Friedman and Schwartz vs. the Austrians

I’m certainly no expert on Austrian economics, but I have always viewed Friedman and Schwartz’s Monetary History as a sustained attack on both the Austrian and Keynesian views of the Great Depression.  Now we have a revival of the Austrian view from an extremely unlikely source.  Before considering her arguments, let’s first look at the F&S analysis of monetary policy during an asset price bubble.

On page 291 of the Monetary History , F&S consider the “difficulties raised by seeking to make policy serve two masters”:

There seems little doubt that, [beginning in 1927] had it been willing to take such [contractionary] measures, it could have succeeded in breaking the bull market.  On the other hand, if it had single-mindedly pursued the objective implicit in its 1923 policy statement of promoting stable economic growth, it would have been less restrictive in 1928 than it was and would have permitted both high-powered money and the stock of money to grow at something like their usual secular rates.  In the event, it followed a policy that was too easy to break the speculative boom, yet too tight to promote healthy economic growth.

In our view, the Board should not have made itself an “arbiter of security speculation or values” and should have paid no direct attention to the stock market boom, any more than it did the earlier Florida land boom.

This is a strikingly anti-Austrian position.  Not only do they dispute the view that policy was too easy during the stock bubble, they actually argue that it should have been even easier!  And this despite that fact that they implicitly acknowledge that easy money helped fuel the boom.  I think it’s safe to say that F&S would not have been among those arguing that the Fed should abandon inflation targeting to focus on the housing boom in 2003-06.

Any doubts about the anti-Austrian message of this chapter is erased in the final paragraph, where (on page 298) they summarize their argument:

The economic collapse from 1929 to 1933 has produced much misunderstanding of the twenties.  The widespread belief that what goes up must come down and hence also that what comes down must do so because it earlier went up, plus the dramatic stock market boom, have led many to suppose that the United States experienced severe inflation before 1929 and the Reserve System served as an engine of it.  Nothing could be further from the truth.  By 1923, wholesale prices had recovered only a sixth of their 1920-21 decline.  From then until 1929, they fell on the average of 1 percent per year.

Thus contrary to the Austrian view, as long as the overall inflation rate is under control, one can ignore asset price bubbles.

It also might be interesting to contemplate what would have happened had the Fed followed their advice after the 1929 crash, and if that advice had succeeded.  They acknowledged that a recession was almost inevitable after the crash, but insisted that a major depression could have been avoided with a more expansionary monetary policy.  Although the Fed did cut rates significantly in the early 1930s, F&S insisted that these cuts were too little to late.  So suppose the Fed had cut rates even more sharply, and that we had merely experienced an ordinary recession.  Wouldn’t that outcome have looked a lot like 2001-03?

Furthermore, F&S consistently argue that interest rates are a highly misleading indicator of monetary policy–if the money supply is falling then policy is tight even if rates are also falling.  They argued that one should not use interest rates as an indicator of the stance of policy.  Now let’s contrast the F&S view of the Depression with the modern neo-Austrian view of recent events:

The Fed was accommodative too long from 2001 on and was slow to tighten monetary policy, delaying tightening until June 2004 and then ending the monthly 25- basis-points increase in August 2006. The rate cuts that began on August 10, 2007, and escalated in an unprecedented 75-basis points reduction on January 22, 2008, were announced at an unscheduled video conference meeting a week before a scheduled FOMC meeting. The rate increases in 2007 were too little and ended too soon. This was the monetary policy setting for the housing price boom.

This is about as far removed from F&S as one can get.  The stance of monetary policy is judged by interest rates, not the money stock.  And policy is judged to have been too expansionary because it fed a housing boom, not because it increased the overall rate of inflation (which was relatively low.)  Even worse from the perspective of F&S, she argues that monetary policy should have been tightened further after the housing boom peaked in mid-2006, and indeed argues that policy should have been even tighter than it was in late 2007 and early 2008, just as the economy was entering a recession.

Or consider the following views by the same economist:

How did we get into this mess in the first place? As in the 1920s, the current “disturbance” started with a “mania.” But manias always have a cause. “If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset.

“The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates that induced ordinary people to say, well, it’s so cheap to acquire whatever is the object of desire in an asset boom, and go ahead and acquire that object. And then of course if monetary policy tightens, the boom collapses.”

