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?

Eichengreen’s reading list to European policy makers

Barry Eichengreen provides a Summer reading list for European policy makers in his latest article on Project Syndicate. Here is Eichengreen:

“Milton Friedman’s and Anna Schwartz’s A Monetary History of the United States belongs at the top of the list. At the center of their gripping narrative is a chapter on the Great Depression, anchored by an indictment of the US Federal Reserve Board for responding inadequately to the mounting crisis.

Friedman and Schwartz are generally seen as reproving the Fed for failing to react swiftly to successive waves of bank failures, first in late 1930 and then again in 1931 and 1933. But a close reading reveals that the authors reserve their most scathing criticism for the Fed’s failure to initiate a concerted program of security purchases in the first half of 1930 in order to prevent those bank failures.

That is a message that the European Central Bank’s board members could usefully take to heart, given their announcement on August 2 that they were ready to respond to events as they unfolded but were taking no action for now. Reading Friedman and Schwartz will remind them that it is better to head off a crisis than it is to rely on one’s ability to end it.”

So true, so true…if just European policy makers had read and understood “Monetary History” then we would not be trapped in this crisis.

There are a couple of other titles on Eichengreen’s reading list, but in my view he forgets a very important book and that is his own “Golden Fetters”. Anybody who would like to understand the international monetary perspectives of the Great Depression should read “Golden Fetters”. And if you understand that you have a much better idea about the international monetary sources of the present crisis. Read Eichengreen’s “Golden Fetters” and replace “gold standard” with “dollar standard” everywhere and then you will get a pretty good idea about why we are still in this crisis. In the Great Depression it was excess demand for gold (from Europe) that caused the crisis. Today it is excess demand for dollars, which is causing the crisis. European policy makers should especially concentrate on what Eichengreen has to say about the mistakes made by European policy makers in 1931-32.

One day I hope to write a book with the title “Green Fetters”, but it will never be as good as “Golden Fetters”, but the topic would be the same – the insane commitment to a failed monetary regime and its dire consequences for the global economy. If just only policy makers would learn a bit from history.

HT David Altenhofen

PS See also Eichengreen’s critique of the ECB’s and the Fed’s inaction here (In German).

Related posts:

Between the money supply and velocity – the euro zone vs the US

International monetary disorder – how policy mistakes turned the crisis into a global crisis

1931-33 – we should learn something from history

Recommend reading for aspiring Market Monetarists

Good deflation – the case of Ireland

Deflation can be good or bad. I am sure that our friends in Ireland like this kind of deflation:

Ok…this is not really deflation. It is the price of one product declining and it is not necessarily good news if it reflects a decline in aggregate demand (as it probably is…). That said, we need a bit to smile about. You could also smile about the remarkable rally in the Irish fixed income markets. It increasingly looks like Ireland has become detached from the rest of the PIIGS – so maybe it is time to spell it PIGS again. I for Italy.

HT Martin Jul who sent me this story.

More on Laffer’s math

I guess that most of my readers have noticed that I have been somewhat upset by Arthur Laffer’s attempt to demonstrate that fiscal stimulus doesn’t work. While I am certainly very skeptical about how fruitful fiscal stimulus will be I was not impressed with Laffer’s “evidence” that fiscal stiumulus does not work. I did, however, not plan to write more on this – as I certainly do not want to promote fiscal easing anywhere and find this fiscal issue somewhat boring and irrelevant for understanding the present crisis – but then I got an interesting email from Jim Allbery.

Jim is not an economist, but a software developer with a degree in math. Jim had been equally upset by the bad math in Laffer’s Wall Street Journal piece as I had been and Jim actually has taken a closer look at Laffer’s math. Jim sent me a note on his considerations about Laffer’s math. I think Jim’s note is rather interesting and Jim has kindly allowed me to publish it. So here is Jim’s comment on Bad Math in the WSJ

Finally, just to get my position clear. I believe there is a rather significant need for fiscal consolidation in both the US and the euro zone. There is therefore no room for fiscal easing in the US or in most euro zone countries. However, the fiscal position is being made worse by overly tight monetary policy, which seriously depresses growth in both the US and the euro zone. I therefore agree with Laffer that fiscal stimulus is not the way forward in the present situation. However, I am no Calvinist and I do not believe that our present problems are due to bad fiscal policies, but rather due to overly tight monetary policy.


