard the brake in 1969, and too hard on the accelerator in the seven months of 1971. Federal Reserve officials have admitted their errors after the fact—as Chairman Burns did in July 1971, in testimony before the Joint Economic committee—and have promised better performance in the future. But then the same forces have produced a repetition of same errors.

We conclude that the urgent need is to prevent the Fed from being a source of economic disturbance.

2. The Limitations of our Knowledge.
Economic research has established two propositions: (1) there is a close, regular, and predictable relation between the quantity of money, national income, and prices over any considerable period of years; (2) the same relation is much looser from month to month, quarter to quarter, or even year to year. In particular, monetary changes take time to affect the economy, and time delay is itself highly variable.

The first proposition means that a steady price level over the long pull requires that the quantity of money grow fairly steady rate roughly equal to the average rate of growth of output.

The second proposition means that any attempt to monetary policy for fine-tuning is likely simply to introduce additional instability. And this is indeed what has happened.

3. The Promotion of Confidence.
An announced, and adhered to, policy of steady monetary growth would provide the business community with a firm basis for confidence in monetary stability that no discretionary policy could provide even happened to produce roughly steady monetary growth.

4. Neutralization of the Fed.
An independent Fed may at times be too insulated from political pressures—as it was in early 1930s—and yet at other times unduly affected by political pressures. If we really knew enough to use monetary policy for fine-tuning, we would probably experience a four- year cycle, with unemployment reaching its trough in years divisible by four and inflation reaching its peak in the succeeding year.

A monetary rule would insulate monetary policy both from arbitrary power of a small group of men not subject to control by the electorate and from the short-run pressures of partisan politics.

Is the rule that we have proposed technically feasible? Can the Fed control the quantity of money? No serious student of money—whatever his policy views—denies that the Fed can, if it wishes, control the quantity of money. It cannot, of course, achieve a precise rate of growth from day to day or week to week. But it can come very close from month to month and quarter to quarter.

As I wrote some five years ago, if the monetary rule were followed, “other forces would still affect the economy, require change and adjustment, and distort the even tenor of our ways. But steady monetary growth would provide a monthly climate favorable to the effective operation of those basic forces of enterprise, ingenuity, invention, hard work, and thrift, that are the true springs of economic growth. That is the most that we can ask from monetary policy at our present stage of knowledge. But that much—and it is a great deal— is clearly within our reach.”