K Percent Rule

The K Percent Rule, a concept proposed by economist Milton Friedman, suggests that central banks increase the money supply based on a country’s growth rate, which is measured by its Gross Domestic Product (GDP). Its purpose is to adjust the money supply in an economy to promote stability and economic growth.

It is a monetary policy measure applied to achieve price stability while balancing both inflation and deflation. This rule enables the smooth functioning of a country’s monetary system. It must be noted that K indicates the number (percentage of increase) the central bank chooses, and it may be higher or lower than the GDP at times. It is referred to as the K variable.

• The K percent rule was defined and promulgated by the economist Milton Friedman in the 1960s in the book “A Program for Monetary Stability”.
• It states that central banks should increase the money supply to match the country’s growth rate, which is taken as its Gross Domestic Product (GDP).
• Milton Friedman believed that monetary policy was the best way to facilitate and maintain economic stability in a country.
• It acts as an excellent measure for long-term planning and price stability.

K Percent Rule was propagated by Milton Friedman as a monetary policy theory. It recommended tackling varied aspects of an economy by managing its money supply. According to Friedman, increasing or decreasing the money supply in response to economic growth promotes economic stability. It is considered more relevant in theory than as a policy measure. This theoretical concept states that adjusting the money supply in line with the growth rate enables an economy to achieve steady future growth.

This concept dates back to 1960 when it was propagated in the book A Program for Monetary Stability. The book says the Friedman K percent rule focuses on the link between a country's central bank and its gross domestic product (GDP). Friedman believed that monetary policy plays a vital role in maintaining economic stability. While others propagated fine-tuning monetary policy for different economic conditions, the k percent rule suggested a single-minded approach. 

According to this rule, a country can increase the money supply in line with its GDP, which usually falls between 1% and 4%. Here, k is a constant percentage indicating the increase in money supply every year despite a country’s existing economic conditions. However, depending on a country’s requirement, this percentage may not always equal the country’s GDP.

Hence, if a nation is undergoing a recession, the central banks may increase the money supply, meaning the rate of increase will be more than the GDP per the k percent rule. With this money circulating in the economy, production, distribution, and other activities resume. At the same time, the rate of consumer spending may increase. Thus, the GDP may surpass the previous number. Similarly, central banks may reduce the money supply during inflation, and the flow of money slows. As a result, the economic situation improves with time.

It is important to understand that this measure if implemented, must be accompanied by other proven methods when a country aims to stabilize its economy. Many argue that this is not a real-world solution, even though it may seem effective in theory. This is because it takes a one-size-fits-all approach to policy formulation.

Let us study some examples in this section and see whether percent rule statistics hold in reality.

Example #1

Suppose a fictional economy called Starland has an average GDP of 4% per year. Hence, based on this rule by Friedman, the country’s central bank plans to increase its money supply by 4% every year.

Now, when this happens, various scenarios or situations may appear since the rule says that the money supply should be increased without taking into account the existing or changing economic conditions.

In the first year of the 4% increase in money supply, Starland underwent a minor recession. However, because the money supply remained constant, the economy began to recover gradually. In the second year, the country saw significant economic growth when its GDP increased. Similarly, the interplay between the money supply and GDP continues until Starland’s government initiates policy revision.

The government of Starland stated that long-term growth and price stability were its key objectives while making this decision.

Example #2

A white paper published in May 2022 discussed Milton Friedman’s k percent rule in various economic scenarios. The paper dissected how the Federal Reserve (the Fed) set and dealt with the United States inflation rate target and other economic variables over the years.

As part of this analysis, the paper covered the Fed’s focus on price stability and full employment. It talked about the flexibility of the inflation rate and the subsequent changes introduced by the Fed to handle inflation.

The paper highlighted what Milton Friedman would likely opine about the Fed’s decisions regarding inflation, employment, price stability, and other economic factors. Friedman promoted a focused approach to handling various economic variables and believed that the central bank should operate in a limited capacity in an economy.

Based on this understanding, the paper said that the economist would have supported certain expansionary measures of the US government while probably criticizing other aspects that could lead to likely unwarranted inflation.

This rule offers certain advantages when an economy applies it in its entirety. Let us study them in this section.

• Maintains economic and price stability: The K percent rule focuses on long-term economic growth and monetary system stability by introducing predictability in the money supply. It aims to contain the adverse effects of both inflation and deflation in an economy.
• Reduces adverse effects of economic fluctuations: With a constant supply of money, a country finds itself equipped with the tools required to handle economic changes, difficulties, and fluctuations. 
• Discourages the use of discretionary policies: Central banks may sometimes be forced to adhere to arbitrary policies or discretionary decisions. However, some actions or decisions may not be practical or suitable, which might lead to a lower growth rate. Therefore, implementing this rule reduces the involvement of central banks and mitigates the effects of decisions made on account of political or other pressures. 
• Helps achieve long-term growth rate: It enables businesses to focus on their future goals, allowing them to rely on specific estimations to achieve growth objectives.
• Reduces government intervention: The K percent rule reduces the undue interference of government officials and policymakers, particularly when decisions are made to benefit their political aspirations. This helps ensure the required input is available without manipulation while making decisions. 

This article has been a guide to what is the K Percent Rule. Here, we explain the concept in detail along with its examples and advantages. You may also find some useful articles here -

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