Friedman’s monetary golden rule regularly features in monetary policy analyses as central banks adjust their key interest rates in response to persistent inflationary pressures. Behind this expression lie two distinct proposals that are often confused, but have different implications for today’s economy. Measuring the gap between these theoretical prescriptions and the current practices of monetary institutions helps assess what remains relevant in Milton Friedman’s legacy.
The Friedman rule and the k-percent rule: two proposals not to be confused
The term “Friedman’s golden rule” commonly refers to two different concepts. The Friedman rule in the strict sense recommends a nominal interest rate close to zero to reduce the opportunity cost of holding money. The idea is that if holding money costs nothing, economic agents will hold the amount they need.
The second proposal, the k-percent rule, prescribes constant growth in the money supply at a fixed rate, regardless of economic conditions. Friedman believed that mechanically managing the money supply would prevent the discretionary errors of central bankers, which he considered more destabilizing than the shocks themselves.
An in-depth analysis of these two proposals is available on the Via Le Web website, which details their theoretical foundations and respective implications.
| Criterion | Friedman rule (zero nominal interest rate) | K-percent rule (fixed money supply growth) |
|---|---|---|
| Target variable | Nominal interest rate | Money supply (M2 or M3 aggregate) |
| Main objective | Minimize the cost of holding money | Stabilize inflation expectations |
| Role of the central banker | Maintain a floor on interest rates | Apply a mechanical rule, without discretion |
| Relationship to economic conditions | Independent of the business cycle | Independent of the business cycle |
| Contemporary application | No central bank applies it as such | Abandoned by most central banks since the 1980s |
Current monetary policy: why central banks abandoned fixed money supply management
The US Federal Reserve defines its mission around two mandates: maximum employment and price stability. Its actions rely on adjusting key interest rates and setting inflation targets, not on directly controlling the amount of money in circulation. The European Central Bank follows a similar approach, with a medium-term inflation target of around two percent.
The abandonment of fixed money supply management is explained by empirical evidence. The relationship between the money supply and the price level, which Friedman considered stable and predictable, proved far more volatile from the 1980s onward. The financialization of the economy, the proliferation of financial instruments, and the globalization of capital flows made monetary aggregates difficult to interpret.
An article by the Epicenter Network notes that the ECB itself drew lessons from the pandemic period, observing that the massive expansion of the money supply did not produce the immediate inflationary effects that quantitative theory would have predicted, before delayed inflation emerged after an unusually long lag.
The paradox of prolonged low interest rates
Key interest rates held at very low levels for more than a decade in developed countries offer an interesting case study. On the surface, this situation resembled the Friedman rule (a nominal interest rate close to zero), but for entirely different reasons: the aim was to stimulate demand, not to optimize the holding of money.
The observed effects (asset bubbles, compressed bank margins, and a search for yield in risky assets) illustrate that bringing the nominal interest rate close to zero without the theoretical conditions Friedman envisaged creates distortions that the original model did not anticipate.
Friedman’s monetary rule and emerging markets: a different field of application
In emerging markets, the question of monetary discipline arises in ways that lend some renewed relevance to Friedman’s insights. Several economies facing chronic inflation have sought credible nominal anchors to stabilize prices.
- Countries with high inflation often suffer from excessive monetary discretion, precisely the problem Friedman sought to solve with an automatic rule
- Partial dollarization in some emerging economies reflects a lack of confidence in the local currency, echoing Friedman’s analysis of the cost of poor monetary management
- Central banks in these countries sometimes adopt monetary aggregate targets alongside inflation targeting, a hybrid approach that draws in part on the k-percent rule
Conditions in emerging markets show that the Friedman framework remains useful as a diagnostic tool, even when its mechanical prescription cannot be applied as is. Identifying the monetary origins of instability remains worthwhile, even if Friedman’s proposed remedy—a fixed rule—seems too rigid given the complexity of the shocks these economies face.
Milton Friedman and contemporary monetary policy: what remains relevant
Friedman’s legacy is not measured by the literal application of his rules, but by how he transformed the intellectual framework in which central banks operate. Several principles drawn from his work still shape the debate.
- The idea that inflation is always a monetary phenomenon in the long run remains an analytical reference point, even though transmission in the short term has proved more complex than expected
- Distrust of central bankers’ unfettered discretion has led to the widespread adoption of rules (inflation targeting, forward guidance), which strike a balance between Friedmanian rigidity and complete flexibility
- The principles of transparency and communication at central banks stem directly from the importance Friedman placed on economic agents’ expectations
Recent research on monetary policy, including work published by Fair Observer, emphasizes that the debate between rules and discretion, which Friedman helped shape, remains the dominant analytical framework for evaluating central bank decisions.
Friedman’s monetary golden rule is not applied by any major central bank in its original form. Its main contribution lies in the intellectual safeguards it established: today, any monetary policy must justify its departures from a rule, not the other way around. This reversal of the burden of proof is probably Milton Friedman’s most enduring legacy in economic policymaking today.
