A Milton Friedman Revival
Bloomberg columnist Caroline Baum laments that monetarists have “followed Milton Friedman to the grave.” Monetarist, of course, is a term used to identify those who agree with the ideas of the great free-market economist who died in 2006. But I see neither those ideas nor their adherents going to the grave. Indeed, the experience of the economic crisis is proving that Milton Friedman’s ideas were right all along, and they are 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 follow 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 from 2002 to 2005. But Caroline Baum wonders whether the Fed should now just print a lot more money and buy more mortgages or other securities. Though that might sound like a monetarist solution, Friedman did not believe in big discretionary changes in 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. Friedman 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 cautious as it brings back down the size of its balance sheet, which exploded during the crisis.
Friedman’s idea about the ineffectiveness of fiscal policy is reinforced by the growing recognition that the discretionary fiscal stimulus packages did little good. Forty years ago, in a famous debate with Keynesian economist Walter Heller, Friedman said “The fascinating thing to me is that the widespread faith in the potency of fiscal policy… rests on no evidence whatsoever. It’s based on pure assumption. It’s based on a priori reasoning.” It is bad news that Washington policy makers did not heed these words in the past few years as they embarked on massive fiscal stimulus packages. But the good news is that many are heeding those words now.
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Re: A Milton Friedman Revival
Yes, yes, yes. Quite.
May '10
Re: A Milton Friedman Revival
Macro-economics is not my strong point, so please correct me if I'm wrong. Is this mainly about predictability? Greater predictability leads to greater investment. Business owners shouldn't have to worry about what the dollar will do from year to year. Is that the main reason Friedman objected?
Jul '10
Re: A Milton Friedman Revival
As Friedman famously said, "Inflation is always and everywhere a monetary phenomenon."
The housing bubble was a demonstration of his axiom, as a torrent of easy money inflated the price of the least productive asset class in the economy.
That, of course, was aided by insane loosening of mortgage standards, driven by Washington.
For those who still have any appetite for investing, the message is clear - assume criminal economic incompetence on the part of the political elites and find assets which shelter your wealth from their craziness.
Farmland, food, seeds, gold, silver.
And guns.
Edited on Sep 3, 2010 at 6:50pmRe: A Milton Friedman Revival
To Friedman's point, we've had 40 years of evidence to the contrary. Reagan, and George W. Bush proved the stimulative effect of what happens when money stays in the private versus the public sector. Meanwhile, Obama proves Friedman's point by default. My question, which may be more political than economic, is why anyone with the IQ of a ferret takes Keynesian economists seriously these days? Their model is falling down around them, and still they call for more of the same, while drawing paychecks for doing so.
Jun '10
Re: A Milton Friedman Revival
Aaron Miller
Sep 3 at 6:41pm
No, it's about real growth rate versus an inflated growth rate. The fed has a real problem trying to define what the real growth rate in GDP is on an annual basis. If money supply is expanded at a rate that exceeds real growth the result is inflation. If the money supply is expanded at a rate lower than real growth the result is a stunted economy, which might lead to increased interest rates and hightened unemployment. Even for pro economists this is a tough nut to crack because there are many measures of money supply.
Edited on Sep 3, 2010 at 7:54pmJul '10
Re: A Milton Friedman Revival
Dave Carter
To Friedman's point, we've had 40 years of evidence to the contrary. Reagan, and George W. Bush proved the stimulative effect of what happens when money stays in the private versus the public sector. Meanwhile, Obama proves Friedman's point by default. My question, which may be more political than economic, is why anyone with the IQ of a ferret takes Keynesian economists seriously these days? Their model is falling down around them, and still they call for more of the same, while drawing paychecks for doing so. · Sep 3 at 7:11pm
Dave, you're a nice guy, so I'm going to over-look your slander against Ferrets.
Given free reign, any ferret would do a better job of managing the economy than the Obama crew.
Jun '10
Re: A Milton Friedman Revival
Free markets never lie for the sake of convenience. Market regulators do.
May '10
Re: A Milton Friedman Revival
Dr. Taylor, doesa this mean that you disagree with Prof. Sumner's view that the monetary policy became to tight after/because of the 2008 drop in GDP?
Jul '10
Re: A Milton Friedman Revival
The big question to me is will the Fed have the ability and/or will to tighten monetary policy quickly and effectively enough to head off the massive inflation that is sure to follow when the velocity of money finally begins to take off.
Edited on Sep 3, 2010 at 9:11pmJul '10
Re: A Milton Friedman Revival
Kenneth: As Friedman famously said, "Inflation is always and everywhere a monetary phenomenon."
The housing bubble was a demonstration of his axiom, as a torrent of easy money inflated the price of the least productive asset class in the economy.
For the ordinary person for the postwar era, housing's (or at least home ownership) most productive use was as a hedge against inflation. Ironic, huh?
Of course, that was predicated on sane and predictable lending policies not distorted by government intervention (as was the mortgage based securities markets) and relatively prudent monetary policy.
Edited on Sep 3, 2010 at 9:32pmMay '10
Re: A Milton Friedman Revival
Dave Carter
My question, which may be more political than economic, is why anyone with the IQ of a ferret takes Keynesian economists seriously these days? Their model is falling down around them, and still they call for more of the same, while drawing paychecks for doing so. · Sep 3 at 7:11pm
The Keynesian model is taken seriously because is is taught in prestigious universities by highly distinguished professors and referenced in books and papers by highly reputed authors. In the academic world, and by extension amongst economists, reputation trumps reality, especially as reputation is much easier to measure and manage.