The house-price boom began with the very low interest rates in the early years of this decade under former Fed Chairman Alan Greenspan.

So not only the recent housing boom, but earlier booms such as the 1920s stock bubble, were caused by excessive monetary ease.  And she is not going to accept any excuses that “policy [cannot] serve two masters.”:

In other words, Mr. Greenspan “absolves himself. There was no way you could really terminate the boom because you’d be doing collateral damage to areas of the economy that you don’t really want to damage.”

[She] adds, gently, “I don’t think that that’s an adequate kind of response to those who argue that absent accommodative monetary policy, you would not have had this asset-price boom.” Policies based on such thinking only lead to a more damaging bust when the mania ends, as they all do. “In general, it’s easier for a central bank to be accommodative, to be loose, to be promoting conditions that make everybody feel that things are going well.”

By now you’ve probably guessed that these neo-Austrian quotations from here and here, are by Anna Schwartz.  Many people forget that the argument in the Monetary History would have actually been considered quite progressive in the late 1920s and early 1930s.  Were he alive today, Friedman would be horrified by the neo-Austrian views of Anna Schwartz.

In fairness to Ms Schwartz, one is entitled to change one views, I have done so many times.  However in her WSJ piece she clearly presents her current views as being representative of the sort of analysis that she did with Friedman in the Monetary History.  Nothing could be further from the truth.

(For what it’s worth, I favor the F&S view.  However, because I prefer nominal GDP targeting to inflation targeting, I think that policy should have been a bit tighter in 2004-06 (but not 2007-08).)



33 Responses to “Friedman and Schwartz vs. the Austrians”

  1. Gravatar of Bill Woolsey Bill Woolsey
    17. February 2009 at 16:18

    I agree that monetary policy (or institutions) should aim at stable growth of nominal income, letting the market determine the prices (nominal or relative) of classes of assets like stocks or real estate. Having the central bank determine that the Dow is too high or rising to fast and then engineering a reduction in the growth rate of nominal income so that stock prices will fall–that is a mistake.

    However, suppose one favored a money growth rule. The Fed, not following that approach, manipulates the federal funds rate as usual. The critic’s preferred measure of the money supply grows faster than the proposed target. Some speculative mania occurs at about this time. There is little inflation of final goods and know, long and variable lags. The bubble pops for some reason or other. Perhaps the Fed raises interest rates because they just think they have been too low. Regardless, the stop and go monetary policy caused the speculative boom.

    Unfortunately, there are a variety of Austrian views, so comparing Schwartz’s views to “the” Austrian view is difficult. The simplest view sees malinvestment as being caused by any increase in the money supply. This pushes interest rates below where they otherwise would be–too low. But the key point is that there is no notion here that the central bank should do something to stop a speculative bubble. It should refrain from expanding the money supply, and so not start any speculative bubbles in the first place.

    An alternative view is that the an ideal monetary policy should have the money supply change to offset changes in velocity, leaving nominal expenditure constant. On this view, growing nominal expenditure leads to malinvestments. Speculative bubbles are interpreted as being this sort of malinvestment. Again, there is no notion that a central bank should act to stop a speculative bubble. It is rather than it should not cause one by expanding the money supply in a way that leads to growing nominal income.

    I believe that Schwartz may well agree with your (and my) view. The proper policy does not include identifying speculative bubbles and then doing something to stop them. And I am sure that is true of both varieties of Austrian Trade Cycle theory I have described here. The proper “policy” would be the same regardless of any speculative bubbles that might exist. The claim is that the Federal Reserve didn’t follow the proper policy and what it actually did caused the speculative bubble.

    Yes, describing the Fed’s mistakes by describing its actual policy of changing the federal funds rate may suggest that the critics think the Fed should have manipulated the federal funds rate in a different fashion (and that may be Schwartz’s view, see Taylor’s arguments on this,) but I think the fixed money supply or fixed aggregate expenditures version of Austrian Trade Cycle theory advocate letting market forces determine all interest rates always and so are never proposing that the Federal Reserve manipulate interest rates in a different fashion.

  2. Gravatar of ssumner ssumner
    17. February 2009 at 17:17

    Bill, That was very helpful. As I indicated, I’m not an expert on Austrian business cycle theory, and don’t even know the distinction between various Austrian views. There are a couple points, however, that I still think I might be right about.