Related posts:

Arthur Laffer you’re embarrassing yourself
More on Laffer and Estonia – just to get the facts right
“Meantime people wrangle about fiscal remedies”
There is no such thing as fiscal policy

David Glasner’s posts on Laffer’s math:
Arthur Laffer, Anti-Enlightenment Economist
A Laffer Postscript

More on Laffer and Estonia – just to get the facts right

Arthur Laffer’s recent piece in the Wall Street Journal on fiscal stimulus has generated quite a stir in the blogosphere – with mostly Keynesians and Market Monetarists coming out and pointing to the blatant mistakes in Laffer’s piece. I on my part I was particularly appalled by the fact that Laffer said Estonia, Finland, Slovakia and Ireland had particularly Keynesian policies in 2008.  In my previous post I went through why I think Laffer’s “analysis” is completely wrong, however, I did not go into details why Laffer got the numbers wrong. I do not plan to go through all Laffer’s mistakes, but instead I will zoom in on Estonian fiscal policy since 2006 to do some justice to the fiscal consolidation implemented by the Estonian government in 2009-10.

In his WSJ article Laffer claims that the Estonian government has pursued fiscal stimulus in response to the crisis. Nothing of course could be further from the truth. One major problem with Laffer’s numbers is that he is using public spending as share of GDP to analyze the magnitude of change in fiscal policy. However, for a given level of public spending in euro (the currency today in Estonia) a drop in nominal GDP will naturally lead to an increase in public spending as share of GDP. This is obviously not fiscal stimulus. Instead it makes more sense to look at the level of public spending adjusted for inflation and this is exactly what I have done in the graph below. I also plot Estonian GDP growth in the graph. The data is yearly data and the source is IMF.

Lets start out by looking at pre-crisis public spending. In the years just ahead of the escalation of the crisis after the collapse of Lehman Brother in the autumn of 2008 public spending grew quite strongly – and hence fiscal policy was strongly expansionary. I at the time I was a vocal critique of the Estonian’s government fiscal policies.

There is certainly reason to be critical of the conduct of fiscal policy in Estonia in the boom-years 2005-8, but it does not in anyway explain what happened in 2008. Laffer looks at changes in fiscal policy from 2007 to 2009. The problem with this obviously that he is not looking at the right period. He is looking at the period while the Estonian economy was still growing strongly. Hence, while the Estonian economy already started slowing in 2007 it was not before the autumn of 2008 that the crisis really hit. Therefore, the first full crisis year was 2009 and it was in 2009 we got the first crisis budget.

So what happened in 2009? Inflation adjusted public spending dropped! This is what makes Estonia unique. The Estonian government did NOT implement Keynesian policies rather it did the opposite. It cut spending. This is clear from the graph (the blue line). It is also clear from the graph that the Estonian government introduced further austerity measures and cut public spending further in 2010. This is of course what Laffer calls “fiscal stimulus”. All other economists in the world would call it fiscal consolidation or fiscal tightening and it is surely not something that Keynesians like Paul Krugman would recommend. On the other hand I think the Estonian government deserves credit for its brave fiscal consolidation. The Estonian government estimates that the size of fiscal consolidation from 2008 to 2010 amounts to around 17% (!) of GDP. I think this estimate is more or less right – hardly Krugmanian policies.

And maybe it is here Laffer should have started his analysis. The Estonian government did the opposite of what Keynesians would have recommend and what happened? Growth picked up! I would not claim that that had much to do with the fiscal consolidation, but at least it is hard to argue based on the data that the fiscal consolidation had a massively negative impact on GDP growth. Laffer would have known that had he actually taken care to have proper look at the data rather than just fitting the data to his story.

Laffer of course could also have told the story about the years 2011 and 2012, where the Estonian government in fact did introduce (moderate) fiscal stimulus. And what was the result? Well, growth slowed! The result Laffer was looking for! Again he missed that story. I would of course not claim that fiscal policy caused GDP growth to slow in 20011-12, but at least it is an indication that fiscal stimulus will not necessary give a boost to growth.

I hope we now got the facts about Estonian fiscal policy right.

PS David Glasner has an excellent follow-up on Laffer’s data as well.

