Case closed: Milton Friedman would have favored monetary stimulus

In a recent post I argued that Milton Friedman would have been extremely critical of the Fed’s tight money policy since late 2008.  I cited a number of factors, including:

1.  He said in late 1997 that the ultra-low interest rates in Japan were actually a sign that money had been too tight.

2.  Late in his career he moved from money targeting toward other options like inflation targeting.  He even endorsed Hetzel’s proposal to target TIPS spreads.

3.  I forget to mention the interest on reserves policy, which is very similar to the 1936-37 policy of doubling reserve requirements.  Both programs only raised short term rates by about a 1/4 point, but Friedman (and Schwartz) understood that the 1937 policy was highly contractionary despite the tiny interest rate increase, because it sharply reduced the money multiplier.  He would have been a severe critic of the current IOR policy.

But there was one weakness in my argument, which I acknowledged.  Friedman was famous for favoring steady money supply growth, and M2 and MZM grew quite rapidly during 2008-09.  So would Friedman now have opposed stimulus, despite the fact that growth in these aggregates fell close to zero after mid-2009?  John Taylor thinks so.

But I have found an even more recent Friedman article that sharply undercuts the only plausible argument that Friedman would have been with the inflation hawks.  In 2003 he wrote a very interesting article on recent trends on monetary policy, and basically made peace with the new Keynesian inflation targeting approach:

To keep prices stable, the Fed must see to it that the quantity of money changes in such a way as to offset movements in velocity and output. Velocity is ordinarily very stable, fluctuating only mildly and rather randomly around a mild long-term trend from year to year. So long as that is the case, changes in prices (inflation or deflation) are dominated by what happens to the quantity of money per unit of output.

Prior to the 1980s, the Fed got into trouble because it generated wide fluctuations in monetary growth per unit of output. Far from promoting price stability, it was itself a major source of instability, as Chart 1 illustrates. Yet since the mid ’80s, it has managed to control the money supply in such a way as to offset changes not only in output but also in velocity. This sounds easy but it is not — because of the long time lag between changes in money and in prices. It takes something like two years for a change in monetary growth to affect significantly the behavior of prices.

The improvement in performance is all the more remarkable because velocity behaved atypically, rising sharply from 1990 to 1997 and then declining sharply — a veritable bubble in velocity. Chart 2 shows what happened. Velocity peaked in 1997 at nearly 20% above its trend value and then fell sharply, returning to its trend value in the second quarter of 2003.

The relatively low and stable inflation for this period documented in Chart 1 means that the Fed successfully offset both the decline in the demand for money (the rise in V) before 1973 and the subsequent increase in the demand for money. During the rise in velocity from 1988 to 1997, the Fed kept monetary growth down to 3.2% a year; during the subsequent decline in velocity, it boosted monetary growth to 7.5% a year.

Some economists have expressed concern that recent high rates of monetary growth have created a monetary overhang that threatens future inflation. The chart indicates that is not the case. Velocity is precisely back to trend. There is as yet no overhang to be concerned about. (Italics added.)

Note that Milton Friedman is criticizing “some economists” who have “expressed concerns that the high rate of money growth . . . threatens future inflation.”  Today those “some economists” are obviously monetarists, Austrians, and conservative Keynesians (but not all in those camps.)  And Friedman is telling his fellow conservatives (from the grave) that they are wrong, that this “is not the case.”

Friedman would have understood that the financial crisis was a special case that led to a rush for liquidity and safety, and a temporary fall in M2 velocity.  He would have seen the low interest rates and low TIPS spreads as indicators of tight money.  He would have favored temporarily allowing higher M2 growth to offset the low velocity, until the economy was back to normal.  Somehow modern conservatives seem to merely recall the bumper sticker message “stable money growth” but overlook the nuanced and highly sophisticated monetary analysis that made Milton Friedman an intellectual giant.

HT:  Jeffrey Hummel

John Taylor’s vision of monetarism: No room for a “monetary kiss of life?”

Caroline Baum of Bloomberg recently suggested that Milton Friedman would have been appalled by the many top economists arguing the Fed is out of ammunition:

Milton Friedman, Nobel Laureate in Economics, died in 2006. Monetarism, the school of thought he founded, seems to have died with him, judging from recent comments.

Academics, such as Princeton’s Alan Blinder and Harvard’s Martin Feldstein, are claiming there’s very little the Federal Reserve can do to stimulate the U.S. economy. Newspaper headlines deliver the same message: the Fed is “Low on Ammo.” The public is feted with explanations — couched in technical terms, such as the “zero-bound” and a “liquidity trap” — as to why the Fed’s hands are tied.

