Updated Jun 26, 2020Definition
A monetary theory (postulated by Milton Friedman) that states that in order to control inflation in the long run, central banks should grow the money supply by a set amount (“k-percent”) each year.
Example
Usually, the “k variable” is set depending on GDP-growth (between 1-4%). By setting “k” slightly above GDP growth, economic activity can be stimulated, since the money supply grows faster than the overall value of the economy. To slow economic activity down, “k” should be set below GDP growth.
Relevance
A central bank’s primary objective is to stabilize the economy. This also includes monitoring growth rates to make sure it does not grow too slowly or too quickly. Therefore, the K-percent rule is a useful tool to protect an economy from hyperinflation or deflation.