    1. However one characterizes Schwartz’s current views, they do seem strikingly different from those in the Monetary History. I suppose there may be some data out there that could reconcile these seemingly contradictory views, like some sort of money supply data from 2003-06. But if that’s her current argument, she certainly has an odd way of expressing it.

    2. I still think the argument at the end of F&S’s chapter on the 1920s is aimed right at Austrian economics, as the term was understood by F&S. The views they portray seem uncannily like descriptions I have read of the Austrian view of the causes of the Great Depression. Especially the argument that monetary policy was inflationary during the 1920s, despite the lack of increase in broad price indices. If the Austrian inflationary view relates solely to nominal income growth, and not at all to asset price inflation, then perhaps F&S did that view a disservice. Or perhaps I misinterpreted intent of F&S’s critique.

    3. If Schwartz favors a nominal income rule, then monetary policy should have become much more expansionary after the onset of the financial panic (which reduces velocity.) But unless I am mistaken, Schwartz has not favored a more expansionary policy during this crisis, despite the sharp slowdown (and then decline) in nominal growth. But I need to double check this point.

    I’m going to try to learn a bit more about this issue, and I may have to revise my conclusions at some point. Right now, however, Schwartz’s recent views still seem strikingly at odds with the quotations from the Monetary History.

  3. Gravatar of Phil P Phil P
    24. February 2009 at 14:24

    Scott, I’m not an economist but the Great Depression is something of a hobby of mine, and I’ve read the Monetary History, among other things, and I noticed when Schwartz’s remarks were first published the contradiction between her views on the housing bubble and what she and Friedman wrote in the MH. This is the first mention of that by a professional that I’ve noticed. Lately there certainly has been a backlash against the expansionary monetary policy followed by Greenspan, and I worry that policy makers will throw out the baby with the bathwater. Greenspan was wrong about many things, but I certainly think he was right that conventional monetary policy is too blunt an instrument for dealing with asset bubbles, and the experience of 1928-9 is an example of that. Permitting excessive leverage on the part of financial institutions seems to me to have been more culpable. The Fed controls the money supply, more or less, but upon that money supply a much larger superstructure of credit is erected, which the Fed doesn’t control. Letting investment banks and broker-dealers increase their leverage from 12-1 to 40-1 and letting banks evade capital requirements with off balance sheet vehicles seems more consequential than lowering the Fed Funds rate to 1%.

    Incidentally, Martin Wolf has pointed out that over the last few years a number of countries have experienced huge housing bubbles, including the UK, Spain, Ireland, Iceland and Australia. What they all had in common with us was running huge current account deficits. There’s a view that the bubble was a result of loose monetary policy – by China.

  4. Gravatar of ssumner ssumner
    24. February 2009 at 18:33

    Thanks for the comment Phil,

    Although you say that you are not an economist, I think you have pretty good economic intuition. The 1% percent interest rate policy is an easy target, but I agree with you that monetary policy cannot address both macro stability and specific asset market trends. You are also right that the excessive leverage was, in retrospect, probably a regulatory mistake (as the government’s implicit too big to fail policy leads to excessive risk taking.)

    I’ve noticed that a lot of the countries with large current account surpluses are also countries with high levels of immigration. This isn’t my area, but I can imagine that with millions of new immigrants flooding in and buying homes based on expectations of higher future income in their new country–the national saving rate might fall short of national investment. Even Spain had surprisingly high immigration, as a fraction of their population. These current account surpluses pull in savings from the high saving Asian countries (which often have low birth rates.) My only reservation with your final point is that I don’t think the key factor was the loose monetary policy in China, but rather the high savings rate in China, and indeed much of Asia (even including the wealthier Persian Gulf nations.)

  5. Gravatar of MattYoung MattYoung
    25. February 2009 at 05:05

    Regarding Friedman and monetary accommodation.

    What happens when the economy expects government to actually do something with resources it controls? Why is this never a consideration? For example, in 1929 the economy may have actually required that government build a road network, that the consumer would not participate until that was done?

    Under this hypothesis, the Great Depression was great simply because it takes a long time to get a critical mass of roadways finished.

    And in 1872, why is it not a conjecture that the business community refused to participate in international trade until the ports were cleared of those damnable horses.