What planet are these people on?

They’re clearly not on planet monetarism.  On the other hand John Taylor thinks Friedman’s message still resonates, but that he would have been opposed to additional monetary stimulus:

I see neither those ideas nor their adherents going to the grave. Indeed, the experience of this crisis is proving that Milton Friedman’s ideas were right all along, and I can see them gaining favor.

Two of Friedman’s most famous ideas in the macroeconomic sphere were (1) that monetary policy should follow a simple policy rule and (2) that discretionary fiscal policy is not useful for combating recessions, and indeed could make things worse. Both ideas have been reinforced by the facts during the recent crisis.

The first idea is reinforced by the evidence that the crisis was brought on by the failure of the Fed to keep following the rules-based monetary policy that had worked well for 20 years before the crisis. Instead, it deviated from such a policy by keeping interest rates too low for too long in 2002-2005. But Caroline Baum wonders whether the Fed should now just print a lot more money and buy more mortgages or other securities. That might sound like a monetarist solution, but Friedman did not believe in big discretionary changes the money supply. Rather, he advocated a constant growth rate rule for the money supply. I doubt that he would have approved of the rapid increase in the money supply last year, in part because he would have known that it would be followed by a decline in money growth this year. He always worried about monetary policy going from one extreme to the other and thereby harming the economy. That is why the Fed should be clear and careful as it brings back down the size of its balance sheet, which exploded during the crisis.

While Taylor’s argument is defensible (and I agree with him on fiscal policy), I believe the weight of evidence supports Baum’s interpretation.  Let’s look at what Milton Friedman had to say about Japan in December 1997.  The subtitle is as follows:

Nobel laureate and Hoover fellow Milton Friedman gives the Bank of Japan step-by-step instructions for resuscitating the Japanese economy. A monetary kiss of life.

And here’s Friedman’s argument:

The surest road to a healthy economic recovery is to increase the rate of monetary growth, to shift from tight money to easier money, to a rate of monetary growth closer to that which prevailed in the golden 1980s but without again overdoing it. That would make much-needed financial and economic reforms far easier to achieve.

Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”

The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately. A return to the conditions of the late 1980s would rejuvenate Japan and help shore up the rest of Asia.

The Interest Rate Fallacy

Initially, higher monetary growth would reduce short-term interest rates even further. As the economy revives, however, interest rates would start to rise. That is the standard pattern and explains why it is so misleading to judge monetary policy by interest rates. Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

In the article, Friedman presents data showing Japanese monetary growth slowing sharply in the 1990s.  He also notes that RGDP growth slowed from 3.3% during what he calls the “Golden Age” of 1982-87 to only 1.0% during 1992-97.  Inflation slowed from 1.7% to 0.2%.  From this we can infer:

1.  Friedman does not seem to agree with Fed hawks who think price stability is a good thing.  After all, Japanese prices were very stable during the 5 year period when he thinks money was far too tight.  Admittedly, some at the Fed define price stability as 2% inflation, but the hawks clearly don’t agree, as inflation is 1% and falling, yet the hawks still oppose stimulus.

2.  Friedman thinks near-zero interest rates are a sign that money has been too tight.  And he suggest that QE is the proper response.

3.  Friedman cites data showing that Japanese NGDP growth has slowed from 5% during the golden age to 1.3% in 1992-97.  Of course 5% NGDP growth is quite close to the US experience from 1992-2008, another “golden age.”  But then US NGDP fell 3% between mid-2008 and mid-2009, nearly 8% below trend.  And it continues to grow at well under trend during the “recovery.”  Friedman would have seen that as a warning sign.

4.  Friedman advocates raising money growth rates in Japan (M2) up much closer to the 8.2% of Japan’s Golden age.

5.  In the US monetarists tend to look at broader aggregates like M2 and MZM (although unfortunately we lack the ideal divisia index that monetarists like Mike Belongia say is needed.)  For what it’s worth, here are the growth rates of M2 and MZM from mid-2008 to mid-2009, and then from mid-2009 to mid-2010:

2008-09:   M2 grew 8.8%,  MZM grew 10.2%

2009-10:  M2 grew 2.1%, MZM fell 1.8%

So on average the aggregates grew around 9-10% during the financial turmoil, and then barely changed over the following 12 months.  It is difficult to know what Friedman would say about the increase in the money supply between 2008 and 2009.  Obviously the facts don’t exactly fit either my interpretation or Taylor’s.  But if we take a more expansive view of Friedman’s approach to macroeconomics, then I believe there is even more reason to believe that he would now favor monetary stimulus, just as in Japan:

