All posts tagged Milton Friedman

Expectations and the transmission mechanism – why didn’t anybody think of that before?

As I was writing my recent post on the discussion of the importance of expectations in the lead-lag structure in the monetary transmission mechanism I came think that is really somewhat odd how little role the discussion of expectations have had in the history of the theory of transmission mechanism .

Yes, we can find discussions of expectations in the works of for example Ludwig von Mises, John Maynard Keynes and Frank Knight. However, these discussions are not directly linked to the monetary transmission mechanism and it was not really before the development of rational expectations models in the 1970s that expectations started to entering into monetary theory. Today of course New Keynesians, New Classical economists and of course most notably Market Monetarists acknowledge the central role of expectations. While most monetary policy makers still seem rather ignorant about the connection between the monetary transmission mechanism and expectations. And even fewer acknowledge that monetary policy basically becomes endogenous in a world of a perfectly credible nominal target.

A good example of this disconnect between the view of expectations and the view of the monetary transmission mechanism is of course the works of Milton Friedman. Friedman more less prior to the Muth’s famous paper on rational expectation came to the conclusion that you can’t fool everybody all of the time and as consequence monetary policy can not permanently be use to exploit a trade-off between unemployment and inflation. This is of course was one of things that got him his Nobel Prize. However, Friedman to his death continued to talk about monetary policy as working with long and variable lags. However, why would there be long and variable lags if monetary policy was perfectly credible and the economic agents have rational expectations? One answer is – as I earlier suggested – that monetary policy in no way was credible when Friedman did his research on monetary theory and policy. One can say Friedman helped develop rational expectation theory, but never grasped that this would be quite important for how we understand the monetary transmission mechanism.

Friedman, however, was not along. Basically nobody (please correct me if I am wrong!!) prior to the development of New Keynesian theory talked seriously about the importance of expectations in the monetary transmission mechanism. The issue, however, was not ignored. Hence, at the centre of the debate about the gold standard in the 1930s was of course the discussion of the need to tight the hands of policy makers. And Kydland and Prescott did not invent Rules vs Discretion. Henry Simons of course in his famous paper Rules versus Authorities in Monetary Policy from 1936 discussed the issue at length. So in some way economists have always known the importance of expectations in monetary theory. However, they have said, very little about the importance of expectation in the monetary transmission mechanism.

Therefore in many ways the key contribution of Market Monetarism to the development of monetary theory might be that we fully acknowledge the importance of expectations in the transmission mechanism. Yes, New Keynesian like Mike Woodford and Gauti Eggertsson also understand the importance of expectations in the transmission mechanism, but their view of the transmission mechanism seems uniformly focused in the expectations of the future path of real interest rates rather than on a much broader set of asset prices.

However, I might be missing something here so I am very interested in hearing what my readers have to say about this issue. Can we find any pre-rational expectations economists that had expectations at the core of there understand of the monetary transmission mechanism? Cassel? Hawtrey? Wicksell? I am not sure…

PS Don’t say Hayek he missed up badly with expectations in Prices and Production…

PPS I will be in London in the coming days on business so I am not sure I will have much time for blogging, but I will make sure to speak a lot about monetary policy…

15 Comments

by Lars Christensen on March 12, 2012 • Permalink

Posted in Efficient-Market Hypothesis, General economic theory, Hayek, Milton Friedman, MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules, Reading recommendations, Transmission mechanism

Tagged Efficient-Market Hypothesis, Frank Knight, Gustav Cassel, Milton Friedman, Ralph Hawtrey, Rational expectations, Rules vs Discretion

Posted by Lars Christensen on March 12, 2012

https://marketmonetarist.com/2012/03/12/expectations-and-the-transmission-mechanism-why-didnt-anybody-think-of-that-before/

Jason finds (one of) Friedman’s gems

Here is Jason Rave over at Macro Matters on “History’s Lessons”:

Continuing with the Monetary theme I’ve had going lately, following Lars Christensen’s post about “Free to Choose” I decided to re-read Friedman and Schwartz’s “A Monetary History of the United States”. I came across this gem again, just about as beautiful explanation of a recession I think there is. Because of the number of parallels the passage has with the current economic climate, I thought I would share the relevant text here. The passage is referencing the banking crisis of 1907 in the US.

