MLI Paper – Rules-based monetary policy delivers results: Too many countries relying on discretion
OTTAWA, June 11, 2012 – In a period of runaway monetary stimulus by the industrialized world, two distinguished economists write about the invaluable contributions of Milton Friedman – lessons that are once again worth revisiting.
Friedman led the counter-revolution to the popular mid-20th Century theories of John Maynard Keynes – theories that contributed to economic stagnation in western countries. Friedman’s challenge to the Keynesian consensus that governments could regulate the business cycle eventually triumphed, and set those same countries on the path to three decades of prosperity.
At the advent of Friedman’s 100th birthday, two essays on Friedman’s theories around monetary policy have been published by the Macdonald-Laurier Institute. They are written by distinguished economists Allan Meltzer of Carnegie-Mellon University and Jerry Jordan, former president of the Cleveland Federal Reserve Bank.
In his essay Milton and Monetarism, Allan Meltzer writes that there have been enormous benefits to those countries that moved towards a rules-based approach to monetary policy, as advocated by Friedman versus the discretion policies advocated by Keynesians. For many years, Friedman was the leading – and often only – proponent of a monetary rule.
Some of the rules aim at stabilizing growth of nominal GDP at a low rate of inflation. According to Meltzer, a world-leading scholar in monetary policy, announcing and following a rule is the only way to restore independence and is also effective in reducing the extraordinary increase in excess reserves.
Meltzer concluded that “Today, rule-like behaviour is an accepted conclusion, and several central banks – including Canada’s central bank – follow rule-like procedures. Unfortunately, the U.S. Federal Reserve does not.”
In the second essay, Friedman and the Phillips Curve, Jerry Jordan takes on the underlying premise of Keynesian monetary policy – and concludes it is based “on fallacious reasoning and faulty empirical testing.”
“The notion of a trade-off between unemployment and inflation surely ranks among the most subversive ideas in economics,” writes Jordan.
These two essays provide important insights into the rules and principles that best guide monetary policy as well as helping to illuminate the ways in which Friedman enhanced our understanding. The Macdonald-Laurier Institute is pleased and honoured to publish essays by these two internationally recognized economists.
Jerry L. Jordan is former president of the Cleveland Federal Reserve Bank and earned a doctorate in economics from UCLA and holds honorary doctorates from Denison and Capital universities. Allan H. Meltzer is the Allan H. Meltzer University Professor of Political Economy at Carnegie Mellon University.
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The Macdonald-Laurier Institute is the only non-partisan, independent national public policy think tank in Ottawa focusing on the full range of issues that fall under the jurisdiction of the federal government. www.macdonaldlaurier.ca.
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