1.  In the Monetary History, Friedman and Schwartz decided not to use the monetary base as their indicator of the stance of monetary policy.  In my view, this was partly because the base increased sharply between 1929 and 1933.  Friedman understood that NGDP had fallen in half during those four years, and thus monetary policy had obviously been too contractionary for the needs of the economy.  He also understood that the increase in the base reflected hoarding of cash and reserves during the banking panics.  Thus the most natural monetary indicator for a libertarian, the one directly controlled by the government, was not going to work.  Instead he and Anna Schwartz focused on broader aggregates, which declined sharply between 1929 and 1933.

2.  Now consider the 2008-09 increase in the broader aggregates.  Because we now have FDIC, people no longer hoard cash during a liquidity crisis; instead they hoard the very liquid and safe assets that make up MZM.  Friedman would have understood that the financial crisis was a special situation, and hence required economists to look past the temporary blip in MZM, just as he had overlooked the rise in the base during 1929-33.  He understood that money was actually tight during 1929-33, despite the increase in the base and the low interest rates.  (And he’d understand that the bloated base since 2008 largely reflects interest-bearing excess reserves, where yields exceed the rate on T-bills.)

3.  Friedman also understood that in uncertain times markets can provide an indication of whether money is too tight.  Recall his defense of speculators, and also floating exchange rates.  He clearly thought market signals were meaningful.  In 1992 [Money Mischief] he endorsed Robert Hetzel’s idea of having the Fed directly target expected inflation, by trying to peg the spread between nominal and indexed bonds.  Now recall that the TIPS spread briefly went negative in late 2008, and even today is only about 1% for one and two year T-bonds.  So if Friedman thought Hetzel’s proposal was a good idea, I think it unlikely he would brush off the message in the TIPS markets, as many conservatives seem to do.  The markets are clearly indicating both inflation and output will remain below the Fed’s implicit target for quite some time.  Friedman would have seen the importance of those market signals.

4.  There are some modern monetarists, such as Tim Congdon  (and this), who have made many of the same arguments that I’ve used in this post.

To summarize:

1.  In 2009 NGDP fell at the sharpest rate since 1938.  And NGDP growth is expected to remain very weak.   If M*V is that weak, something must be wrong.

2.  Friedman argued the low rates in Japan were actually evidence of tight money.

3.  Friedman would have been concerned by the abrupt slowdown in the growth rates of the monetary aggregates since mid-2009.

4.  Some modern monetarists like Tim Congdon think money is way too tight.

The burst of M2 and MZM in 2008-09 does point slightly in John Taylor’s favor, but overall I believe the evidence supports Baum’s view.

Of course neither John Taylor nor I hold identical views to Friedman.  He supports the Taylor Rule (why not, he invented it!)  I give him a lot of credit, as the Taylor principle is the primary factor behind the Great Moderation.  However I believe a Svenssonian “targeting the forecast” approach is even better.  In September 2008 the Fed failed to cut rates below 2%, looking backward at the high rates of headline inflation during the summer of 2008.  But forward-looking real growth and inflation indicators were already slowing rapidly, indeed the TIPS spread on 5 year bonds fell to 1.23% just before the post-Lehman Fed meeting.  I think almost everyone would now agree the Fed should have moved much more aggressively in September 2008, before rates had fallen to zero.  A forward-looking approach would have allowed them to do so, but instead they relied on historical data that seemed to suggest the risks of inflation and recession were equally balanced.  They did nothing.

I suppose the fight over Friedman’s legacy is related to the fact that he is the one right-wing macroeconomist who is almost universally respected by conservative/libertarian economists.  Even though I’m not a strict monetarist, I’d like to think he would support my view of the current crisis.  I’m guessing Taylor feels the same way.

HT:  DanC, Benjamin Cole, David Pearson, Richard W.

PS:  After 16 months of leisure frantic blogging activity, school starts tomorrow.  Unfortunately, posting and comment replies will have to slow down.

Milton Friedman vs. the conservatives

After my recent trip I was appalled to discover the number of leading conservative voices opposing monetary easing.  Even worse, many seemed to assume the Fed was already engaged in monetary stimulus.  Before considering their views, let’s examine the thoughts of the greatest conservative monetary economist of all time, Milton Friedman.  Here he discusses the zero rate problem in Japan:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.