PPS If you really want to know what have driven Estonian growth – then you should have a look at the ECB. Both the boom and the bust was caused by the ECB. It is that simple – fiscal policy did not play the role claimed by Laffer or Krugman. It is all monetary and I might do post at that at a later stage.

PPPS Time also has an article on the “Laffer controversy”

Welcome on board James Pethokoukis

Take a look at these articles from the American Enterprise Institute’s James Pethokoukis:

Fed study says Bush and the banks didn’t cause the Great Recession. The Fed did

Is it time for the Fed to launch a pro-growth monetary policy?

Does the euro zone have a debt crisis or a nominal GDP crisis?

Yeah, it seems like we got an ally at the AEI. Welcome on board James!

HT David Beckworth

Update: Also listen to James’ interview with Scott Sumner.

Friedman, Schuler and Hanke on exchange rates – a minor and friendly disagreement

Before Arthur Laffer got me very upset on Monday I had read an excellent piece by Kurt Schuler on about Milton Friedman’s position on floating exchange rates versus fixed exchange rates.

Kurt kindly refers to my post on differences between the Swedish and Danish exchange regimes in which I argue that even though Milton Friedman as a general rule prefered floating exchange rates to fixed exchange rates he did not argue that floating exchange rates was always preferable to pegged exchange rates.

Kurt’s comments at length on the same topic and forcefully makes the case that Friedman is not the floating exchange rate proponent that he is sometimes made up to be. Kurt also notes that Steve Hanke a couple of years ago made a similar point. By complete coincidence Steve had actually a couple of days ago sent me his article on the topic (not knowing that I actually had just read it recently and wanted to do a post on it).

Both Kurt and Steve are proponents of currency boards – and I certainly think currency boards under some circumstances have some merit – so it is not surprising they both stress Friedman’s “open-mindeness” on fixed exchange rates. And there is absolutely nothing wrong in arguing that Friedman was pragmatic on the exchange rate issue rather than dogmatic. That said, I think that both Kurt and Steve “overdo” it a bit.

I certainly think that Friedman’s first choice on exchange rate regime was floating exchange rates. In fact I think he even preffered “dirty floats” and “managed floats” to pegged exchange rates. When I recently reread his memories (“Two Lucky People”) I noted how often he writes about how he advised governments and central bank officials around the world to implement a floating exchange rate regime.

In “Two Lucky People” (page 221) Friedman quotes from his book “Money Mischief”:

“…making me far more skeptical that a system of freely floating exchange rates is politically feasible. Central banks will meddle – always, of corse, with the best of intentions. Nevertheless, even dirty floating exchange rates seem to me preferable to pegged rates, though not necessarily to a unified currency”

I think this quote pretty well illustrates Friedman’s general position: Floating exchange rates is the first choice, but under some circumstances pegged exchange rates or currency unions (an “unified currency”) is preferable.

On this issue I find myself closer to Friedman than to Kurt’s and Steve’s view. Kurt and Steve are both long time advocates of currency boards and hence tend to believe that fixed exchange rates regimes are preferable to floating exchange rates. To me this is not a theoretical discussion, but rather an empirical and practical position.

Finally, lately I have lashed out at some US free market oriented economists who I think have been intellectually dishonest for partisan reasons. Kurt and Steve are certainly not examples of this and contrary to many of the “partisan economists” Kurt and Steve have great knowledge of monetary theory and history. In that regard I am happy to recommend to my readers to read Steve’s recent piece on global monetary policy. See here and here. You should not be surprised to find that Steve’s position is that the main problem today is too tight rather than too easy monetary policy – particularly in the euro zone.

PS I should of course note that Kurt is a Free Banking advocate so he ideally prefers Free Banking rather anything else. I have no disagreement with Kurt on this issue.

PPS Phew… it was much nicer to write this post than my recent “anger posts”.


Related post:
Schuler on money demand – and a bit of Lithuanian memories…

Arthur Laffer you’re embarrassing yourself

During George W. Bush’s years as president I most say that I lost a lot of respect for Paul Krugman. It was very clear that he was suffering from what Charles Krauthammer called the “Bush Derangement Syndrome” (BDS). BDS undoubtedly made Krugman write crackpot articles about all kind of subjects. Krugman for example on numerous occasions has argued in favour of protectionism – something the pre-Bush Krugman would never have done.