I am very happy to have inspired Jason to read Monetary History. It is a true masterpiece and anybody interested in monetary history and theory should read it. Jason goes on to quote Friedman and Schwartz on the 1907 crisis:

“The business contraction from May 1907 to June 1908, though relatively brief, was extremely severe, involving a sharp drop in output and employment. Even the annual net national product figures show a fall of over 11 per cent in both constant and current prices from 1907 to 1908
(…)
From May 1907 on, the stock of money, seasonally adjusted, declined in every month until February 1908 – mildly until the panic, then sharply. From May to the end of September, the money stock fell by 2.5 per cent, from September to February by 5 per cent. Though mild, the decline before the panic is worth noting. It gives some evidence of unusually strong downward pressure, at least in the monetary field. Thanks to its strong upward trend, the stock of money typically rises during mild contractions, declining at most for an occasional month or two. There are only three subsequent contractions in which the estimated money stock in any month of the contraction was below its previous peak by a larger percentage than the 2.5 per cent decline from May to September 1907 alone.

…”The initial decline of about 2.5 per cent (from May to September 1907) reflected in part a decline in high-powered money by about 1 per cent…the rest of the initial decline reflected a fall in the ratio of deposits to reserves, as banks increased their high-powered money holdings by some 5 per cent despite the decline in total high-powered money…(also) although the absolute amount of both deposits and currency fell, deposits fell by 2 per cent, currency by 5 per cent.

The subsequent decline in the money stock from September 1907 to February 1908, on the other hand, has all the earmarks of an active scramble for liquidity on the part of both the public and the banks. The stock of high-powered money rose by 10 per cent over that five-month period, yet the money stock fell by 5 per cent. As in 1893 the public’s distrust if the banks…(was) reflected in the combination of a rise in currency in the hands of the public, this time by 11 per cent, and a decline in deposits, this time by 8 per cent. The two together produced a decline in the ratio of deposits to currency from 6.0 to 5.0. At the same time, the banks sought to improve their capacity to meet the demands of the public by raising their currency holdings… The result was a decline in the ratio of deposits to reserves from 8.2 to 7.0. Taken by itself, each of the changes in the deposit ratios would have produced a decline of 7-8 per cent in the stock of money and, together, of nearly 14 per cent. The actual decline was kept to 5 per cent only because of the accompanying 10 per cent rise in high-powered money”

Jason then draws a very interesting parallel:

The similarities in the process of deleveraging and the flight to liquidity between then and over 100 years later are striking. I think what’s more important to remember for the current crisis and policy response is what Friedman and Schwartz gone on to describe as the post crisis response of economic agents;

“The deposit-currency ratio rebounded rapidly and within less than a year seems to have resumed it’s earlier trend. The deposit-reserve ratio resumed its rate of rise after 1908 but at a lower level rather than at the level of the earlier trend… The experience of the panic apparently raised the liquidity preference of the commercial banks for a considerably longer period than it did that of their depositors. The same contrast in the behaviour of the two ratios is noticeable after the monetary crises of 1884 and again after the troubled period of 1980 to 1893. We shall see it occurs again after the panic of 1933.”

Given the fact that Euro zone M3 is currently growing at a below trend rate (see here), and given last night saw the third record high level of overnight deposits held with the ECB at EUR827.534 billion, I’d imagine a similar dual speed deposit ratio recovery is prevalent in the currency bloc as we speak (stay tuned for some statistical analysis of this). This has important implications for policy. That is, if depositors regain confidence in banks more rapidly than banks do in depositors and the economy, the problem is bottlenecks in the willingness to lend on the part of banks due to permanent increases in the demand for money. Thus the ECB and other central banks should be doing all they can to meet this demand, as I have argued here and here, and should continue to flood the market with cheap money until they do so (were they not constrained by inappropriate inflation targets).

Despite being written over 50 years ago about events over 100 years ago, Friedman and Schwartz’s economic documentation is still incredibly applicable to events occurring this very minute.

So what Jason basically conclude is that the ECB’s actions since December basically is what Friedman would have suggested. I of course fully agree that Friedman would have advocated increasing the money base to avoid a collapse in nominal spending. However, I would also stress that a key weakness in ECB’s policies is the lack of a clear statement of the real purpose of these operations. The ECB needs to be much more clear on it’s nominal target. In the dream world the ECB would formulate a clear NGDP level target, but we all know that that is never going to happen.