Friedman was absolutely right, near-zero interest rates are an almost foolproof indicator that money has been too tight.  Were he still alive, I can’t even imagine what he would think of the views being expressed by his fellow conservatives.  Here is Minneapolis Fed president Narayana Kocherlakota:

Monetary stimulus has provided conditions so that manufacturing plants want to hire new workers. But the Fed does not have a means to transform construction workers into manufacturing workers.

Actually money has been tight.  And those construction jobs were mostly lost in 2007 and early 2008, when employment was still high.  The serious unemployment problem developed in late 2008 and early 2009, and reflected a generalized drop in AD across the entire economy.  And manufacturing has also shed lots of jobs.

Update:  Regarding 2007-08, I should have specified construction jobs associated with the housing bubble.  The subsequent sharp fall in NGDP obviously cost construction jobs in commercial and industrial building.  But those were cyclical losses due to tight money, not misallocation problems.

The right seemed to have latched onto the view that since tight money can’t be the problem, it must be some mysterious “structural problem.”  Obviously there may be some structural problems, indeed I have argued that some government labor market policies are counterproductive.  But there is nothing structural that could explain the sudden dramatic jump in unemployment between 2008 and 2009.

Even worse, we already have a perfectly good explanation for that rise in unemployment; in 2009 NGDP fell at the fastest rate since 1938.  You’d expect a massive rise in unemployment from this sort of nominal shock, even if there were no structural problems.  Now of course there is a respectable argument that the US currently faces both problems.  But economists who make that argument (e.g. Tyler Cowen) correctly note that this means we need more monetary stimulus.  They simply warn us not to expect miracles.  But unless you are an extreme RBC-type who doesn’t believe monetary shocks matter at all (and most conservatives are not) then how can one not favor monetary stimulus?

I suppose one argument is that we are “recovering,” and hence that no more stimulus is needed.  People seem to have forgotten that deep recessions are generally followed by fast growth.  Both NGDP and RGDP growth was very fast in the first 6 quarters of recovery from the 1982 recession.  But now we are getting only 4% NGDP growth, not the 11% of the earlier recovery, so how can we expect the 7.7% RGDP growth of the recovery from 1982?  Even worse, David Beckworth presents data (from Macroeconomic Advisers) that NGDP peaked in April, and actually declined in May and June.  We may see the already anemic 2nd quarter numbers revised downward this week.  Goldman Sachs expects less than 2% growth in 2011.  And a rise in unemployment.  That’s no recovery.

If we really were facing structural problems, then on-target NGDP growth would lead to stagflation, as in the 1970s.  Conservatives keep insisting that high inflation is just around the corner, and Paul Krugman keeps making them look like fools.  This pains me because I like most conservative economists more than I like Krugman.

Friedman and Schwartz noted that in the 1930s the low interest rates and high levels of liquidity (cash and reserves hoarding) lulled people into thinking money was easy.  Thus pundits during that era pointed to all sorts of structural problems, which were actually symptoms of the Depression, not causes.  So I have been disappointed to read statements like this one from Edmund Phelps:

THE steps being taken by government officials to help the economy are based on a faulty premise. The diagnosis is that the economy is “constrained” by a deficiency of aggregate demand, the total demand for American goods and services. The officials’ prescription is to stimulate that demand, for as long as it takes, to facilitate the recovery of an otherwise undamaged economy “” as if the task were to help an uninjured skater get up after a bad fall.

The prescription will fail because the diagnosis is wrong. There are no symptoms of deficient demand, like deflation, and no signs of anything like a huge liquidity shortage that could cause a deficiency. Rather, our economy is damaged by deep structural faults that no stimulus package will address “” our skater has broken some bones and needs real attention.

Or William Poole:

More bond buying from the Federal Reserve won’t help the U.S. economy, because purchases can’t remedy the main problem plaguing the U.S., which is fiscal and regulatory uncertainty, former St. Louis Federal Reserve President William Poole said.

While the Fed buying more debt will bring rates down, it won’t inspire spending and lending given uncertainties in the U.S. ranging from tax cuts to health care reforms.

Or Gerald O’Driscoll:

A policy of low interest rates is a textbook response of monetary authorities to the economic weakness brought on by deficient aggregate demand. The policy is justified by pointing to various ways in which money can promote economic activity””including by stimulating investment, discouraging savings, encouraging consumption spending, and allowing individuals to lower their debt burdens by refinancing existing debt. While these effects are theoretically plausible, this textbook policy does not apply to our present situation.

