Blogs review: The intellectual legacy of Milton Friedman
What started as a series of post by David Glasner on the legacy of Milton Friedman turned into a major dispute after Paul Krugman wrote that “historians of economic thought will regard him as little more than an extended footnote”.
What’s at stake: What started as a series of post by David Glasner on the legacy of Milton Friedman turned into a major dispute after Paul Krugman wrote that “historians of economic thought will regard him as little more than an extended footnote”. Although it quickly appeared that the statement did not apply to Friedman, the economist, but to Friedman, the guiding light for conservative economic policies (see for example his influential Free to Choose TV series), the discussion continued as to whether the Great Recession had given a serious hit to Friedman’s economic analysis.
The disappearance of Friedman’s role in conservative economic discourse
Paul Krugman writes that one way to think about Friedman is that he was the man who tried to save free-market ideology from itself, by offering an answer to the obvious question: “If free markets are so great, how come we have depressions?” Until he came along, the answer of most conservative economists was basically that depressions served a necessary function and should simply be endured. Hayek, for example, argued that “we may perhaps prevent a crisis by checking expansion in time,” but “we can do nothing to get out of it before its natural end, once it has come.” But if markets can go so wrong that they cause Great Depressions, how can you be a free-market true believer on everything except macro?
Noah Smith writes that Friedman hasn’t disappeared from policy discourse; he’s disappeared from right-wing policy discourse. Friedman’s ideas are pretty close to the mainstream New Keynesian idea of the macroeconomy – the kind of thing promoted by Mike Woodford, Smets and Wouters, Greg Mankiw, and Miles Kimball. New Keynesian models use consumption smoothing, monetary policy rules, and a NAIRU with a downward-sloping short-run Phillips curve – all Friedman ideas. And in New Keynesian models, monetary policy reigns supreme; only at the zero lower bound is monetary policy possibly ineffective. That’s a very Friedman idea too. Furthermore, the policy of Quantitative Easing – which takes us beyond the New Keynesian framework – was what Friedman explicitly suggested for Japan.
Friedman’s ideas in the Great Recession
Paul Krugman writes that even if you give him a pass on the 3 percent growth in M2 thing, which was abandoned by almost everyone long ago, Friedman was still very much associated with the notion that the Fed can control the money supply, and controlling the money supply is all you need to stabilize the economy. In the wake of the 2008 crisis, this looks wrong from soup to nuts: the Fed can’t even control broad money, because it can add to bank reserves and they just sit there; and money in turn bears little relationship to GDP. And in retrospect the same was true in the 1930s, so that Friedman’s claim that the Fed could easily have prevented the Great Depression now looks highly dubious.
David Beckworth writes that Abenomics is largely a fulfillment of the policy prescriptions Friedman outlined for Japan 13 years ago. Here is Friedman in 2000: The Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?” It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high-powered money starts getting the economy in an expansion. Friedman knew that even though the monetary base and treasuries may be near perfect substitutes in a zero lower bound environment, they would not be in the future. And since investors make decisions on what they think will happen in the future, a monetary base injection that is expected to be permanent and greater than the demand for the it in the future is likely to affect spending today.
Paul Krugman writes that Friedman’s success, with Phelps, in predicting stagflation was what really pushed his influence over the top; his notion of a natural rate of unemployment, of a vertical Phillips curve in the long run, became part of every textbook exposition. But it’s now very clear that at low rates of inflation the Phillips curve isn’t vertical at all, that there’s an underlying downward nominal rigidity to wages and perhaps many prices too that makes the natural rate hypothesis a very bad guide under depression conditions.
Nominal interest rates as a poor guide to the monetary stance
Mike Moffatt sends us to keynote address that Friedman gave at the Bank of Canada in 2000 where he explains that we know from the past that interest rates can be a very deceptive indicator of the state of affairs. A low interest rate may be a sign of an expansive monetary policy or of an earlier restrictive policy. And similarly, a high rate may be a sign of restriction, of trying to hold things down; or it may be a sign of past inﬂation.
Scott Sumner writes that nearly 15 years ago Milton Friedman was shocked to discover that he was one of the very few economists who understood that low rates don’t mean easy money, something he had assumed was pretty obvious. 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.
Paul Krugman writes that there may have been a time — maybe 50-plus years ago — when Keynesians were confused about this point. But no modern user of IS-LM forgets that the diagram must be drawn for a given expected rate of inflation, and that large changes in expected inflation can make a big difference. And we’ve had low, fairly stable inflation expectations for a generation now. So that in the world we’ve been living in this past quarter-century or more, inflation expectations haven’t moved much, and nominal interest rates have, in practice, been a pretty good guide to the stance of monetary policy.
The special genius of the Monetary History was methodological
Stephen Williamson points to the importance of the “Monetary History of the United States” for its data collection effort and its detailed study of the Great Depression. But an arguably even more important legacy of the Monetary History is methodological. As Ben Bernanke pointed out, the special genius of the Monetary History is the authors’ use of what some today would call "natural experiments" – in this context, episodes in which money moves for reasons that are plausibly unrelated to the current state of the economy. By locating such episodes, then observing what subsequently occurred in the economy, Friedman and Schwartz laboriously built the case that the causality can be interpreted as running (mostly) from money to output and prices.
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