    And in 2008 why is it not a consideration that a significant and important consumer group refused to participate in consumer spending until the fixed transportation cost of shopping was reduced?

    Under each of these proposed narratives the problem involved government industry, physical movement of material with deregulation, not banking errors.

  6. Gravatar of Noah Yetter Noah Yetter
    25. February 2009 at 06:16

    Austrian models do not consider the word “inflation” to have anything to do with the price level. Inflation is about monetary expansion. You can have steady prices with the money pumps running wide open, if productivity gains are simultaneously making everything cheaper. What causes booms (and their inevitable busts) is not changes in the price level, it is monetary expansion.

  7. Gravatar of Greg Ransom Greg Ransom
    25. February 2009 at 08:06

    To call this “neo-Austrian” is a misnomer if you are not going to get the productivity / inflation / deflation part right. Productivity growth has to be taking into consideration when you are talking about the “overall inflation rate” being “low”.

    Part of the understanding both in the 2000s and in the 1920s on the part of the Hayekians is that productivity was rising, rate inflation — see the work of George Selgin.

    Austrians attacked Greenspan and Bernanke in the early 2000s for their false fears of “deflation” on these grounds.

    And I wish people would keep this in mind, when they are doing history of economic thought.

    Hayek worked with very limited data and factual knowledge when he talked about real events in the 1920s and 1930s — and he wasn’t a specialist about America. He new the Austrian economy in the 1920s and lived in Britain through the 30s and 40s. And spent most all of his time in the 30s and 40s on theory, and almost no time at all on data.

    So throughout the 20s and 30s Hayek was merely guessing about what was happening, based on a fairly bad knowledge base. His judgment would have been different given different — and far more correct — data.

  8. Gravatar of Hayek vs Friedman: Anna Schwartz — Hayekian Macroeconomist Hayek vs Friedman: Anna Schwartz — Hayekian Macroeconomist
    25. February 2009 at 08:09

    […] Chicago school economists Scott Sumner examines Anna Schartz’s recent abandonment of the Friedman / Schwartz position on money and the business cycle in favor of a neo-Hayekian view. […]

  9. Gravatar of Greg Ransom Greg Ransom
    25. February 2009 at 08:57

    It’s easy to get a basic introduction to Hayekian macro.

    Go here:

    I particularly recommend the Hayek vs. Keynes Power Point presentation, for the quick yet insightful illustration of what Hayekian macro brings to the table that much of “modern” macro simply pretends doesn’t exist.

    But to really “get it” Garrison’s book _Time and Money” is non-optional.

  10. Gravatar of Scott Wimer Scott Wimer
    25. February 2009 at 17:30

    Right now, there are 19 million vacant homes in the U.S.

    It is worth asking how on earth this happened. Seriously. 19 million is lot of houses. How on earth do you end up with 19 million extra houses?

    About the only way that I can think of to end up with this many extra houses is credit that is way to cheap. It’s not like there isn’t information about the number of people in a given zipcode or their average income.

    So, then the question is, why on earth was credit this cheap? Who, if anyone, is responsible for this pricing?

    And this is where the Austrian school of thought seems to make a good deal of sense to me — if you think about the money supply consisting of all cash + credit. Banks were too loose with credit because relatively safe loans (Treasuries) paid diddly squat.

  11. Gravatar of ssumner ssumner
    25. February 2009 at 18:45

    Noah and Greg, Thanks for the tips on Austrian economics. I will study it more fully in the future. I actually think that I know a bit more than you might have assumed, but my post was a bit sloppy. I knew, or think I knew:

    1. F&S defined inflation in terms of goods and services prices, which I consider the standard definition.
    2. Austrians look at other definitions–I wasn’t sure if it was asset prices, or money supply growth, or nominal GDP growth, but I knew they used other definitions.
    3. I was sloppy in suggesting that they didn’t focus on inflation, I should have said that they didn’t focus on F&S’s definition of inflation. Since I don’t read much Austrian economics, I just thought in terms of goods and services inflation, and forgot that Austrians have other definitions of inflation. So my wording was misleading.
    4. Perhaps I should have titled the piece “F&S vs. Schwartz”, and left out the Austrian references. I still think I have a strong argument that she has shifted her views quite dramatically.

