In a recent post I pointed out the uncanny correlation between the very small group of economists that either explicitly or implicitly criticized Fed policy as being too tight during the recent crisis, and the even smaller group that had published articles advocating a forward-looking policy of “targeting the forecast.” It seems that having this forward-looking perspective made us especially likely to view monetary policy as too contractionary last fall. When I came up with that list, I was thinking only of those who had made a contribution to the futures targeting literature, not minor figures who merely endorsed the ideas of what others. I know only one economist who falls into the latter category:
Carl Futia sent me the following note and the quotation from Friedman:
Here is an excerpt (edited to improve readability) from the preface to Hetzel’s 2008 book “The Monetary Policy of the Federal Reserve”. It is part of a March 1991 letter sent by Milton Friedman to Michael Bruno, then governor of the Bank of Israel:
“..Hetzel has suggested…that the Federal Reserve be instructed by the Congress to keep the difference between a nominal and an indexed bond yield below some number. [This] is the first nominal anchor that has been suggested that seems to me to have real advantages over the nominal money supply. Clearly it is far better than a price level anchor which is always backward looking.”
So it looks like we can add Friedman to the list:
Did “targeting the Viewed Fed policy as too forecast” research contractionary in late 2008
1. Thompson 1. Thompson
2. Hall 2. Hall
3. Glasner 3. Glasner
4. Me 4. Me
5. Hetzel 5. Hetzel
6. Woolsey 6. Woolsey
7. Svensson 7. Svensson
8. Jackson 8. Jackson
9. Dowd 9. Congdon
10. Friedman 10. ???
Even if you completely disagree with my view of the crisis, I don’t see how anyone could deny the close correlation between these two lists. To repeat, the lists are undoubtedly not complete, but adding a few more names wouldn’t change that fact the correlation is not due to chance.
It turns out that Friedman also spent about three pages discussing Hetzel’s idea in what I believe was his last major book on monetary economics; Money Mischief. I have often criticized the monetarists’ focus on long and variable lags, arguing that monetary policy should immediately impact asset prices. If one targets the forecast, then there should be no lag at all. What does the person who actually coined the term “long and variable lags” have to say about that idea?
“There have been recent proposals for legislation requiring the Fed to aim at zero inflation. The objective is desirable, but such a requirement cannot be effectively monitored or enforced—again because of the ‘long lag,’ which would visit the sins (or the reverse) of the current monetary authorities on their successors. That problem does not arise with a requirement based on the difference between the two interest rates.” (p. 229, emphasis added.)
The phrase “the two interest rates” refers to the yields on conventional and indexed bonds. Something tells me that the man who fervently condemned the deflationary monetary policies of the 1930s, and who claimed that even the milder post-war recessions were triggered by tight money, would not have looked kindly on a monetary policy that drove TIPS yields much higher than conventional bond yields, i.e. a policy expected to produce deflation. Especially if the policy was adopted during the worst financial crisis since the 1930s. What do you think?
Friedman was known as a monetarist, but the central planning aspects of monetarism (fixed money growth rate, 100% reserve money, etc.) seem oddly out of place for a libertarian economist who had a passionate belief in free markets. Given that one of his most famous arguments was that speculation stabilizes prices, I don’t think he would have been persuaded by those who discount the relevance of market signals such as TIPS spreads. Toward the end of his life Friedman was clearly moving away from monetarism and toward what in the 1980s was known as the “New Monetary Economics.” That is, a monetary policy based on efficient markets theory, not central planning. A policy focused on directly stabilizing the (expected) value of money, rather than stabilizing its quantity and hoping for the best.
Friedman died less than a year before the sub-prime crisis flared up. I imagine that many people assume that if Friedman were alive he would now share Anna Schwartz’s view that money has been far too easy. Certainly she claimed her recent views corresponded to the ideas in their Monetary History, although in this post I showed they were actually 180 degrees opposed. Obviously I cannot claim to know for certain what Friedman would have thought, but I wouldn’t discount the possibility that his late conversion to targeting the forecast might have led him in some rather surprising directions.
PS. When I visited the cathedral in Ely, England, the guide mentioned that there was a revered Saxon princess buried there, whose remains had been stolen from a nearby town. I hope my fight over the intellectual legacy of Milton Friedman is not considered equally unseemly.