Unfortunately, this President Derangement Syndrome (PDS) has infected a number of US right-wing economists who used to be clever economists, but today seem to have forgotten everything about economics – mostly as a result of an apparent hatred of President Obama. I am no fan of President Obama, but I do not let that change my view of economics.

I have earlier highlighted that I think that Allan Meltzer who is one of my great monetarist heroes seems to have forgotten everything about monetary theory that he once preached exactly because of PDS. Unfortunately he is not the only right-wing US economist to suffer from PDS. The latest example is supply-side hero Arthur Laffer who frankly is embarrassing himself in a recent Wall Street Journal article.

The stated purpose of Laffer’s article is to show that “in country after country, increased government spending acted more like a depressant than a stimulant.”

Anybody who reads my blog would know that I am certainly no fan of “fiscal stimulus” and that I believe that fiscal policy can not “overrule” monetary policy. Hence, I believe in the so-called Sumner Critique. Furthermore, I strongly believe that there is good empirical evidence that a larger government is a drag on the economy and that more government spending in general will tend to reduce productivity growth in the longer run. Hence, I strongly agree with Laffer in terms of the overall view that fiscal stimulus is unlikely to be helpful in getting us out of this crisis and in the long run a larger public sector is likely to hamper growth.

However, even though I agree on Laffer’s skeptical view of fiscal stimulus I nonetheless find his “analysis” to be shockingly bad.

In his analysis Laffer compares the change in real GDP growth from 2006-2007 to 2008-2009 with the change in government spending in the same period in different OECD countries. (By the way look Laffer’s numbers look very odd – David Glasner discusses that in his post on Laffer here.) Here is Laffer’s somewhat surprising conclusion:

“The four nations—Estonia, Ireland, the Slovak Republic and Finland—with the biggest stimulus programs had the steepest declines in growth.”

Are you joking Art?? Estonia? Biggest stimulus program? You can’t seriously think so. I think Prime Minister Ansip of Estonia would be rather upset that you say that his government apparently has conducted some kind of Keynesian fiscal stimulus. I know for a fact that Mr. Ansip has no respect for Keynesian fiscal stimulus. In fact his government has rightly been praised for its conservative fiscal stance.

Mr. Ansip’s government has since the crisis hit in 2008 (in fact it already started in 2007 in Estonia) passed significant austerity measures such as cutting public sector wages and pensions. Mr. Ansip’s government has shown an enormous commitment to reducing the budget deficit and reining in the public debt. In fact by saying what you are saying Mr. Laffer you are making a mockery of the truly remarkable fiscal consolidation in Estonia.

I don’t know where Mr. Laffer has been recently – didn’t he notice that THE KEYNESIAN Paul Krugman has been highly critical of Estonia’s fiscal consolidation and that has upset Estonian policy makers a great deal (and rightly so). Mr. Laffer would of course have known this if he had read the WALL STREET JOURNAL!!!

Estonia by far has the lowest debt-to-GDP ratio in the OECD area so how Mr. Laffer can claim that Estonia is an example of an evil Keynesian experiment is somewhat of a puzzle to me. The limit for public debt in the EU is 60% of GDP. Estonia’s public debt is 6% (!) of GDP. And Estonia is running a public finance SURPLUS!

But ok, lets say that Mr. Laffer made one mistakes in his assessment. The three other countries have to be irresponsible countries. No! They are certainly not. In fact Finland and Slovakia are both in the group of the most fiscally conservative countries in the EU and the markets agree. Just look at Finnish and Slovakian bond yields. In fact few market participants would question the creditworthiness of Finland. After all Finland has a BETTER credit rating than Germany! Finnish government bond yields is basically at the same level as German bond yields.

So how about Ireland? It is true that the country has seen a sharp rise in public debt since 2008. However, that can hardly been seen as a result of “fiscal stimulus”. The rise in public debt is mostly due to banking rescues in 2008 and 2009, which of course can be questioned whether that has been a good idea, but you can hardly say that Ireland has conducted keyensian style fiscal stimulus. Furthermore, after the sharp rise in public debt consecutive Irish governments have put a lot of effort into fiscal consolidation and Ireland has rightly been praised for its effort to curb public debt. As a result Ireland is generally perceived more positively by the markets and credit rating agencies than the other so-called PIIGS countries.

