ABSTRACT
From our discussion of Friedman’s restatement of the quantity theory in Chapter 11 and the empirical evidence in this chapter, we have seen how money has once more come to be regarded as an important policy variable. We have seen that there is considerable evidence to support the hypothesis that the money supply is a major determinant of the level of economic activity but we have also concluded that the unpredictable lags make it difficult to view the money supply as a useful policy instrument. Indeed, Friedman would argue that the use of the money supply as a short term policy instrument may have been responsible for exacerbating or even causing many short term fluctuations in the economy including the depression of 1929. In the longer term he would argue that the money supply has no effect on real variables and that these tend to their ‘natural’ levels. From these points he derives a more ‘laissez faire’ view of the economic policy than many contemporary economists. He believes that monetary policy should have a passive role with the money supply allowed to grow at such a rate that no short run disequilibria result.
There is, of course, much relevant empirical work which we have not discussed in this chapter but which is covered in considerable detail in the references listed. Inasmuch as it is possible to derive one conclusion from all the empirical work it appears that the major difference between fiscal and monetary policy is ‘in the channels of influence, the speed of response and in the sectoral impact of the policies rather than in the total effectiveness of one and the total impotence of the other’. One might conclude that the purpose of monetary policy could be to create a suitable financial environment for long term growth without causing a short run destabilising influence while fiscal policy should be employed for short run fine tuning of the economy.
In practice, central governments have, in recent years, employed a combination of Keynesian and neo-classical policy instruments reflecting the rather ad hoc approach of trying all possibilities. Whatever view is taken of the theoretical and empirical work of the monetarist school in general and Friedman in particular, there is no doubt that it has provided a great stimulus to both theoretical and empirical macroeconomics.