1 Comment

by Lars Christensen on March 7, 2012 • Permalink

Posted in Anna Schwartz, ECB, euro crisis, Milton Friedman

Tagged Anna Schwartz, ECB, Euro crisis, Jason Rave, Milton Friedman

Posted by Lars Christensen on March 7, 2012

https://marketmonetarist.com/2012/03/07/jason-finds-one-of-friedmans-gems/

Long and variable leads and lags

Scott Sumner yesterday posted a excellent overview of some key Market Monetarist positions. I initially thought I would also write a comment on what I think is the main positions of Market Monetarism but then realised that I already done that in my Working Paper on Market Monetarism from last year – “Market Monetarism – The Second Monetarist Counter-revolution”.

My fundamental view is that I personally do not mind being called an monetarist rather than a Market Monetarist even though I certainly think that Market Monetarism have some qualities that we do not find in traditional monetarism, but I fundamentally think Market Monetarism is a modern restatement of Monetarism rather than something fundamentally new.

I think the most important development in Market Monetarism is exactly that we as Market Monetarists stress the importance of expectations and how expectations of monetary policy can be read directly from market pricing. At the core of traditional monetarism is the assumption of adaptive expectations. However, today all economists acknowledge that economic agents (at least to some extent) are forward-looking and personally I have no problem in expressing that in the form of rational expectations – a view that Scott agrees with as do New Keynesians. However, unlike New Keynesian we stress that we can read these expectations directly from financial market pricing – stock prices, bond yields, commodity prices and exchange rates. Hence, by looking at changes in market pricing we can see whether monetary policy is becoming tighter or looser. This also has to do with our more nuanced view of the monetary transmission mechanism than is found among mainstream economists – including New Keynesians. As Scott express it:

Like monetarists, we assume many different transmission channels, not just interest rates. Money affects all sorts of asset prices. One slight difference from traditional monetarism is that we put more weight on the expected future level of NGDP, and hence the expected future hot potato effect. Higher expected future NGDP tends to increase current AD, and current NGDP.

This is basically also the reason why Scott has stressed that monetary policy works with long and variable leads rather than with long and variable lags as traditionally expressed by Milton Friedman. In my view there is however really no conflict between the two positions and both are possible dependent on the institutional set-up in a given country at a given time.

Imagine the typical monetary policy set-up during the 1960s or 1970s when Friedman was doing research on monetary matters. During this period monetary policy clearly was missing a nominal anchor. Hence, there was no nominal target for monetary policy. Monetary policy was highly discretionary. In this environment it was very hard for market participants to forecast what policies to expect from for example the Federal Reserve. In fact in the 1960s and 1970s the Fed would not even bother to announce to market participant that it had changed monetary policy – it would simply just change the policy – for example interest rates. Furthermore, as the Fed was basically not communicating directly with the markets market participant would have to guess why a certain policy change had been implemented. As a result in such an institutional set-up market participants basically by default would have backward-looking expectations and would only gradually learn about what the Fed was trying to achieve. In such a set-up monetary policy nearly by definition would work with long and variable lags.

Contrary to this is the kind of set-up we had during the Great Moderation. Even though the Federal Reserve had not clearly formulated its policy target (it still hasn’t) market participants had a pretty good idea that the Fed probably was targeting the nominal GDP level or followed a kind of Taylor rule and market participants rarely got surprised by policy changes. Hence, market participants could reasonably deduct from economic and financial developments how policy would be change in the future. During this period monetary policy basically became endogenous. If NGDP was above trend then market participant would expect that monetary policy would be tightened. That would increase money demand and push down money-velocity and push up short-term interest rates. Often the Fed would even hint in what direction monetary policy was headed which would move stock prices, commodity prices, the exchange rates and bond yields in advance for any actual policy change. A good example of this dynamics is what we saw during early 2001. As a market participant I remember that the US stock market would rally on days when weak US macroeconomic data were released as market participants priced in future monetary easing. Hence, during this period monetary policy clear worked with long and variable leads.

In fact if we lived in a world of perfectly credible NGDP level targeting monetary policy would be fully automatic and probably monetary easing and tightening would happen through changes in money demand rather than through changes in the money base. In such a world the lead in monetary policy would be extremely short. This is the Market Monetarist dream world. In fact we could say that not only is “long and variable leads” a description of how the world is, but a normative position of how it should be.

