What is the K-Percent Rule?
The K-Percent Rule was a proposal by economist Milton Friedman that the central bank should increase the money supply by a constant percentage every year.
The K-Percent Rule proposes to set the money supply growth at a rate equal to the growth of real GDP each year. In the United States, this would typically be in the range of 2-4%, based on historical averages.
Understanding the K-Percent Rule
In addition to proposing the K-Percent Rule, Milton Friedman was a Nobel Prize winner in economics and the founder of monetarism, a branch of economics that singles out monetary growth and related policies as the most important driver of future inflation.
Friedman believed that monetary policy was a major contributor to cyclical fluctuations in the economy. Trying to fine tune the economy by varying monetary policy, depending on economic conditions, was dangerous because too little was known about its effects.
The best way to bring stability to the economy over the long term was to have central banking authorities automatically grow the money supply by a set amount (the "k" variable) each year, regardless of the state of the economy. Specifically, he said the money supply should rise at an annual rate between 3 to 5 percent. "The precise definition of money adopted and the precise rate of growth chosen make far less difference than the definite choice of a particular definition and a particular rate of growth," he stated.
While the U.S. Federal Reserve Board is well-versed on the k-percent rule's merits, in practice most advanced economies do in fact base their monetary policy on the state of the economy. When the economy is cyclically weak, the Federal Reserve and others look to grow the money supply at a faster rate than the K-Percent Rule would suggest. Conversely, when the economy is performing well, most central banking authorities seek to constrain money-supply growth.