Can Gradual Interest-Rate Tightening Prevent A Bust? | 11/2/2017 | Staff
maye (Posted by) Level 3
Fed policy makers are of the view that if there is the need to tighten the interest rate stance the tightening should be gradual as to not destabilize the economy.

The gradual approach gives individuals plenty of time to adjust to the tighter monetary stance. This adjustment in turn will neutralize the possible harmful effect that such a tighter stance may have on the economy.

Means - Policy - Damage - Economy - Policies

But is it possible by means of a gradual monetary policy to undo the damage inflicted to the economy by previous loose monetary policies? According to mainstream economic thinking, it would appear that this is the case.

In his various writings, the champion of the monetarist school of thinking, Milton Friedman, has argued that there is a variable lag between changes in money supply and its effect on real output and prices. Friedman holds that in the short run changes in money supply will be followed by changes in real output. In the long run, according to Friedman, changes in money will only have an effect on prices.

Short-run - Years - Changes - Output - Decades

In the short-run, which may be as much as five or ten years, monetary changes affect primarily output. Over decades, on the other hand, the rate of monetary growth affects primarily prices.

According to Friedman, the effect of the change in money supply shows up first in output and hardly at all in prices. It is only after a longer time lag that changes in money start to have an effect on prices. This is the reason, according to Friedman, why in the short run money can grow the economy, while in the long run it has no effect on the real output.

Friedman - Reason - Non-neutrality - Money - Run

According to Friedman, the main reason for the non-neutrality of money in the short run is the variability in the time lag between money and the economy. Consequently, he believes...
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