Concluding there is no conflict between whether monetary policy works with long and variable leads or lags, but rather this is strictly dependent on the monetary policy regime and how monetary policy is implemented. A key problem in both the ECB’s and the Fed’s present policies today is that both central banks are far from clear about what nominal targets they have and how to achieve it – in some ways we are back to the pre-Great Moderation days of policy uncertainty. As a consequence market participants will only gradually learn about what the central bank’s real policy objectives are and therefore there is clearly an element of long and variable lags in monetary policy. However, if the Fed tomorrow announced that it would aim to increase NGDP by 15% by the end of 2013 and it would try to achieve that by buying unlimited amounts of foreign currency I am pretty sure we would swiftly move to a world of instantaneously working monetary policy – hence we would move from a quasi-Friedmanian world to a Sumnerian world.

Without rules we live in Friedmanian world – with clear nominal targets we live live in Sumnerian world.

PS Today is a Sumnerian day – hints from both the Fed and the ECB about possible monetary tightening is leading to monetary policy tightening today. Just take a look at US stock markets…(Ok, Greek worries is also playing apart, but that is passive monetary tightening as dollar demand increases)

15 Comments

by Lars Christensen on March 6, 2012 • Permalink

Posted in ECB, Economic and monetary history, Efficient-Market Hypothesis, Federal Reserve, Financial markets, Milton Friedman, MM Research agenda, Monetary institutions, Monetary policy, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Reading recommendations, Scott Sumner, The Great Moderation, The Great Recession, Transmission mechanism

Tagged Long and variable lags, Long and variable leads, Milton Friedman, NGDP Targeting, Nominal Income Targeting, Scott Sumner, Transmission mechanism

Posted by Lars Christensen on March 6, 2012

https://marketmonetarist.com/2012/03/06/long-and-variable-leads-and-lags/

Mises was clueless about the effects of devaluation

Over at the Ludwig von Mises Institute’s website they have reproduced a comment from good old Ludwig von Mises on “The Objectives of Currency Devaluation” from Human Action. I love Human Action and there is no doubt Ludwig von Mises was a great economist, but to be frank when it comes to the issue of devaluation he was basically clueless. Sorry guys – his views on this issue are not too impressive.

He mentions five reasons why policy makers might favour “devaluation”:

To preserve the height of nominal wage rates or even to create the conditions required for their further increase, while real wage rates should rather sink
To make commodity prices, especially the prices of farm products, rise in terms of domestic money or, at least, to check their further drop
To favor the debtors at the expense of the creditors
To encourage exports and to reduce imports
To attract more foreign tourists and to make it more expensive (in terms of domestic money) for the country’s own citizens to visit foreign countries

It might be that this is what motivates policy makers to devalue the currency, but he forgets the real reason why it might make perfectly good sense to allow the currency to weaken. If monetary policy has caused nominal GDP to collapse as was the case during the Great Depression (or during the the Great Recession!) then a policy of devaluation is of course the policy to pursue. Hence, von Mises totally fails to understand the monetary implications of devaluation.

The core of von Mises’ lack to understand of the monetary impact of devaluation is that he – like Rothbard – has a very hard time differentiating between good and bad deflation. George Selgin has a great discussion of von Mises’ view of deflation in his 1990 paper “Ludwig von Mises and the Case for Gold”. George goes out of the way to explain that von Mises really did understand the difference between good and bad deflation and that given his views he should really have supported a monetary policy regime (rather than the gold standard) that ensures stabilisation of nominal spending (M*V). The paradox is of course that you can interpret von Mises in this way, but why would he then be so outspoken against devaluation? In my view von Mises did not fully appreciate that there is good and bad devaluation – so it is no surprise that his modern day internet supporters (of the populist kind…) is so in love with the gold standard. By the way the kind of arguments von Mises has against devaluation and in favour of the gold standard are very similar to the arguments of the most outspoken proponents of the euro today. Yes, the logic of a common currency and the gold standard is exactly the same.

