We mentioned Milton Friedman’s advice that central bankers should follow a “fixed money growth rule,” where the broad money supply (M1 or M2) grows at the same rate every year. Other economists have instead recommended that central bankers follow “nominal GDP targeting,” which is similar to a fixed AD curve. Assume that the central bank really can control money growth and velocity growth within a reasonable period of time if it tries to do so.
a. What is the difference between a fixed money growth rule and nominal GDP targeting from the point of view of the AD equation?
b. If velocity shocks never occur, what’s the best policy for keeping AD as stable as possible: fixed money growth, nominal GDP targeting? Or are both equivalent?
c. If velocity shocks are common, what’s the best policy for keeping AD as stable as possible: fixed money growth, nominal GDP targeting? Or are both equivalent?