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Friedman and the Quantity Theory

Much of Friedman's monetary theory has been developed from empirical observations on changes in the monetary stock, prices, nominal and real income, and income velocity in the U.S. economy from 1867 to 1960 [11]. (All references to Friedman's articles, unless otherwise noted, are to the secondary source: Optimum Quantity of Money and Other Essays, (O.Q.M.); Chicago, Aldine, 1969.) Observations on these five variables are always discussed by Friedman in the context of the "quantity equation of exchange" (QEE) identity (MV= PQ ? YM) with M (nominal money stock), V(income velocity), P (general price level or price index), Q (real GNP), and YM (nominal GNP). Friedman's empirical approach to monetary theory, in fact, is almost entirely based on the refinement of this famous identity. The M variable can be divided into two portions: (1) D, the nominal money stock demanded, and (2) S, the nominal money stock supplied. Friedman has theoretically analyzed both these aspects of M. His theory of D is more explicitly stated than his theory of S, however. It has been carefully described in the 1956 article and amplified upon in many textbooks.1 But Friedman's description of how the S variable is integrated into his theoretical analysis has never been summarized in any con venient source. For example, when should S be treated as an exogenous policy variable and when should it be treated as endogenous? When S is exogenous and it varies independently, what changes does it cause? Are these changes felt immediately or over the long run? What causes S to become endogenous? How does the mode of changing S affect the economy? When S increases at various rates, how and why does inflation occur? The answers to these questions comprise the major points concerning the QEE that Friedman has discussed in his major articles, yet they have largely been neglected by writers on money-policy issues. This may be because they have not been presented by Friedman in a single source which is convenient to the student of monetary theory, in whch they can easily be contrasted and compared. The major