I never understood people who support free markets could also be in favour of fixing the price of the currency – to me that makes absolutely no sense. Milton Friedman of course reached the same conclusion and more important Friedman realised that if you try to peg your currency at an unsustainable level then policy makers will try to pursue interventionist policies to maintain this peg. Capital restrictions and protectionism are the children of pegged exchange rates. Just ask Douglas Irwin.

Christina Romer is also in love with Milton Friedman

Our friend Noah Kristula-Green has an interesting quote from Christina Romer on The Daily Beast:

When you asked me for my list of books, I debated about whether to put The General Theory by John Maynard Keynes on the list. The General Theory is an incredibly important book, but it’s basically a theoretical explanation of how aggregate demand could affect output. It was Friedman and Schwartz who provided the empirical evidence that supported the theory. That’s why A Monetary History went to the top of my list.

Christina Romer is of course totally right – Friedman was right about the Great Depression. Because Romer read Friedman she also fully well understand the monetary reasons for the Great Recession.

Noah continues:

It is a testament to Friedman’s scholarship that his work holds up so well.

Now if only conservatives can admit that if Friedman was alive, he would support having the Federal Reserve be much more active in working to speed up the economic recovery.

Noah is one of the few conservative commentators in the US to consistently come out in support of Market Monetarist positions. Keep up the good job Noah!

PS See my earlier post on Christina Romer’s support of NGDP targeting here.

UPDATE: As one of my regular commentators Cthorm notes market monetarists are not calling of “active” monetary policy. We are opposed to “discretionary” and “activist” monetary policy. We want monetary policy to be rule based. I explained that that often. This my latest post on that issue here.

4 Comments

by Lars Christensen on March 2, 2012 • Permalink

Posted in Christina Romer, Milton Friedman

Tagged Christina Romer, Milton Friedman, Noah Kristula-Green

Posted by Lars Christensen on March 2, 2012

https://marketmonetarist.com/2012/03/02/christina-romer-is-also-in-love-with-milton-friedman/

A personal tribute to Milton Friedman

The Danish free market think tank CEPOS will later in the spring republish the Danish edition of Milton Friedman’s Free to Choose. I am extremely honoured that the good people at CEPOS have asked me to write the preface for “Det Frie Valg” as “Free to Choose” is known in Danish.

I now finalised writing the preface and it has surely been a joyand I would like to share it in a slightly revised English version of the Danish preface with my readers here. Those strictly interested in monetary policy should probably stop reading now and for the rest of you please bare with me – I am not completely rational when I speak about my wife, my son and Milton Friedman.

Here goes…

I have no doubt that the Free to Choose changed my life. I read the Danish version of Milton Friedman’s now-classic bestseller first time in the last half of the 1980s when I was 16-17 years old. It was one of the first books about politics and economics that I had ever read and it shaped the views of the world that I maintain to this day.

I am therefore very grateful that not only has CEPOS chosen to reprint the Danish edition of Free to Choose, but has asked me if I would write this preface. It makes me happy. Since I read Free to Choose almost 25 years, I have constantly spoken, read and written about Milton Friedman, and there is no doubt that the Free to Choose was a key reason why I later decided to study economics.

Miton Friedman’s crucial strength is in addition to being one of the twentieth century’s most important economists is his great teaching abilities. Friedman talks about political, social and economics issues in an enormous engaged and engaging way. He sells his message of freedom and free choice forcefully and effectively. It’s incredibly hard not to be convinced of the correctness of his message. That at least was the case or me. I agreed with Friedman in most of what he wrote, and almost 25 years later not much have changed. I still consider Milton Friedman to be the biggest impact on my political and economic thinking.

In my 2001 book about Milton Friedman I called him a pragmatic revolutionary. It is meant as an honorary title and the title was very much inspired by the Free to Choose. Friedman’s message of freedom and especially freedom of choice may seem radical, even revolutionary to a European and especially to a Scandinavian reader. We are not accustomed to any questions about the size and tasks of government. In Denmark, the “Welfare State” is virtually non-negotiable, but if you read Free to Choose you will be left with the feeling and the knowledge that there is something fundamentally wrong with the cradle-to-grave society we have created not only in Denmark, but also in large parts of Europe and indeed in the US.

