The economist Irving Fisher assumed the transactions of velocity money is constant. Suppose the real GDP growth is determined by the structure of the…

The economist Irving Fisher assumed the transactions of velocity money is constant. Suppose the real GDP growth is determined by the structure of the economy and the rate of technological progress. Thus, if money supply grows at the same rate as real output, the price level will be stable. Countries could control inflation directly by limiting money growth. This logic led Milton Friedman to conclude that central banks should simply set money growth at a constant rate. That is, M1 and M2 should grow at a rate equal to the rate of real growth plus the desired level of inflation (Friedman’s k% Rule.)

However, Friedman knew that the central bank does not have a perfect control of monetary aggregates. To make the rule work, Friedman suggested changes in regulations (!!!) that would limit commercial banks’ ability to create money and thus tighten the relationship between the monetary aggregates and monetary base, limiting the fluctuations in money multiplier. How would doing so help Friedman’s rule to operate? Explain. 

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