Fellows with Friedman
John Taylor explains the importance of understanding money—what is it is and what it is for—when studying monetary policy. Money serves three functions: as a medium of exchange, as a store of value, and as a unit of account. Central banks determine how much money there is in the economy and control the money supply using the formula MV = PY (money supply x velocity = price level x output, or real GDP).
Why is monetary policy important? It’s important because it plays a critical role in the economy. Central banks use monetary policy to promote robust economic growth and to stabilize the economy when growth is uneven. The independence of central banks allows them to make difficult decisions in the face of political pressure. Understanding monetary policy can help us avoid future recessions or financial crises.
John Taylor argues that sound monetary policy is essential for strong economic growth and stability. Monetary policy is often only noticeable when the Federal Reserve gets it wrong, as it has several times in recent history. In order to get it right, it helps to follow a rules-based policy instead of one based on discretion.