K-Percent Rule

What Is the K-Percent Rule?

The K-Percent Rule was a proposal by economist Milton Friedman that the central bank ought to increase the money supply by a consistent percentage consistently.

Understanding the K-Percent Rule

The K-Percent Rule proposes to set the money supply growth at a rate equivalent to the economic growth rate every year. Gross domestic product (GDP) is a metric that shows the percentage growth of all goods and services delivered in an economy. In the United States, the ordinary GDP growth rate is 2-4%, based on historical midpoints. The K-Percent Rule would permit the level of money supply in the economy to develop with the GDP growth rate.

Friedman guaranteed that the best method for carrying stability to the economy over the long term was to have central banking specialists naturally develop the money supply by a set percentage or amount (the "K" variable) every year, regardless of economic conditions.

Freidman contended the money supply ought to rise at an annual rate between 3% to 5%. The K-percent rule doesn't permit Fed authorities any slack while making monetary choices. Friedman accepted that monetary policy would be more effective under a rules-based system since discretionary policy could lead to mistakes and extreme monetary reactions to economic conditions.

The Federal Reserve is the central bank of the United States and is accused of dealing with the money supply. Assuming economic growth eases back, the Fed can increase the money supply through different tools, which effectively increases lending through the banking system. For instance, a cut in interest rates regularly leads to a whirlwind of consumers to borrow more money, which is utilized to purchase homes, cars, and different products. These purchases animate the economy by making spending and occupations, which thusly increases economic growth.

As well as proposing the K-Percent Rule, Milton Friedman was a Nobel Prize champ in economics and the pioneer behind monetarism, a branch of economics that singles out monetary growth and related policies as the main driver of future inflation. Inflation is a measure of the pace of rising prices in an economy. Assuming that prices rise too fast, the wages paid to workers would have less purchasing power.

Friedman accepted that monetary policy was a major supporter of cyclical variances in the economy. Attempting to tweak the economy by changing monetary policy, contingent upon economic conditions, was dangerous in light of the fact that too little was known about its effects.

The rule, Friedman contended, would assist with forestalling mistakes by Federal Reserve authorities. For instance, during the 1930s, the Fed diminished the money supply in the U.S. economy, which exacerbated the depression.

Discretionary Monetary Policy

While the U.S. Federal Reserve Board is knowledgeable on the K-percent rule's merits, in practice, most advanced economies in all actuality do base their monetary policy on the state of the economy. At the point when the economy is cyclically weak, the Federal Reserve and others look to develop the money supply at a faster rate than the K-percent rule would recommend.

On the other hand, when the economy is performing great, most central banking specialists seek to oblige money-supply growth. Nonetheless, current U.S. monetary policy isn't a rules-based system that is just set off based on economic conditions. All things being equal, the policy is discretionary based on advancing economic growth and price stability.

Additionally, Fed authorities can utilize that carefulness and flexibility to assist with combatting economic shocks and financial crises. For instance, during the 2007-2008 financial crisis, the Fed initiated various policies to take the economy back to growth, including diminishing interest rates to almost zero and carrying out a buying program of U.S. Treasuries and different securities. Having the Fed as a buyer of debt made a colossal injection of cash into the banking system.

Features

• The K-Percent Rule was a proposal by economist Milton Friedman that the central bank ought to increase the money supply by a consistent percentage consistently.
• The K-Percent Rule proposes to set the money supply growth at a rate equivalent to the growth of gross domestic product (GDP) every year.
• In the United States, this would regularly be in the scope of 2-4%, based on historical midpoints.