Like much of politics these days, its all ad hominum. If the big name says it is so, then it must be so. Besides, measured results are so messy and inelegant, eh?
Aug '10
Re: A Milton Friedman Revival
To be fair, Keynesian Economics is at least based on a logical assumption - that if you have idle resources because demand is down, you can use fiscal policy to directly put those people to work. The idea of a fiscal multiplier isn't even crazy. It's easy enough to do the math to show exactly how it potentially works.
The problem with the current models, is that they completely ignore the potential negative effects that can occur when the government simply creates demand by fiat: misallocations of labor and capital, crowding out effects, moral hazards, distortions created by politicians disbursing funds based on political considerations rather than on economic rationality, and distortions of prices which make it harder for markets to be efficient,
Keynes' models are based on simplified models that treat production, labor, and capital as aggregates. To me, that's the big flaw. You can't just treat the production of a nation as a single variable.
End result - a great aggregate model applied to a complex economy that has no business being aggregated, followed by lots of reports of 'unexpected' bad news.
And a lot of excuses for why the model didn't work.
Aug '10
Re: A Milton Friedman Revival
How the world has changed. In 1976 Friedman was given a Nobel Prize for his work. In 2008 the Nobel was given to Paul Krugman.
Aug '10
Re: A Milton Friedman Revival
Then they gave one to our Prince-of-Darkness-in-Chief! Lookin' good, Nobel Committee!
Re: A Milton Friedman Revival
Dan, that really sums it up, doesn't it? By ignoring the millions of variables, decisions, and inclinations of the market and treating them as an aggregate, the government substitutes it's judgement for that of the people on the premise that government knows best. Then, when the whole thing predictably implodes, we are told that the uptick in unemployment, the drop in home sales, etc., was "unexpected." Unexpected by whom? Thomas Sowell, Walter Williams, and many other great minds certainly expect it and predict it. But the eggheads at the NYT and the Obama administration are perpetually caught with there intellectual pants down on this stuff. This isn't the audacity of hope. It's the audacity of arrogance and absurdity. Back to my coffee now.
May '10
Re: A Milton Friedman Revival
Political realities also undermine the Keynesian model: Suppose, for example, that our borrowed stimulus of the past two years constituted the construction of nuclear power plants, coal gassification plants, oil refineries, drilling platforms and exploration, re-arming our military, missile defense, a border fence. A decent case could be made that such a spending spree could have had longterm beneficial effects--even multiplying effects, to use their jargon--like the interstate highway system in the 50's.
Instead we got...nothing. Payoffs and waste and postponed pain. So even if, hypothetically, Keynesian plans have potential if effectively executed, the point is moot, because in the real world, we get porkulus, not stimulus.
Re: A Milton Friedman Revival
Replying to Aaron Miller’s question, Friedman favored rules over discretion in part because rules bring greater predictability and less uncertainty which is good for investment and job-creation. But he also found that attempts by the Fed to “fine tune” usually made things worse, causing booms and busts.
Duane Oyen wonders whether monetary policy was too tight in 2008. I would say that monetary policy was too erratic in this period, especially starting in August 2007 when the crisis flared up, and that this helped bring on the panic in the fall of 2008. The Fed introduced new many lending facilities and opened its balance sheet to bail out the creditors of Bear Stearns, but then closed it to Lehman, then opened it again to AIG and then closed it again without any clear strategy.
Edited on Sep 4, 2010 at 10:01amJun '10
Re: A Milton Friedman Revival
Scott you write:
"Suppose, for example, that our borrowed stimulus of the past two years constituted the construction of nuclear power plants..."
Scott, you have tapped into the very essence of the debate over deficits. To decoct still further we might ask, under what circumstances or for what reasons would it be appropriate for government to deficit finance? You go on to list a series of "Capital" projects. This is exactly when government can and should deficit finance as the assets so financed are used in the future, which more stricktly matches revenues and expenses. What we have today are governments that finance operating shortfalls by deficit financing, which is a big no-no that can best be described as robbing from our children and grandchildren. This is the case because we are using up government services today and passing the cost down to future generations. Not only is this unfair, it should be considered criminal. Come November maybe the election should be scrapped in favour of perp-walking Pelosi, Reid, and Obama into jail. Its not like our grandkids could do worse.
Aug '10
Re: A Milton Friedman Revival
Dave Carter
Dan, that really sums it up, doesn't it? By ignoring the millions of variables, decisions, and inclinations of the market and treating them as an aggregate, the government substitutes it's judgement for that of the people on the premise that government knows best...
As far as I can tell, the theoretical foundations of macro economics are all derived from classical thermodynamics where the details of the individual interactions are of little interest. Economies are complex, chaotic systems in which the rules of individual interaction are everything. The aggregates are all emergent properties that are impossible to derive from the rules governing the actors. Economic growth isn't like the temperature of water. You can't just light a big fire under it and expect it to get hotter. In fact by lighting the economic equivalent of fire, the so called stimulus, you risk changing how people make economic decisions resulting in unintended consequences.
Aug '10
Re: A Milton Friedman Revival
Hayek grasped the qualitative elements of complexity theory 60 years ago. Since then there has been a huge amount of research into complex systems. No one can rightly call themselves an economist without being intimately familiar with complexity, chaos, computational irreducibility, non-computability, and emergence. How many can even provide rudimentary definitions of those terms?