Friedman believes that money supply will theoretically lead to a decline in interest rates, but it will also lead to changes in other factors, such as the redistribution of wealth, which will also lead to changes in interest rates.
There are three situations:
1, the money supply increases, but the price level and people's inflation expectations remain unchanged, which will lead to the decline of short-term interest rates and long-term interest rates.
2. With the increase of money supply, short-term interest rate drops, but with the slow rise of price level, consumer spending increases, bond demand decreases, and long-term interest rate rises.
3, the money supply increases, people have inflation expectations, the demand for bonds decreases, and interest rates rise.
The increase of people's income is inevitably accompanied by the increase of money supply, and the distribution of wealth in money and bonds deviates, which increases people's demand for bonds and lowers interest rates. The implementation of compulsory settlement and sale of foreign exchange accumulated a large amount of foreign exchange reserves for China in the early stage of reform and opening up, and made certain contributions to China's economic growth.
In the foreign exchange market, the compulsory settlement and sale of foreign exchange system makes enterprises have to settle foreign exchange in banks according to the required proportion, which leads to unconditional foreign exchange supply and conditional foreign exchange demand in the foreign exchange market, exaggerating the pressure of RMB appreciation, but covering up the pressure of RMB depreciation, resulting in a false situation of oversupply in the market.
From the perspective of monetary policy operation, under the compulsory foreign exchange settlement and sale system, the central bank needs to continuously buy foreign exchange sold by commercial banks, which will bring about the sustained growth of foreign exchange reserves and the launch of base currency. In order to prevent the continuous release of base money from bringing excess liquidity and inflationary pressure to the domestic economy, the central bank needs to continuously recover funds through open market operations, which greatly restricts the independence of the central bank's monetary policy.