So we can easily conclude that Arthur Laffer got it completely wrong. So why is that? Well, maybe he never heard about cyclically adjusted government spending. It should be no surprise to anybody who just spent one hour reading an intermediate textbook on public finances that government spending tend to increase in cyclical downturns and tax revenues drop when the economy slumps.

Estonia in 2007-2010 went through a Great Depression sized collapse in economic activity and hence it is no surprise that that led to an increase in public spending as outlays to unemployment benefits and other social benefits rose sharply. To its credit the Estonian government reacted to this worsening of public finances by putting through significant austerity measures. Mr. Laffer, however, in his eagerness to badmouth President Obama’s fiscal policies forgets this and knowingly or unknowingly trashes the heroic fiscal performance of Mr. Ansip’s Estonian government. I think an excuse would be in order.

I am sorry to say it, but Mr. Laffer’s article is yet another example of right-wing US economists that for the sake of partisan politics completely trash all economic logic. That is too bad, because Mr. Laffer could instead have told the story of the great example of Estonia, a country that is gradually coming out of this crisis WITHOUT fiscal stimulus. He could also have told the story about Greece’s and Spain’s fiscal stimulus packages of 2009 that did a lot to increase these countries’ public debt levels. He could also have told the story about how fiscally conservative policies have ensured that Finland is the country in Europe with the best credit rating.

I strongly believe that less public spending is positive for long-term growth (and that is a supply-side argument Mr. Laffer!) and I doubt that fiscal stimulus (without monetary stimulus) will do much to increase growth in the short-run, but I have far better arguments than Mr. Laffer.

I think it is about time that my fellow free market economist friends in the US start to behave as economists rather than playing party politics. That would strengthen the case for free markets and less government intervention. By playing party politics economists like Allan Meltzer and Arthur Laffer are not doing the cause much service.


PS I use the term “right-wing” economist above to mean an economist who generally is in favour of free markets and generally opposes government intervention in the economy. In that sense I am obviously a right-wing economist myself.

PPS I also suspect John Cochrane and Casey Mulligan of suffering from PDS.

Update: Brad DeLong also has a comment on Laffer’s WSJ piece. I am getting tired of agreeing with him and Krugman in their criticism of (certain!) “right-wing” economists.
Update 2: Karl Smith joins the debate.
Update 3: And here is Matt O’Brien on the same topic – with a golden quote: “He really is the anti-Keynes. When the facts change, Laffer changes the facts back, so he won’t have to change his mind.”

Guest post: Yes Lars, inflation is always and everywhere a monetary phenomenon (By Jens Pedersen)

Guest post: Yes Lars, inflation is always and everywhere a monetary phenomenon
By Jens Pedersen

The host of this blog, my good friend and colleague, on a daily basis reminds me “inflation is always and everywhere a monetary phenomenon” – and even more so this week where we have celebrated Milton Friedman’s birthday. I certainly do not need any convincing. On the contrary with this blog post I will present evidence that this is has indeed also been the case during the “The Great Recession”.

Following the general New Keynesian Phillips curve formulation current inflation depends on the expected future inflation and the gap between current output and the natural level of output. If a larger share of prices is adjusted every period then current inflation will depend more strongly on the current output gap and vice versa.

Using the New Keynesian framework it is possible to show that monetary policy during “The Great Recession” has had leverage over the development of prices both in the short run and the long run. Atlanta Fed’s monthly sticky price index will serve helpful in this. The sticky price index basically comprises the price components in the US consumer price index that are adjusted infrequently. Atlanta Fed furthermore publishes a flexible counterpart comprising the components in the US consumer price index that are adjusted frequently.

The first chart below depicts the development in US flexible core price inflation since 2008. I have used the three-month annual inflation rate only to get a smoother trend – it does not affect the main points of the analysis. I have marked seven turning points in the flexible core inflation that coincides with significant monetary policy shocks. 1) ECB surprises with a 0.25 %-point increase in interest rates, 2) Fed launches first round of QE, signals extended period of low rates, other major central bank cuts rates, Fed open dollar swap line, 3) Fed ends dollar swap line, 4) Bernanke mentions QE2, Fed launches QE2, 5) Trichet signals “strong vigilance”, ECB raises the interest rate twice, 6) ECB implements 3 year LTRO, 7) ECB tightens collateral rules.