Friedman is revolutionary because he was questioning the social order, but he’s also pragmatic. His was always eager to engage supporter of big government and supports of the welfare state. He would not compromise his fundamental believes but he would talk to people that had other view than he did. He confronted – in always polite and humorous fashion – but also agreed that their motives may have been sincere. He told to them “If you want the best education for school children, why will you not make the schools compete? Why will you not let parents choose the school. “

Friedman shows in Free to Choose that if we let parents choose the schools for their children, we will get better schools, happier and smarter children. But what makes Friedman’s arguments so strong is that if the Free Choice works for education, why should not it work for hospitals? For nursing homes? And if private schools are free to compete public schools why not private hospitals and private nursing homes. Yes, if the free choice is the right thing when we go shopping in the supermarket and when we send our children to school why should not it be the foundation of our society?

Friedman’s argument for school choice through the use of vouchers is undoubtedly one of the things that made the biggest impression on me because it totally convinced me of the importance of individual sovereignty. The rights of the individual should also be above the “right” of the government. It is the individual’s free choice, which should be at the core of any social order. A society that does not respect the free choice is not only inefficient, but it also becomes totalitarian.

Another thing that made an enormous impression on me in Free to Choose was Milton Friedman’s discussion of monetary policy. One topic that was somewhat foreign to me as a 16 year old, but since then has been the economic policy issue that has intrigued me the most – both intellectually as professionally. Friedman is the founder of the monetarist school, which stresses the importance of monetary policy on development in particular inflation, but also the business cycle and other macroeconomic conditions. I was convinced by reading Free to Choose that I was a monetarist, and to this day I will unhesitatingly tell anyone who will listen that I am monetarist.

The present economic crisis can only be understood if one understands monetary economics and there is no better teacher for monetary theory than Milton Friedman. It was of course especially for his contribution to the monetary policy research that he was awarded the 1976 Nobel Prize in economics. Free to Choose is not monetary textbook but it does offer a good introduction to the topics, which especial today is so important.

And is just yet another confirmation that Free to Choose is exactly as important as when it was first published in 1980.

Free to Choose is not just a book. There was actually produced a television series of the same name – paradoxically by the American public broadcaster PBS (also in 1980). The book is based on the TV series. Although it is a great TV series, it was not TV series but the book that convinced me why the freedom of choice must be the foundation of our society.

I’m not the only one who has been convinced of the Free to Choose. When the book was published in 1980 it was a huge success and the book is probably one of the best-selling books about economics and politics ever and has since been translated into several languages.

Finally I would like once again to thank CEPOS for getting this very important book republished in Danish on occasion that Milton Friedman in 2012 would have turned 100 years and I hope the book will make as big an impression on today’s readers as it did on me almost 25 years ago.

I would be happy to hear what my readers have to say about how Milton Friedman impacted their thinking and their choices in life. Furthermore, have a look at Pete Boettke’s excellent comment on Free to Choose here.

Finally I would like note that The Free to Choose Network is honouring Milton Friedman’s Century all through 2012. I plan on doing the same thing.

Update:

Friedman in Free to Choose on the Fed:

“In one respect the System has remained completely consistent throughout. It blames all problems on external influences beyond its control and takes credit for any and all favorable occurrences. It thereby continues to promote the myth that the private economy is unstable, while its behavior continues to document the reality that government is today the major source of economic instability.”

21 Comments

by Lars Christensen on February 28, 2012 • Permalink

Posted in Milton Friedman

Tagged Free to Choose, Milton Friedman

Posted by Lars Christensen on February 28, 2012

https://marketmonetarist.com/2012/02/28/a-personal-tribute-to-milton-friedman/

New TV Series celebrating Milton Friedman

A new TV series from PBS will be celebrating Milton Friedman. Have a look at the trailer. I am surely looking forward to this!

PS Recently I had the honour to met Bob Chitester who produced the original PBS series with Milton Friedman “Free to Choose”. Bob is founder and president of Free To Choose Network.

Are we overly focused on nominal issues?

Here is Trevor Adcock in answer to my previous post on “Regime Uncertainty”:

“Real regime uncertainty could also cause a recession if the uncertainty was over policies that affect prices and wages. The New Deal policies that distorted prices and wages directly contributed about as much to the Great Depression as policies that affected them indirectly through nominal GDP shocks. I sometimes feel that Market Monetarists focus too much on the left side of the equation of exchange and not enough on the right side.”

