Friedman’s Japanese lessons for the ECB

I often ask myself what Milton Friedman would have said about the present crisis and what he would have recommended. I know what the Friedmanite model in my head is telling me, but I don’t know what Milton Friedman actually would have said had he been alive today.

I might confess that when I hear (former?) monetarists like Allan Meltzer argue that Friedman would have said that we were facing huge inflationary risks then I get some doubts about my convictions – not about whether Meltzer is right or not about the perceived inflationary risks (he is of course very wrong), but about whether Milton Friedman would have been on the side of the Market Monetarists and called for monetary easing in the euro zone and the US.

However, today I got an idea about how to “test” indirectly what Friedman would have said. My idea is that there are economies that in the past were similar to the euro zone and the US economies of today and Friedman of course had a view on these economies. Japan naturally comes to mind.

This is what Friedman said about Japan in December 1997:

“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.”

So Friedman was basically telling the Bank of Japan to do quantitative easing – print money to buy government bonds (not to “bail out” the government, but to increase the money base).

What were the economic conditions of Japan at that time? The graph below illustrates this. I am looking at numbers for Q3 1997 (which would have been the data available when Friedman recommended QE to BoJ) and I am looking at things the central bank can influence (or rather can determine) according to traditional monetarist thinking: nominal GDP growth, inflation and money supply growth. The blue bars are the Japanese numbers.

Now compare the Japanese numbers with the similar data for the euro zone today (Q1 2012). The euro zone numbers are the red bars.

Isn’t striking how similar the numbers are? Inflation around 2-2.5%, nominal GDP growth of 1-1.5% and broad money growth around 3%. That was the story in Japan in 1997 and that is the story in the euro zone today.

Obviously there are many differences between Japan in 1997 and the euro zone today (unemployment is for example much higher in the euro zone today than it was in Japan in 1997), but judging alone from factors under the direct control of the central bank – NGDP, inflation and the money supply – Japan 1997 and the euro zone 2012 are very similar.

Therefore, I think it is pretty obvious. If Friedman had been alive today then his analysis would have been similar to his analysis of Japan in 1997 and his conclusion would have been the same: Monetary policy in the euro zone is far too tight and the ECB needs to do QE to “rejuvenate” the European economy. Any other view would have been terribly inconsistent and I would not like to think that Friedman could be so inconsistent. Allan Meltzer could be, but not Milton Friedman.


* Broad money is M2 for Japan and M3 for the euro zone.

Related posts:

Meltzer’s transformation
Allan Meltzer’s great advice for the Federal Reserve
Failed monetary policy – (another) one graph version
Jens Weidmann, do you remember the second pillar?

Leave a comment


  1. Ravi

     /  August 15, 2012

    Nice post Lars. I think you have the bars mislabelled in the graph though (or perhaps the text is wrong – one of the two!)

  2. Robert

     /  August 16, 2012

    Presumably though Friedman was talking about permanently increasing the quantity of high powered money, not the QE we have now where it’s increased and then everybody is told it will be removed if it starts to have any effect.

  3. nickik

     /  August 16, 2012

    You belive in rational expectation right? How long must NGPD in the euro zone grow at any given rate until people addopt.

    In a world where we had Selgins productivity norm growth of nominal gdp would be zero (depening if you correct for growth of poputation) but around 1-3% growth in real gdp. If people would know that this was happening it would probebly work and keep monetary equillibrium (aproximatly) stable and we would have ‘natural growth’.

    For how long must the NGDP growth stay constat for you to say that more QE does not help?

  4. nickikt

     /  August 16, 2012

    Additional questions, as long as the ECB still has inflation targeting, how big would the diffrence be in effect? So the ECB doing QE now, or first anouncing NGDP target at X% growth starting at some point or getting back to some trend.

    Another one, you talk about QE but how much NGDP growth would you like to have and from what point on, or back to with trend line?

  5. Benjamin Cole

     /  August 17, 2012

    Excellent post.
    I cannot fathom what central bankers are thinking today–unless they have so long exalted their resolve against inflation and their independence they cannot change. It helps insularity that central bankers and their staffs do not suffer in economic downturns.

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