Finding wisdom in letters to The Economist

It is always a pleasure to read The Economist. Normally, however, I do not find the letters to the editor especially interesting. However, when I picked up this week’s edition of the magazine today I stumbled on an interesting letter from Paul DeRosa. Mr. DeRosa writes about what Milton Friedman might have thought of the present crisis.

Here is from Mr. DeRosa’s letter to The Economist:

“At a seminar once, I remember hearing him [Friedman] make the generalization that monetary policy is easy only when the prices of assets are rising faster than the prices of the goods they produce…In any case, this thought applied to any reasonable constructed index of asset prices reveals that the Federal Reserve is barely on the easy side of neutral, and the European Central Bank has Europe in death grip”

I find Mr. DeRosa’s comments extremely interesting. The comments are interesting because it indicates that Milton Friedman indeed paid attention to asset prices as an indicator for the monetary policy stance – something that of course is at the core of Market Monetarism. Second, I believe the Mr. DeRosa’s conclusion is entirely correct – the markets are clearly telling us that monetary policy in the euro zone is insanely tight – and that the Fed is not doing a much better job.

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  1. Hmm. That is an interesting measure of the stance of monetary policy. And interesting too that Friedman said it. Notice that it’s *rising* rather than *high* relative asset prices.

    • Nick, I agree. I must say I am slightly suspect about this as I have not see Friedman say this kind of thing at other occasions. However, it is nonetheless interesting.

  2. Lars and Nick, perhaps Arnold Kling’s latest is relevant here:
    I.e. stocks rising faster than output.

    Also, in “Factors Affecting the Level of Interest Rates”, from a speech he gave to the United States Savings and Loan Society in 1968, Friedman says (while discussing the transmission mechanism for monetary expansion):

    “The next effect is the income and price-level effect. As cash balances are built up, people’s attempts to acquire other assets raise the prices of assets and drive down the interest rate. That will tend to produce an increase in spending. Along standard income and expenditure lines, it will tend to increase business investment. Alternatively, to look at it more broadly, the prices of sources of services will be raised relative to the prices of service flows themselves. This leads to an increase in spending on the service flow, and therefore to an increase in current income. In addition, it leads to an increase in producing sources of services in response to the higher price which can now be obtained for them.

    (my emphasis)

    I’ve been crusading in vain to get more people to read this. (He begins the speech by distinguishing between money and credit, before going on to emphasize the unreliableness of interest rates in indicating the stance of monetary policy.)

    • Saturos

       /  August 4, 2012

      Whoops, the emphasis should have been around. (I wanted to emphasize the text that’s not italicized.)

    • Saturos, you are right this is very interesting! And I promise to have a closer look at Friedman’s speech asap.


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