First, our lingering crisis and economic weakness was brought on not by a Keynesian failure of effective demand, but by a Hayekian asset boom and bust. Second, the textbook case for low interest rates treats the policy as one of benefits without costs. No such policy exists.

Yes, Hayek did briefly oppose monetary stimulus in the early 1930s.  But in the 1970s he admitted that he had been wrong, as the problem was not simply “misallocation” resulting from an asset boom, but also insufficient nominal spending.

Or the Wall Street Journal:

As the Bible says, we know that our redeemer liveth. And on Wall Street and Washington these days, the economic redeemer of choice is the Federal Reserve. When the Fed’s Open Market Committee meets again today, markets are expecting a move toward easier money that is supposed to prevent deflation, re-ignite a lackluster recovery, revive the jobs market, and turn water into Chateau Petrus.

It’s a tempting religion, this faith in the magical powers of Ben Bernanke and monetary policy, but it’s also dangerous. It puts far too much hope in a single policy lever, ignores the significant risks of perpetually easy money, and above all lets the political class dodge responsibility for its fiscal and regulatory policies that have become the real barrier to more robust economic growth.  .  .  .

As for the current moment, the Fed has maintained its nearly zero interest rate target for 20 months, while expanding its balance sheet by some $2 trillion. By any definition this is historically easy monetary policy, and not without costs of its own.

Not by Milton Friedman’s definition.  And then it gets worse:

This is the real root of our current economic malaise””the conceit of Congress and the White House that more government spending, taxing and rule-making can force-feed economic expansion. Now that this great government experiment is so obviously failing, the politicians and the Wall Street Keynesians who cheered the stimulus are asking the Federal Reserve to save the day. Mr. Bernanke should tell them politely but firmly that his job is to maintain a stable price level, not to turn bad policy into wine.

So that’s what it’s really all about.  I agree that Obama’s economic policies are highly counterproductive.  But unlike some conservatives I am not willing to unemploy millions of workers to win a policy argument.  I guess that’s the difference between hard core conservatives and pragmatic classical liberals like Friedman and I.  We should do the right thing and then put our trust in the democratic system.

Update:  I should clarify that my attack here was not directed at all conservatives–most are well intentioned, but rather the sentiments in the WSJ editorial.  On many policy issues I agree with the other conservatives mentioned here.

BTW, when I researched the Great Depression, I was shocked at how the conservative Wall Street establishment hated dollar devaluation, despite the fact that the stock market obviously loved it.  I noted (to myself) that “at least the modern WSJ is much better; they often use the market reaction to policy announcements as a way of establishing their likely effects.”  I guess the WSJ has reverted back to the primitive pattern of the 1930s.  “Yes, the markets are screaming for easier money, probably because it will boost the economy.  But we can’t have that because it might make Obamanomics look successful.”  Plus ca change . . .

HT:  Marcus Nunes, JimP, 123, Ryan Avent.

Two untimely deaths

Benjamin Strong was President of the New York Fed during the 1920s, which effectively made him the Ben Bernanke of his time.  According to Liaquat Ahamed (p. 293-94), Strong favored a policy that attempted to stabilize the economy by looking at “the trend in prices and the level of business activity.”  Today we would call those variables the price level and real GDP, i.e. NGDP.  His policies were highly successful during the 1920s, as NGDP grew at a fairly low but steady rate after 1921.

A good example occurred during the very mild recession of 1927.  Contrary to the Austrian view, policy wasn’t particularly easy by modern standards.  Short term rates were cut to 3.5%, but that would be like 5.5% under our modern 2% inflation regime.  (In those days the trend rate of inflation was roughly zero.)  In any case, this policy insured that the recession was very mild, and the economy soon recovered.

Unfortunately, Strong died on October 16, 1928, and a year later a tight money policy by the Fed began driving both RGDP and prices far lower than they had fallen in 1927.  Irving Fisher, Ralph Hawtrey, Milton Friedman and Anna Schwartz all argued that his death deprived the Fed of “Strong” leadership, and that the resulting power vacuum contributed to the Fed’s passivity during the Great Contraction.  I’d say that praise from those 4 scholars represent a pretty good testimonial!   Sometimes I think that if Strong had lived another 10 years, WWII might never have happened.  (Or maybe it would have been fought between the US and Soviets in 1959, with nukes.)

Are there any analogies to the current crisis?  Greenspan left the Fed in 2006, about a year before the sub-prime crisis blew up.  But I am not going to argue that he could have prevented the current crisis.  His recent policy statements don’t inspire much confidence on that score.

