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

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34 Responses to “Two untimely deaths”

  1. Gravatar of John Hall John Hall
    12. July 2010 at 17:42

    I see you making the argument that money wasn’t easy b/c of what short-term interest rates were doing. Don’t you normally criticize inferring the tightness/easiness of monetary policy from interest rates?

  2. Gravatar of ssumner ssumner
    12. July 2010 at 18:40

    John, No, I am simply pointing out that extremely tight money is usually associated with ultra-low interest rates. Therefore we definitely should not blindly assume low rates mean easy money.

  3. Gravatar of John John
    12. July 2010 at 18:41

    I ran into this quote from Anna Schwartz a little while back. If her Austrian conversion wasn’t weird enough, it sounds like she proposed a Keynesian solution for the recession.

    “People are saving, not spending. In order to revive this economy…” she paused, hesitating on the thought, “the government will have to resume spending. By spending, the government will require that the current inventory will be depleted and have to be replenished. And that will bring on additional production and jobs.”

  4. Gravatar of Philo Philo
    12. July 2010 at 20:07

    Friedman’s premature death (at the age of 94) did indeed make it impossible for him, at what would have been the age of 96[!], to lead us out of our economic troubles.

    “Today there is no real leadership among right wing economists.” I sense an opportunity for . . . Scott Sumner! (At least, keep on trying.)

  5. Gravatar of Joe Joe
    12. July 2010 at 21:50

    Well, you’ve got Mundell on your side, he’s not just anybody…

    Except he argues that the bubble started due to a cheap dollar in 2001.

  6. Gravatar of J J
    13. July 2010 at 01:54

    Scott, are you assuming that the TIPS market was an accurate indicator of inflation expectations in late 2008/early 2009? I would hope it is obvious as to why this is not true, particularly during that period.

  7. Gravatar of Mattias Mattias
    13. July 2010 at 06:14

    Isn’t Paul Volcker very respected among right wing economists? Or did he lose their respect when he joined the Obama team? Has he said anything about the Fed policy?

    I’m most surprised by how many finance gurus seem to be austrians. They all sell the same idea, that Greenspan has created all problems with too low interest rates. Most of them are amateur economists (nothing wrong with that) and they seem convinced that almost all professional economists are keynesians (=socialists), stupid and corrupt. They remind me of scientologists – they have read one book and think they know the only truth.

  8. Gravatar of Jeremy Goodridge Jeremy Goodridge
    13. July 2010 at 07:27

    I’m not sure you are right that Friedman would have said that we had tight money in 2008. He focused so much on the path of M2 — which did continue to grow in 2008. I know later in his life, he started to consider that money had to COMPENSATE for drops in velocity, but I still think M2 was his default way of measuring whether money is or is not tight. I seem to remember a Wall Street Journal editorial he wrote examining Japan, in which he measured monetary policy strength in Japan by M2 growth. He also correlated M2 growth with NGDP growth. So maybe he would have seen the low NGDP growth in 2008 and said that money was tight on that basis alone.

  9. Gravatar of scott sumner scott sumner
    13. July 2010 at 07:58

    John, Wow, That’s worth a post.

    Philo, But he was feisty until the end!

    You said:

    “”Today there is no real leadership among right wing economists.” I sense an opportunity for . . . Scott Sumner! (At least, keep on trying.)”

    If so, then we are really in trouble!

    Joe, Yes, I forgot about Mundell. But even with his Nobel Prize, he doesn’t have the sort of prestige that Friedman had among those on the right.

    J, I am assuming that the sharp fall in TIPS spreads in late 2008 did in fact reflect the fact that inflation expectations were plummeting–although the specific amount may have been off. The most popular alternative explanation is that conventional T-bond yields were falling due to a rush for safety and liquidity. But note, even if that alternative explanation was correct, it would still mean the economy needed much easier money–albeit for different reasons.

    In addition, there is also a CPI futures market. I know less about this market, but when I looked at in in 2009, it also showed low inflation expectations. And it would not be biased by a rush for liquid T-bonds.

    Also note that the T-bond yields are still quite low 2 years later, and there is no longer a such an intense liquidity crisis. So the low bond yields back then were justified.

    Mattias, Volcker is not at all in the same category as Friedman. And in any case, I haven’t heard him call for easier money–in fact just the opposite.

    Jeremy, You said;

    “I’m not sure you are right that Friedman would have said that we had tight money in 2008. He focused so much on the path of M2 “” which did continue to grow in 2008.”

    That is possible, but M2 had also been growing during the Japanese case–and he called that tight money. I think he would have understood that in a major financial crisis people want to hold save assets like FDIC-insured deposits. This recession is different in that respect from other postwar recessions, and I think he would have understood that. But you are right, we can’t be sure.

    I also think that people like him hate to look inconsistent. He would have sensed that the interest on reserve program gave him an easy “out” from the charge of inconsistency. It was something the Fed had never done, and all models of the demand for base money had implicitly assumed that the base earned zero interest.

  10. Gravatar of John Papola John Papola
    13. July 2010 at 08:24


    Can you explain what you see as the causal relationship underneath this historical correlation between very low rates and tight money.

