Milton Friedman and Anna Schawrtz argued in the last chapter of theirMonetary History of the United Statesthat a shift in the money growth will usually cause velocity to shift in the same direction: So higher money growth causes optimism, and slower growth causes pessimism. They believed that velocity had its own shocks, as well.

Let's run through some examples of how this might work, in a setting where the Fed wants to keep AD growth stable at 10%. To keep thins simple, we'll just assume that the Fed can control money growth perfectly, and we'll assume that a 1% change in money growth causes a 0.5% shock to velocity growth in the same direction. Fill in the table below. In each case, AD = initial velocity shock + money growth + velocity shock caused by money growth.

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