Elsewhere I have argued that the economics profession is to blame for the recession.  We promised policymakers that we had the models and tools to stabilize nominal aggregates, and then we refused to do so when the time came for action.  The reasons are complex, but I believe that part of the problem is that all the activity at the Fed in late 2008 and early 2009 lulled many economists into thinking that the Fed had adopted a highly accommodative policy.  How many times have you read something to the effect that; “Bernanke was a student of the Depression, and was determined not to make the same mistakes.  Hence policy was very active, and prevented another Great Depression.”  If only it were true.

Of course policy was extremely contractionary during late 2008.  But why was this not recognized?  Among Keynesian economists you can point to an unhealthy fixation on nominal interest rates as an indicator of policy.  On the other hand Keynesians weren’t the main problem—they were not opposed to unconventional easing, just rather apathetic.  The real opposition came from those on the right, who were alarmed at the massive increase in the monetary base.

Milton Friedman died on November 16, 2006, one year before the sub-prime crisis.  I’d like to suggest that his death was the closest equivalent to the death of Strong in 1928.  In 1998 Friedman pointed out that the ultra low interest rates were a sign that Japanese monetary policy was very contractionary, at a time when most people characterized the policy as highly expansionary.

There is little doubt that Friedman would have recognized the low interest rates of late 2008 were a sign of economic weakness, not easy money.  But what about the big increase in the monetary base?  First of all, the base also rose by a lot in Japan, and in the US during the Great Contraction.  Second, Friedman would have clearly understood the importance of the interest on reserves policy, which was very similar in impact to the Fed’s decision to double reserve requirements in 1936-37.  And in his later years he became more open to non-traditional policy approaches, for instance he endorsed Hetzel’s 1989 proposal to target inflation expectations via the TIPS spreads.  Note that the TIPS markets showed inflation expectations actually turning negative in late 2008.

Why was Friedman so important?  I see him as having played the same role among right-wing economists that Ronald Reagan did among conservatives.  Reagan was really the only conservative that all sides respected; social conservatives, economic conservatives, and foreign policy (or neo-) conservatives.  After he left the scene, the conservative movement cracked-up.

Friedman was respected by libertarians, monetarists, new classicals, etc.  Last year I criticized Anna Schwartz for adopting the sort of neo-Austrian view that she and Friedman had strongly criticized in their Monetary History.  If Friedman was still alive, and strongly insisting that money was actually far too tight, then I doubt very much that Schwartz would have gone off in another direction.  It would be like Brad DeLong disagreeing with Paul Krugman on macroeconomic policy.  Once in a blue moon.

Today there is no real leadership among right wing economists.  They are all over the map.  There are new classical types focusing on the role of labor market imperfections.  Well-known monetarists like Schwartz and Meltzer insist that the real danger is easy money, not tight money.  It is true that a few monetarists such as Robert Hetzel, Mike Belongia and Tim Congdon have spoken out against the view that low interest rates imply money is easy, but they aren’t as influential as Friedman.  Austrians are split, with the loudest voices on the internet often drowning out the more thoughtful Austrians who recognize the dangers of a “secondary deflation.”  Inflation hawks at the Fed seem to think this is a good time to get inflation down closer to 0%, where it should have been all along in their view.  When a conservative like John Makin does speak out, it is treated as a sort of freak occurrence.

If only Milton Friedman had lived a few more years, and made the sort of bold clear statement he made in 1998 about the situation in Japan:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.


I can’t say every conservative would have accepted his view.  But they couldn’t ignore it the way they ignore me and Earl Thompson and David Beckworth and David Glasner and Robert Hetzel and Bill Woolsey and Tim Congdon.  Milton Friedman was an intellectual giant, and his voice is dearly missed.

PS.  In January Allan Meltzer had this to say about recent Fed policy:

Mr. Volcker publicly and privately discarded the Phillips Curve in favor of bringing inflation down by high interest rates and better control of the money supply. The result: about 15 years of low inflation and low unemployment. But the Fed abandoned its success by keeping interest rates too low after 2003. And now the Phillips Curve is back in fashion, with strong support from the Fed Board of Governors.

Interestingly, since the Fed abandoned its “success” in 2003, inflation has been considerably lower than in the 15 year golden age ushered in by Volcker in 1982.  And that is precisely the problem—too little inflation.  Low interest rates usually mean low inflation; Friedman understood that.

HT:  Mike Belongia, David Glasner