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

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. CPI CONSUMER PRICE INDEX (1982-1984 = 100). 220. 221. The dollar’s link to gold

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

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  1. 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

  2. CPI CONSUMER PRICE INDEX (1982-1984 = 100) 220 221 The dollar’s link to gold was severed on Aug. 15, 1971. 100

  3. CPI (1982-1984 = 100) Last five years 221 220 211

  4. Printing Money and Spending it. CFO Chapter 18, pp. 341-343: Monetarism CFO Chapter 10: The Money Supply and the Federal Reserve System The Equation of Exchange and the Quantity Theory of Money

  5. How much money is there, anyway? But first…. What do we mean by “money”?

  6. Tim Hudson earns a lot of money. Bill Gates has a lot of money. It’s better to buy a house when money is cheap. I need to cash a check to get some money. Money facilitates the exchange of goods and services.

  7. Tim Hudson earns a lot of money. Bill Gates has a lot of money. It’s better to buy a house when money is cheap. I need to cash a check to get some money. Money facilitates the exchange of goods and services. CURRENCY CREDIT MONEY INCOME WEALTH

  8. How much money is there, anyway? (Money is the medium of exchange.) $ 1,861,000,000,000

  9. M1 = $ 1,861 billion Currency and coin: $ 920 billion Checking deposits: $ 941 billion C&C/M1 = 0.494, or about 49.4%

  10. M1 = $ 1,861 billion Currency and coin: $ 920 billion US Population: 311,000,000 Per capita C&C: $ 2,958 Per family of four: $ 11,833 Just who’s holding all this C&C?

  11. M is the money supply. M1 = $ 1,861 billion Inquiring 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?

  12. Monetarism Friedman was a Marshallian, but he was a macroeconomist. He had his own research Agenda: Money and Inflation. And he was out to counter Keynesian theory and policy. MILTON FRIEDMAN

  13. M stands for the Money supply. M1 = $ 1,861 billion GDP = Y = $ 14,870 billion V = Y/M = 14,870 / 1,861 = 7.99

  14. MV = Y M M1 = $ 1,861 billion GDP = Y = $ 14,870 billion V = Y/M = 14,870 / 1,861 = 7.99

  15. MV = Y = E M1 = $ 1,861 billion --with “investment” to incl. excess inventories GDP = Y = $ 14,870 billion V = Y/M = 14,870 / 1,861 = 7.99

  16. MV = Y = E = PQ M1 = $ 1,861 billion --with “investment” to incl. excess inventories GDP = Y = $ 14,870 billion V = Y/M = 14,870 / 1,861 = 7.99

  17. MV = Y = E = PQ 2008: V = 10.18 2009: V = 9.09 2010: V = 8.22 2011: V = 7.99 --with “investment” to incl. excess inventories Dating from the beginning of the most recent contraction, the velocity of money has declined.

  18. MV = Y = E = PQ 2008: V = 10.18 2009: V = 9.09 2010: V = 8.22 2011: V = 7.99 11.0 10.0 9.0 V E L O C I T Y 8.0 7.0 6.0 5.0 2008 2009 2010 2011 2012 Dating from the beginning of the most recent contraction, the velocity of money has declined.

  19. MV = PQ M is the money supply (outside the banking system). V is money’s velocity of circulation. P is the price level. Q is the economy’s output. PQ is total expenditures (E). MV is total income (Y)

  20. A SAMPLE QUESTION 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.

  21. MV = PQ This is the “Equation of Exchange.” No economist, dead or living, has ever denied that MV actually does equal PQ... …because V is defined as PQ/M.

  22. MV = PQ In normal times: V doesn’t change much. Q changes in the low single digits.

  23. Keynes believed that the velocity of money was subject to dramatic and unpredictable change. He believed that people “hoard” money, more so some times than others. (increased hoarding means a decrease in velocity.) In extreme episodes, people may be overcome by the “fetish of liquidity,” the fetish often accompanying the waning of animal spirits.

  24. MV = PQ So, what happens when M is doubled—say, from $ 1,861 billion to $ 3,722 billion? P would also double. But the doubling of P takes time.

