|By the late 1950s, the majority of macroeconomists had
arrived at a sort of consensus about macroeconomic theory and macroeconomic
policy making. The theory consisted of a short-run view of the world that
looked approximately like the IS-LM and AS-AD models. The long-run view
was more like the classical model: in which prices and wages would eventually
adjust so that the economy returned to the natural rate of output. Fiscal
and monetary policy had effects on output and employment that lasted for
a number of years, but the policy tools could not be used to change output
forever. Economists were also optimistic that the central bank and the
government could use their policy tools effectively to stabilize the economy.
|Beginning in the late 1950s, but taking many years to
surface as an important policy alternative, Milton Friedman and colleagues
began to espouse a different view. Their world-view was conceptually similar
to that of most macroeconomists, but they differed in certain key areas:
|Monetary policy had larger impacts on output than was
|Central banks did not really have a good handle on using
monetary policy. Changes in the money supply had uncertain effects that
last for long periods of time. To get policy right, one needed to be able
to forecast the future path of the economy, and economists are just not
very good at doing this.
|The economy, if left to its own devices, is generally
stable. Central banks were more likely to get things wrong than they were
to get things right, and so attempts to actively use monetary policy to
stabilize the economy were instead likely to destabilize it.
|The best thing the central bank could do was nothing,
and so they should be made subject to rules that stopped them from trying
to fine tune the economy. Instead, they should simply be made responsible
for attaining a low and stable rate of growth in the money supply.
|In this section, we begin by looking at central banking
in a little more detail. We then turn to studying monetarism's basic tenets,
and some of the evidence for Friedman's views on the importance of money.
We then ask whether forecasting is indeed as difficult as claimed, and
if so why.
|Download transparencies for this section here
|Review questions for this section can be found here.