    For example, I could imagine the following reason:
    After a bust, which may have an Austrian easy-money-boom-to-input-inflation-bust cause, central banks generally cut rates to very low levels in an effort to stimulate demand. But because central banks are central planners, they tend to be behind the curve and so, even though they cut rates by increasing the base money supply, they don’t increase it enough to offset the drop in the money multiplier or investment demand. The result is a recurring correlation between tight money and low rates as a central bank error much like today.

    If what I said is true, and it’s based on no significant empirical knowledge (like a good pop Austrian), than the relationship between low rates and tight money need not imply that money was tight in 2003 or 04.

    Even if I’m right, I still get tripped up here in thinking about the difference between “real’ rates and “nominal” rates and the relationship between the price level and the Fed’s monetary policy to manipulate nominal rates. It seems like the interest rates would be the first order impact with rising prices only occuring if/when the increased money supply becomes increased nominal demand. So I guess there’s a lag, right?

    Low short term rates can be tight in 2001/02 but then become loose in 2003/04 as NGDP picks up, with price inflation following as demand hits supply constraints.

    Did that make any sense?

  11. Gravatar of Benjamin Cole Benjamin Cole
    13. July 2010 at 08:35

    Another excellent post by Sumner.
    I sense right-wing economists are falling back on shibboleths more than shrewd insights at this point.
    Yes, QE feels like cheating. But if you can cheat death, you should. That is the best analogy I can come up with.

  12. Gravatar of Silas Barta Silas Barta
    13. July 2010 at 08:51

    Okay, perhaps money *is* tight. But considering that dinosaur banks can borrow at 0% by only putting up toxic MBSes as collateral, it sure looks like a loose monetary policy for them.

    Why can’t *I* get secured loans from the Fed at 0%? Why should big banks have all the fun?

  13. Gravatar of JimP JimP
    13. July 2010 at 09:12

    One Fed guy who doesn’t believe in cowering in front of the deflationists. He should give Obama a call.

  14. Gravatar of Bob O’Brien Bob O'Brien
    13. July 2010 at 09:13

    Do we have a world economy that is dependent on the presence of a single “wise” economist to stay out of serious trouble? Maybe we should think up a better system!

  15. Gravatar of Benjamin Cole Benjamin Cole
    13. July 2010 at 09:31

    Speech by Vice Chairman Donald L. Kohn
    At the Carleton University, Ottawa, Canada
    May 13, 2010

    The above speech is also on the Fed’s website. It is a long one, but again the issue of QE is daintily raised, but not dismissively. With the usual caveats, and assurances of institutional conservatism.

    Rather laughably, Kohn does raise the spectre that US households, eying the Fed’s balance sheet, might make assumptions about inflation in the future. I wonder what fraction of the US pop even knows what is the Fed–indeed, even serious economists wrestle with the results of Fed actions, or even if the Fed today is tight or loose.

    So Mr. and Mrs America are going to be examining Fed QE?

    Still, again, I think this Kohn speech another trial balloon. The Fed is preparing the policy community (not the public) for more Fed QE.
    They know we have no inflation, possible deflation, and zero percent real interest rates. We can’t run up federal deficits forever.

    Ergo, the options are as Scott Sumner states. QE, baby, QE.

  16. Gravatar of Inflationist, Heal Thyself Inflationist, Heal Thyself
    13. July 2010 at 09:31

    […] was reading Scott Sumner and came across this: Benjamin Strong was President of the New York Fed during the 1920s, which […]

  17. Gravatar of Jeff Jeff
    13. July 2010 at 09:34


    A lot of people calling themselves Austrians are just cranks who blame the Fed no matter what it does. They want a free-banking system, and anything less is illegitimate and bound to screw things up. The fact that that every democracy that has tried free banking has eventually gotten rid of it does not seem to matter to them.

  18. Gravatar of Jon Jon
    13. July 2010 at 10:51

    A lot people calling themselves Keynesian are just cranks who blame the Fed/the public no matter what it does. They want congress to direct industrial policy, and anything less is illegitimate and bound to screw things up. The fact that every democracy that has tried aggressive socialism has eventually gotten rid of it does not seem to matter to them.

    Which book would that be?

  19. Gravatar of Doc Merlin Doc Merlin
    13. July 2010 at 11:19

    ‘Do we have a world economy that is dependent on the presence of a single “wise” economist to stay out of serious trouble? Maybe we should think up a better system!’

    YES! Central banking like all centrally planned systems suffers from this flaw. This is why we should ditch it.

  20. Gravatar of Liberal Roman Liberal Roman
    13. July 2010 at 12:29

    Doc Merlin,

    What’s the alternative? Even the gold standard requires an entity to maintain the gold peg. Meaning printing money and buy gold when the price of gold goes down and selling gold when the price goes up.

    I know the gold standard is some sort of “holy grail” for today’s conservatives, but don’t they understand how ridiculous it is to set monetary policy based on how much gold will be mined this year in the South African mines?

  21. Gravatar of Mattias Mattias
    13. July 2010 at 12:31

    Ok, after checking it turns out Hubbard wrote two books all scientologists read.