What this brief analysis shows is that frequently adjusted prices do react to changes in monetary policy. When monetary policy is eased, demand increases and subsequently prices increase and vice versa.

In contrast, sticky price inflation does not only reflect the reaction to current monetary policy shocks, but also the expectations of the future development in demand. If demand is expected to increase then the sticky price inflation will increase as well.

The second chart below illustrates US sticky core price inflation since 2008. What the sticky core price inflation chart shows is that the monetary policy shocks in the end of 2008 (QE1 and extended period language) briefly improved the outlook for the US economy, but it was not before Fed launched QE2 in the second half of 2010 that sticky core inflation started increasing reflecting expectations of increasing demand. The chart further shows that sticky core inflation has started declining since the end of 2011. Hence, recently monetary policy has not done enough to maintain expectations of increasing demand.

The above analysis shows that consumer prices do contain substantial information on the effects of monetary policy. And to sum up, yes Lars, you are certainly right – inflation is always and everywhere a monetary phenomenon!

PS The Flexible and sticky prices series come from Federal Reserve Bank of Atlanta’s Inflation Project.

Cochrane’s inconsistencies

I just came across a couple of weeks old post from John Cochrane’s blog. Cochrane seems to be very upset about the calls for easier monetary policy in the euro zone. Let’s just say it as it is. Even though Cochrane is a professor at the University of Chicago he is certainly not a monetarist. It is sad how the University of Chicago has totally abandoned its proud monetarist traditions.

Here is Cochrane:

“As you might have guessed, I think it’s a terrible idea (Cochrane refers to a weakening of the euro engineered by easier monetary policy)…The biggest reason is the vanity that you can do it just once. “Devalue and inflate the currency” is hardly a new idea. Portugal, Italy, Spain, and Greece lived on a cycle of continual devaluation and inflation until they joined the Euro.  Going on the Euro was a hard won transformation to precommit to get off this cycle. “

Hence, Cochrane thinks easier monetary policy is very evil. However, in the in the comment section Cochrane states the following:

“I like a price level target. I view money as a set of units for value, and I don’t think the government artfully devaluing the meter and kilo to give shopkeepers a boost is a good idea, any more than fooling with inflation to do so, even if it does “work,” at least once. I’m less of a fan of NGDP targets, and the link from interest rates to price level is pretty tenuous…More coming, a comment isn’t the place for an entire monetary-fiscal program.”

Again you would think that Milton Friedman would be screaming from economist heaven about Cochrane’s odd references to the “tenuous” link between the price level and interest rates – as if interest rates are telling us much about monetary policy. Anyway, note that Cochrane says he likes a price level targeting regime. Fine with me. Then why not endorse Price Level Targeting for the euro zone professor Cochrane?

The graph below shows the euro zone GDP deflator and a 2% trend path for prices. The 2% path is of course what the ECB would be targeting if it implemented a Price Level Target as supported by Cochrane. Now have a look at the graph again and tell me what the ECB should do now if it was a Price Level Targeter?

The graph is very clear: Monetary policy is far too tight in the euro zone and as a result the actual price level is far below the pre-crisis 2% path level.

If Professor Cochrane was consistent in his views then he would obviously conclude that the ECB’s failed monetary policies are keeping the euro zone price level depressed, but I am afraid he did not even care to study the numbers.

Cochrane should obviously be calling for massive monetary easing in the euro zone. Milton Friedman would do so.

I can only again say how sad it is that the University of Chicago professors continue to disregard the economics of Milton Friedman.

PS I hope I am wrong about the University of Chicago so I would be happy if my readers would be able to find just one staffer at UC that is actually a monetarist. Ok, I would be happy if you could just locate a student at UC who has read anything Milton Friedman had to say about monetary theory.

PPS I really do not like this kind of attack on what other economists are writing on their blogs. However, as an admirer of Milton Friedman the continued indirect badmouthing of Friedmanite monetarism by the present day University of Chicago professors upsets me a great deal.


Related posts:

See here on another University of Chicago professor who doesn’t care about Milton Friedman.

Another post on why the ECB should target the GDP deflator rather than HICP.

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