Yesterday on 5/10, The Federal Reserve has taken measures to curb inflation by raising short-term interest rates, marking the highest federal funds rate since 2007. These moves align with Keynesian economic theory, which suggests that controlling inflation requires managing aggregate demand. By increasing interest rates, the Federal Reserve aims to reduce investment and consumption demand, ultimately decreasing aggregate demand. However, Nobel Laureate Milton Friedman argues that inflation is primarily a result of an increase in the money supply rather than excess aggregate demand. The recent decline in inflation can be attributed to a decrease in the money supply, reflected in the M2 measure. While the Federal Reserve claims credit for the decline in inflation due to interest rate hikes, the decrease in the money supply plays a crucial role. It’s important to strike a balance between managing inflation and promoting economic growth by increasing output relative to the growth in the money supply.
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