Criticism of Lucas, Friedman's Monetary Rule - Monetary...

Lucas's Criticism

The American economist Lucas did not agree with such an interpretation. Vulnerable place of the old (or traditional) classical theory is the absence of the impact of expectations. The classical theory implicitly assumes that the expectations of economic agents, primarily inflation expectations, do not change in response to changes in monetary policy:

However, according to Lucas, in fact - and this is shown by monetary practice - expectations really change in response to this or that action of monetary authorities. When the money supply increases, inflation expectations also increase:

As information is distributed unevenly among economic agents, some companies and individuals can respond to rising prices by increasing employment and output, considering this growth not as an inflation factor, but as a driver only for their own industry market. The asymmetry of information slows the action of price signals. The aggregate supply in the short term will be characterized by a positive slope:

where E t-1 P t is the inflation expectations operator.

If , for example, in case of unexpected changes in the money supply, then y t ↑, production in the economy increases. Therefore, money is not neutral, at least in the short term, even if we rely on the basic principles of the classical model.

Friedman's Monetary Rule

Even if monetary policy can have any real impact in the short term, this does not mean that money should be used as an instrument for stabilizing output. American economist Milton Friedman believed that the best monetary policy should adhere to the rule of constancy of the money supply:

t t = const; t t & gt; 0.

Monetary policy does have a significant impact on the economy. However, this influence is not always adequate. Let, for example, during the period 1 there is an overheating of the economic conjuncture, and the monetary authorities want to prevent the inflation of the financial bubble by restraining monetary policy. However, in order to take the necessary measures, sufficient justification is required - data collection and monitoring of economic parameters take time. The economy is already in period 2. Data analysis and monetary decision-making occur in period 3, and the real impact of the money supply will be in period 4, when the economy itself begins to recover. During this period, the deterrent measures of monetary authorities can lead to destabilization of output, toughening the crisis or preventing a new recovery and recovery.

Thus, due to the presence of numerous lags, active (activist) monetary policy, instead of stabilizing output, will help destabilize the economy and increase its volatility. To mitigate the negative consequences of monetary policy can only be if we adhere to a stable and long-term monetary rule, clearly and clearly understood by all participants in the economic process.

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