Friedman or the Fed, who to follow?

As unemployment falls in the US and price inflation rises the Federal Reserve is going to raise interest rates, wrote Prof T Cowen. But will a tighter monetary policy choke off a labor market recovery? "It turns out economists, forecasters and pundits don't actually have a firm handle on the relationship between these variables." A sudden deflationary shock damages employment. The Fed should lower interest rates to increase purchasing power. High inflation makes people work more and they feel that they are earning more but wages do not keep pace with the rate of inflation so workers lose out. A high inflation reduces costs for employers but workers do not realise that their real wages have gone down, known as 'money illusion', so employers hire more people. That would make inflation good for the economy. Since wage growth is low even with low unemployment the Fed should continue with low interest rates to boost growth. "One thing we know about inflation is that voters hate it." People at the top get higher salaries but those lower down do not have the bargaining power for higher wages, so "it is not wrong or immoral for the Fed to take it into account in setting monetary policy". Previously economists believed that unemployment and higher inflation are related, but, "Friedman instead argued that monetary policy can only impact nominal variables, such as prices, and not real variables such as gross domestic product and employment," wrote A Agrawal. The Reserve Bank of New Zealand adopted inflation targeting, or IT, in 1989 which was followed by most central banks. The US Fed has "twin goals of low inflation and maximum unemployment" and has been credited with the turnaround following the 2008 crisis. Now other central banks, including New Zealand, have adopted the same policy. Economists in India strongly believe that a low interest rate helps growth and our Chief Economic Adviser has been at the forefront in urging the Reserve Bank, RBI, to reduce rates. Low interest rate will reduce inflow of foreign funds and weaken the rupee which will be good for exports, wrote Prof A Goyal. According to her, Flexible Inflation Targeting means that the RBI should tolerate a high rate of inflation while keeping interest rate low to allow the government to borrow more. Or else the RBI should have to justify itself to parliament. High oil prices will reduce GDP growth, increase the current account deficit and weaken the rupee, wrote A Nag. A weak rupee increases inflation because of higher cost of imports and high inflation makes the rupee weaker by reducing its buying power. So what should the RBI do to support the rupee, stimulate GDP growth and keep inflation down? There is no end of advice, but as Cowen wrote, economists don't really know. Hence the anger.