Monetary Policy within the IS-LM Framework

Chapter 7

Discretionary Policies

Friedman’s restatement of the quantity theory in 1956 ended practically 20 years of dominance of the use of discretionary policy through fiscal policy. He addressed the three main problems with the classical quantity theory that allowed fiscal policy to become a viable alternative. The problems were due to unrealistic assumptions that were contrary to evidence, such as the constancy of velocity, disjoint between income and money, and exogeneity of the supply of money. It is possible that changes in supply of money are offset by changes in velocity, that real income might be affected by monetary factors, and that an endogenous money supply makes sense because the FED does not operate in a vacuum. Friedman1 defines ...