The Quantity Theory of Money and Friedmanian Monetary Policy: An Empirical Investigation

Abstract:     
We introduce an approach for the empirical study of the quantity theory of money (QTM) that is novel both with respect to the specific steps taken as well as the general methodology employed. Empirical studies of the QTM have focused directly on the relationship between the rate of change of the money stock and inflation. We believe that this is an inferior starting point for several reasons and focus instead on the Cambridge form of the QTM. We find that the coefficient k fluctuates strongly in the short run, but has a low and steady rate of change in the long run, which makes the QTM a useful instrument for the long-run control of inflation. An important finding that contradicts all of the previous literature is that the QTM holds for low inflation as well as for high inflation. We discuss how our findings relate to monetarism generally and propose an adaption of McCallum’s rule for a Friedmanian monetary policy.

Number of Pages in PDF File: 26

Keywords: Cambridge equation, Friedman’s k rule, monetarism, quantity theory

JEL Classification: E310, E410, E510, E590

working papers series