  25. MV = PQ In the long run and with a constant V, the price level (P) moves in proportion to the money 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.”

  26. MV = PQ More generally, In the long run, money-supply growth inexcess of real economic growth impinges wholly on the price level (P) and not at all on the level of real output. Put bluntly: you can’t create real wealth by slapping green ink on paper.

  27. Monetarism MV = PQ This is the unadorned tautology that we call the Equation of Exchange

  28. Monetarism MV = PQ 18-30 months This is the “Quantity Theory of Money.” (The Quantity of Money Theory of the Price Level) In the long run, increases in M affect nothing but P (and W).

  29. Monetarism Keynesianism is to Keynes as Monetarism is to • Ben Bernanke. • Tim Geithner. C. Claude Monet. D. Milton Friedman.

  30. Milton Friedman (1912 - 2006) • MV = PQ • Inflation is always and everywhere a monetary phenomenon!!!

  31. The equation of exchange is so near and dear to Milton Friedman’s heart that he C. has written a parody to the popular Y.M.C.A to memorialize the equation in song. B. has had it spelled out in pansies in the flower garden at Stanford’s Hoover Institution. D. has adopted it as his vanity license plate number for his Cadillac Eldorado. A. has made his wife Rose promise that it will make a tasteful appearance on his head stone.

  32. The equation of exchange is so near and dear to Milton Friedman’s heart that he • tasteful appearance on his head stone. • B. spelled out in pansies in flower garden. • C. parody to the popular Y.M.C.A. • D. vanity license plate number. Gribouillis économiques

  33. GREG MANKIW’S BLOG Random Observations for Students of Economics September 16, 2006: Curious question from Mankiw: “How can you identify my car?” Gregory Mankiw Former Chairman Council of Economic Advisors George W. Bush Administration

  34. mvpy writes: • You know, I hate to spoil things, but I must say, I think Milton Friedman has a better plate. This is from an article I came across:"Years ago, trying to find the Friedman’s apartment in San Francisco, I knew I was in the right location when I spotted a car with 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.. • Canée writes: • I love economists.

  35. Monetarist Policy FOR A GROWING ECONOMY MV = PQ Normally, a healthy economy will experience real economic growth amounting to 2% or 3% per year. Policy implication: Increase M at a slow, steady rate (2% or 3%) to match the long-run rate of growth.

  36. Monetarist Policy FOR A GROWING ECONOMY MV = PQ With this “Monetarist Rule” in effect, there will be no inflation and no deflation. Price-level stability is the hallmark of macroeconomic stability.

  37. Monetarism Some diagnostics: With the “Monetarist Rule” in effect (2 or 3%) and a constant V, the rate of inflation would be zero—or very close to zero. Has the rate of inflation been zero?

  38. Monetarism Some diagnostics: CPI for 1982-1984 = 100 CPI for January 2010 = 216 That is, prices on average are more than double now what they were in the early 1980s. (See FRED.)

  39. CPI CONSUMER PRICE INDEX (1982-1984 = 100) Last five years of the CPI

  40. Monetarism MV = PQ Some 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?

  41. Monetarism MV = PQ Q 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 accordance with the monetary rule) at the rate of 2.5% per year.

  42. Monetarism 2.80% 2.50% 0.90% 0.60% MV = PQ

  43. Monetarism If M had risen at the rate of 2.5% over the period 1983—2008 and P had risen at the rate of 0.60%, the current CPI would be 115.0 instead of 216. That is, prices in general would’ve been only 15% higher than they were in 1983.

  44. 5.0% Monetarism 2.80% 3.1% 0.90% MV = PQ

  45. Monetarism Q 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 $1,383 billion (in 2008), more than tripled. P more than doubles (from 100 to 216

  46. 10% 9% 8% 7% 6% T H E N A T U R A L R A T E O F U N E M P L O Y M E N T 5% 1992 2011 4%

  47. 10% 9% 8% 7% SEPT 11 2001 6% 5% 4%

  48. SEPT 11 2001

  49. SEPT 11 2001

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