The Quantity Theory Of Money And Taylor 's Rules

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The quantity theory of money and Taylor’s rules offer quite different perceptions about “[to what] extent the structural models should enter the monetary policy decision-making process”()that they appear to be on opposite ends of the spectrum on the issue of monetary policy rules. The quantity theory of money, as restated by Friedman, leads to a constant money growth rule. Monetarists believe that “variation in the money supply has major influences on national real output in the short run and the price level over longer periods, and that objectives of monetary policy are best met by targeting the growth rate of the money supply rather than by engaging in discretionary monetary policy”(). The relationships can be illustrated in the following equation, ∆M+∆V=π+∆Q Where M is the total amount of money in circulation on average in an economy during the period, V is the velocity of money, π is inflation rate, and Q is real output. In the long-run, neutrality of money works which implies a change in the stock of money affects only nominal variables in the economy such as prices level, with no effect on real variables, like real GDP. In short run, however, assuming V is a relatively stable variable, a positive correlation exists between a change in the money supply and a change in real output. Having taken into consideration the indeterminate effect ∆M has on ∆V, Milton Friedman prudently proposed a k-percent rule, where the money supply would be automatically increased by a fixed
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