Trevor surely brings up a valid concern. Sometimes it seem like all of us Market Monetarist bloggers run around with our hammer and scream “If just the central banks would target the NGDP then everything would be fine”. We so to speak spend a lot (all?) of our time talking about MV in MV=PY and there might be real worry that people think that we underestimate other problems.

Is that because we do not think that there are structural problems in the US and European economies? Certainly not. I think most of us think that both the US and the European economies face very serious structural challenges and that the structural problems clearly hamper long-term real GDP growth. In fact I think most of us are much more concerned about these issues than mainstream economists – particularly mainstream European economists. After all we are all Free Market oriented (that’s an understatement) economists.

However, I believe that the present crisis both in the US and Europe is 90% nominal and 10% real. The crisis is a result of monetary policy mistakes. So yes, there are supply side problems both in the US and Europe but these problems did not cause nominal GDP to drop 10-15% below the pre-crisis trend level. This is why we are running around with our hammer and scream about NGDP level targeting all the time.

Furthermore, there is an important political-economic perspective on the discussion of nominal versus real problems. History has shown than when misguided monetary policies create problems then opt for interventionist policies to fix these problems rather than by fixing the nominal problems. Just think about NIRA and Smoot-Hawley in the US during the Great Depression or capital controls in France, Austria and Germany in 1930s. Today European policy makers are trying to “fix” the problems with highly damaging proposals for a Tobin tax, a ban on short-selling of stocks, legal attacks on rating agencies etc. No European policy makers (other than a few extreme leftists) were advocating these ideas prior to the crisis. Said in another way the monetary induced problems have led policy makers to come up with high damaging proposals that will reduce long-term real growth and do little or nothing to solve the problems facing the US and European economies at the moment. Milton Friedman’s case for floating exchange rates was to a large extent build on this kind of argument.

In my view some libertarian and conservative economists particular in the US is overplaying the “supply side problems”-card and by doing so actually discredit their own reform proposals. Many US Free Market economists for example have argued that the Obama administration’s proposals for healthcare reform played a key role in postponing the recovering in the US economy. Sorry guys that just comes across as a partisan argument rather than a argument based on sound economic reasoning. And note I am not endorsing Obama’s proposals – I just don’t think that it had any major impact on the speed of the recovery in the US economy. I am no fan of socialized medicine, but the issue is largely irrelevant for the present crisis. When the Clinton administration in the 1990s had proposals that was a lot more interventionist than what the Obama administration has suggested it did not led to a drop in economic activity in the US. And why not? Well, at that time the Federal Reserve was doing its job and kept NGDP growth on track (there comes the hammer again…).

We could of course spend more time on criticising these damaging policy proposals. We could also talk about the massive demographic challenges facing many Europe economies or talking about the massive burden on the economy from high taxes. But just because Milton Friedman focused most of his research on monetary issues I don’t think that anybody would argue that he did not care about supply issues. Market Monetarists are no different than uncle Milt in that regard.

PS see also my related post Monetary policy can’t fix all problems.

3 Comments

by Lars Christensen on February 14, 2012 • Permalink

Posted in Milton Friedman, MV=PY

Tagged Milton Friedman, MV=PY, Supply side

Posted by Lars Christensen on February 14, 2012

https://marketmonetarist.com/2012/02/14/are-we-overly-focused-on-nominal-issues/

Dinner with Bob Chitester

I don’t have a lot of time for blogging this week as I will be busy with a number of dinner arrangements – both fun and business.

Tonight I had dinner with Bob Chitester and other like-minded people. Bob was responsible as executive producer for Milton Friedman’s landmark PBS series “Free To Choose”. I am very happy to have met Bob today. Bob not only produced “Free to Choose” but he was also is the guy who convinced Friedman to do the series and as a consequence Bob truly changed the course of my life as the book that followed the TV series got me hooked on Friedman’s ideas at an age of 16 years or so back in the 1980s. People that know me would clearly acknowledge that I have not stopped talking about Friedman and monetary theory ever since then.

Bob had some wonderful anecdotes about “Uncle Milt”. Milton Friedman not only was a great economist and educator, but also a great sales man of his ideas – both economic and political.

Talking to Bob reminded me yet again of how important it is to “sell” the message in the right way. Milton Friedman of course was second to none in terms of that – what I have called a Pragmatic Revolutionary.