    I’ll try to say something more in a few days when I have had time to examine the slides you sent me. Thanks again.

  12. Gravatar of Josh Josh
    25. February 2009 at 19:36


    I similarly appreciate the work and the views of Friedman and Schwartz, but I think that looking at the inflation rate as a guide to the relative tightness of monetary policy is misleading. For example, you write:

    “Thus contrary to the Austrian view, as long as the overall inflation rate is under control, one can ignore asset price bubbles.”

    Axel Leijonhufvud (hardly an Austrian) argues that using the price level to guide monetary policy is insufficient as it may be effected by downward pressure from globalization and productivity. I happen to agree with this view (as I think would the Austrians) as there are short-run effects that influence the price level that have nothing to do with monetary policy.

    Here is the link to Leijonhufvud’s recent policy paper (if you are interested):

  13. Gravatar of ssumner ssumner
    25. February 2009 at 19:57

    Josh, I should have said “Thus F&S believe that contrary to . . . ”
    I happen to favor nominal GDP targeting, not inflation targeting. I just meant that the Fed should focus on some aggregate, not the specific prices of assets like housing. (Above I admitted to oversimplifying the Austrian view.)

    I think my view has some similarities to the Austrian position, but for slightly different reasons. A agree that if productivity growth is high, then nominal GDP growth might signal monetary excess where inflation doesn’t. So I think the Austrian intuition that money was too easy around 2004-06 has some merit. But I also happen to think that at least some Austrians put too much weight on easy money as a cause of the subprime fiasco–but that’s another post I need to do. (I hope I haven’t erred in assuming that some Austrians thought easy money caused the subprime fiasco.)

    I read Axel Leijonhuvfud a long time ago, and thought he had some good insights–I should look at him again. I think that David Laidler has also had some good insights into problems with inflation targeting-and he is another non-Austrian with some sympathy for this aspect of Austrian thought.

  14. Gravatar of James James
    27. February 2009 at 20:27

    Many Austrians give the wrong idea when they say that monetary policy was “too loose” during the housing bubble. This seems to indicate that Austrians believe there is a “just right” degree of monetary expansion. Or they speak of “boom and bust” in a way that sounds like a belief in “what goes up must come down” or something similar. This is mostly just loose language.

    So far as I understand the Austrian view: entrepreneurs make their production plans by doing cost-benefit analysis based on the relative prices of inputs and outputs. Monetary expansion doesn’t affect all nominal prices to the same extent at the same time, and so monetary expansion affects the nominal relative prices that entrepreneurs see. If the expansion is large enough, really unprofitable production plans will temporarily appear profitable. Entrepreneurs will respond to this appearance of profit by investing in physical and human capital. Once all prices adjust to the increase in the money supply, it will become clear that those capital investments are not suited to producing what people actually want and a bust ensues.

    There is a special case where the nominal price of some capital good or some durable good relative to the nominal price of borrowing appears becomes very high as a result of monetary expansion. When this special case obtains, monetary expansion leads to booms followed by busts. When this special case doesn’t obtain, the results of monetary expansion look about like F&S would claim.

  15. Gravatar of I find Tyler Cowen unconvincing « Entitled to an Opinion I find Tyler Cowen unconvincing « Entitled to an Opinion
    28. February 2009 at 11:33

    […] LATE UPDATE: Scott Sumner indicts Schwartz for “neo-Austrianism” and accuses her of promoting a view her Monetary History […]

  16. Gravatar of ssumner ssumner
    1. March 2009 at 18:20

    James, I’d be interested in your thoughts about:

    1. Whether F&S seemd to be criticizing the Austrian view in their book.

    2. And whether I was wrong in characterizing Schwartz’s current view as Austrian.

    I sense you think I was too simplistic, but could you break it down into those two separate questions.

  17. Gravatar of Lorenzo (from downunder) Lorenzo (from downunder)
    1. March 2009 at 19:16

    I’ve noticed that a lot of the countries with large current account surpluses are also countries with high levels of immigration.
    The relationship between migrants and housing bubbles is an interesting one. Housing bubbles have occurred in jurisdictions where official discretions controlled (and thus constrained) the supply of land for housing. (So, no housing bubble in Germany because they have a constitutional “right to build”.) Constraining the quantity response increases the price response (in this case, to rising demand) which adds the demand for an inflation-beating-asset to the demand for housing-as-housing.