    The gurus have of course read more than one book but it’s the same story peddled over and over again: we should have a gold standard, higher interest rates and let all businesses fail when they get in trouble. Otherwise it will be Weimar all over again. I sure hope that is not representative of all austrians but it’s not they that influences a lot of investors, is it?

  22. Gravatar of Doc Merlin Doc Merlin
    13. July 2010 at 12:45

    @ Liberal Roman

    The alternative is free banking. There is no reason a government has to define what money is at all. They tend to do it because it makes it cheaper for them to finance operations, but the Scottish free banking era and the swiss free banking era showed that it isn’t necessary.

    Anyway, here is a wikipedia introduction to free banking:

  23. Gravatar of Doc Merlin Doc Merlin
    13. July 2010 at 12:46


    Few austrians are gold bugs. Most (like Hayek) prefer competitive money issuance.

  24. Gravatar of Jeff Jeff
    13. July 2010 at 15:00

    Jon, I agree with you. But the fact remains that free banking is just not happening.

  25. Gravatar of JTapp JTapp
    13. July 2010 at 15:22

    Reading through Yergin & Stanislaw’s The Commanding Heights (the comprehensive history of the neoliberal revolution through 2002), Volcker is quoted as saying “I had been concerned about inflation since the 1950s when it was a disastrous 2.5%.”

    0% inflation is a plank of “supply-side” thought.

  26. Gravatar of Jon Jon
    13. July 2010 at 15:59

    What does free-banking have to do with it? I don’t think I mentioned it, and I don’t think it bears a relevant juxtaposition to the topic at-hand; Rothbard’s personal policy prescriptions are just that…

  27. Gravatar of Doc Merlin Doc Merlin
    14. July 2010 at 01:36


    I think that Jeff meant to direct that at me, not at you.

  28. Gravatar of Mattias Mattias
    14. July 2010 at 02:37

    @Doc Merlin

    What I’m saying is that gold bulls and investors worried about inflation to a large degree seems to be inspired by austrian ideas. And I think those ideas have been very influential in the “reflation trade” leading to higher gold prices, which now has become an argument for all the hidden inflation out there that is just ready to explode. I think this influences a lot of politicians on the right too.

  29. Gravatar of scott sumner scott sumner
    14. July 2010 at 06:50

    John Papola, Tight money produces low and/or falling NGDP. And low and or falling NGDP reduces the demand for credit, resulting in low interest rates.

    Thanks Benjamin.

    Silas, Good question.

    JimP, That’s a bit encouraging.

    Bob O’Brien. I agree, and I think we need to eventually move to an automatic system where the market determines the money supply, not the Fed.

    Benjamin#2, An explicit Price level of NGDP target would be even better.

    Liberal Roman, The alternative is NGDP futures targeting. The Fed sets the objective, the market implements it.

    JTapp, The biggest problem isn’t the level of inflation, it is the volatility–even more so for NGDP growth.

  30. Gravatar of John Papola John Papola
    14. July 2010 at 08:12


    So you’re saying that tight money, which at first would raise rates by shifting the supply curve of loanable funds to the left, would ultimately lead to the investment demand curve moving left as well?

    Why? Isn’t the response to a change in the credit supply (with higher rates) going to result in a change in the Quantity Demanded for investment? And wouldn’t that higher interest rate encourage more saving, leading to an increase in the supply of loanable funds?

    What am I missing? It’s be super awesome if the answer didn’t involve needing a “model”. I’m not an economist. I’m a pop austrian.

  31. Gravatar of ssumner ssumner
    15. July 2010 at 09:38

    John, A decrease in money will cause a recession. This wil lreduce business demand ofr credit, because firms typically don’t make investments to add capital stock during recessions. With less demand for credit, interest rates fall.

    BTW, It is because of sticky wages and prices that less money causes the recession, and it also explains the fall in loanable funds. If wages and prices were completely flexible, a decrease in M would not cause any decrease in real loanable funds.

  32. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    24. July 2010 at 03:04

    I remember feeling sad in the autumn of 2008 because we no longer have the guidance from Milton Friedman. But one can always ask “What would Milton Friedman say?”. And by following Friedman’s logic by December 2008 I came to the firm conclusion that contrary to their public pronouncements, ECB’s monetary policy is way too tight. Too bad that most conservatives are not searching for their inner Milton Friedman.

    I’m much more positive on Greenspan. In Summer 2008 he dissmissed FOMC’s fears of inflation by arguing that high commodity prices are a bubble. And his track record tells me he would have avoided the error of Lehman by arranging a bailout or by arranging a much stronger stimulus immediately afterwards.

  33. Gravatar of ssumner ssumner
    24. July 2010 at 16:41

    123, That’s a good point about Greenspan and Lehman. I admit that I didn’t know the Lehman failure would be so costly, and obviously Bernanke didn’t either. Greenspsn might have.

  34. Gravatar of TheMoneyIllusion » The vacuum on the right TheMoneyIllusion » The vacuum on the right
    23. July 2011 at 14:54

    […] year ago I did a post called “Two untimely deaths.”  Here’s an excerpt: Milton Friedman died on […]

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