Milton Friedman of course would have turned 100 years this year. I look forward to celebrating him all through the year.

I want to thanks Bob for a great night and thanks to the Danish Free Market think tank CEPOS for arranging the event tonight.

3 Comments

by Lars Christensen on January 25, 2012 • Permalink

Posted in Milton Friedman

Tagged Bob Chitester, CEPOS, Free to Choose, Milton Friedman, Pragmatic Revolutionary

Posted by Lars Christensen on January 25, 2012

https://marketmonetarist.com/2012/01/25/dinner-with-bob-chitester/

Friedman should have supported NGDP targeting, but never did

I found yet another gold nugget in David Eagle’s research:

“In 2005 at the WEAI conference in San Francisco, Milton Friedman participated in panel where he strongly endorsed IT. After the panel presentations, an economist from the audience asked Friedman how he thought the Federal Reserve should respond to a broad-based 10% drop in real GDP. After spending some time trying think about what could possibility cause such a drop, Friedman responded by saying that the Federal Reserve should respond with a 10% drop in the money supply. However, immediately thereafter, Friedman inserted, “If you ask a foolish question, you get a foolish answer.””

Eagle continues:
“We disagree with Friedman concerning the foolishness of considering unexpected deviations in real GDP because that is when NIT (NGDP targeting) diverges from PLT (Price Level Targeting). Only by considering such unexpected real deviations can we see the differences in central bank responses under IT (Inflation targeting) or PLT from NIT (which we consider to be the equivalent of Friedman’s k percent rule). According to the new equation of exchange, N=PY, if Y unexpectedly increased while N (Nominal spending) remained as expected, the price level would unexpectedly fall. Under NIT, the central bank would be content to do nothing since N is on target. However, under PLT, the central bank would try to interject funds into the monetary system to try to raise N to match the increase in Y in order to return P to its targeted level. Similarly, if Y unexpectedly decreased while N remained as expected, the price level would unexpectedly increase. Under NIT, the central bank would be content to do nothing since N is on target. However, under PLT, the central bank would try to withdraw funds to try to cause N to fall to match the decline in Y in order that the price level not change.”

Hence, shortly before his dead Friedman indirectly said that he was not in favour of NGDP targeting. In my view that is not overly surprising. At that time official inflation targeting had been a success around the world for more than a decade and Friedman undoubtedly saw it as an vindication of his view that central banks should follow rules. So as always Friedman was the pragmatic revolutionary he simply support the successfully (at that time) version of a monetary rule, but I think that was on purely pragmatic reasons. Furthermore, one have to remember that at that time the primary monetary mistakes in recent history was too loose monetary policy rather than too tight monetary policy so from a pragmatic perspective it made “sense” to support inflation targeting.

As I have earlier argued Milton Friedman also acknowledged that velocity was no longer stable and that probably moved him from the left hand side to the right hand side of equation of exchange. By the way that shows that John Taylor’s use of Friedman to criticizing NGDP targeting by stating that Friedman argued that rules should be instrument rules really does not live up to what Friedman came believe in the final years of his life. Yes, Friedman endorsed inflation targeting, but NOT the Taylor rule (See David Glasner’s excellent critique of John Taylor views here). Furthermore, acknowledging that he did not think that velocity was stable (anymore) really makes it hard to use Friedman as an argument against NGDP targeting. BUT, BUT Friedman nonetheless to the end of his life preferred inflation targeting more than anything else.

Would that have change if he had live to see the Great Recession? I really don’t know and does it really matter? I still consider myself a Friedmanite and to me the best pupil of Friedman around is Scott Sumner!

——

See also my earlier post on related topics:

Friedman provided a theory for NGDP targeting
Friedman’s thermostat and why he obviously would support a NGDP target

4 Comments

by Lars Christensen on December 7, 2011 • Permalink

Posted in David Eagle, David Glasner, Milton Friedman, MM Research agenda, Monetary institutions, Monetary policy rules, NGDP Targeting, Nominal Income Targeting, Scott Sumner

Tagged David Eagle, David Glasner, Milton Friedman, NGDP Targeting, Nominal Income Targeting, Scott Sumner

Posted by Lars Christensen on December 7, 2011

https://marketmonetarist.com/2011/12/07/friedman-should-have-supported-ngdp-targeting-but-never-did/

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