    If a housing market has a lot of (foreign-born) migrants, that means it has a lot of housing market entrants who are not politically connected (often not even voters). That means that the interests of housing market entrants will have a higher “political discount” factor so officials are more likely to act in the interest of incumbents (who want higher prices) than entrants. (Such use of official discretions also encourages political donations–licit and illicit–from developers “purchasing” access to regulatory decision-making and raises revenue from increased property taxes.) The “Zoned Zone” in the US tends to be high immigrant areas. “Flatland” tends to be high citizen-movement areas. (In the US, there is a high correlation in housing markets between the ratio of median house price to median household income and the % of the local population which is foreign born.)

    Texas is the most obvious exception to this pattern, but Hispanics are already such a large percentage of Texan voters, that reduces the “political discount” effect and there are institutional factors within Texas which discourage use of official discretions to control land use.

  18. Gravatar of ssumner ssumner
    2. March 2009 at 17:19

    Lorenzo, Very interesting, i learned a lot from your reply. Does Germany have urban sprawl, or are the cities compact? I’ve been there, and thought they were compact, but may have forgotten.

  19. Gravatar of David Stinson David Stinson
    3. March 2009 at 14:35

    Hi Scott. Thanks for your post above. I too was struck by Ms. Schwartz’s statements in the WSJ article when I first read it.

    I have an MA in economics and was steeped in the whole neoclassical, monetarist, equilibrium, rational expectation, mathematical view of the world. However, after 25 years as a practitioner in the world of policy and (de)regulation, and grappling with the many real world issues that “modern” economics conveniently ignores (makes the math too hard), I discovered (actually, more stumbled upon) Austrian economics about a year ago in the course of looking for literature on property rights and market process. It was immediately clear that many “modern” innovations in mainstream economics, such as focus on market dynamics, property rights, information, microfoundations of macroeconomics, contestable markets, non-price rivalry, role of the entrepreneur, etc., were present in Austrian economics many decades ago.

    At first, I didn’t give much weight to what non-Austrians would call Austrian “macroeconomics”, given my confidence in the old mainstream view, i.e., a) monetary expansion could not generally not be considered excessive in the absence of non-negligible general price inflation, b) there was no basis for thinking that excessive monetary expansion would show up instead in the form of market-specific commodity bubbles or asset bubbles, and c) money was thus generally neutral. However, the collapse of the housing price bubble and the collapse of the commodity price bubble (not to mention the impact on my stock portfolio) caused me to take a closer look at what the Austrians were saying. They seemed to me to be the only school that had a theory that explicitly addressed the situation and, not only that, they had been railing on about it for 75 years! It was just about that time that I noticed the Schwartz quote in the WSJ article. I was also struck shortly thereafter by the fact that articles by two other well-regarded non-Austrians, Michael Parkin ( ), coincidentally an old professor of mine, and John Taylor ( ) seem to be tinged with Austrianism, at least with respect to the monetary causes of the bubbles, and perhaps in Professor Parkin’s case, hints also of an Austrian view of the effectiveness of monetary policy in the current situation. You will forgive me, if at the time, I was thinking “gee, perhaps we are all Austrians now.”

    I must confess I haven’t had as much time as I would like to read up on the Austrians but, further to the comment above, David Laidler (also an old professor of mine) recommended to me Roger Garrison’s “Time and Money”. I have also come across another book, “Debt and Delusion” by Peter Warburton that I gather is a good non-Austrian treatment of the monetary causes of bubbles (see a review at

  20. Gravatar of ssumner ssumner
    5. March 2009 at 12:18

    David, I think the Austrians have a lot of interesting things to say (and Hayek is one of my favorite economists.) But with regard to Austrian macroeconomics I have generally thought that it was a matter of reaching sensible conclusions (like NGDP targeting) for the wrong reasons. Over spring break, however, I will read some Austrian stuff and perhaps gain a greater understanding of their ideas.

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  25. Gravatar of Lorenzo from Oz Lorenzo from Oz
    15. June 2010 at 03:43

    Scott: I never answered your question. The answer is, I don’t know.

  26. Gravatar of ssumner ssumner
    15. June 2010 at 06:26

    I’d forgotten the question. 🙂

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