I found Brad Delong’s new The Week column really stimulating. The lesson seems to be that the specifically Friedmanite version of classical liberalism isn’t a coherent position. Friedman wanted relatively free markets in everything but money. When it came to money, he made a huge exception and wholly endorsed central planning of the money supply. The problem is, the sources of money are in fact too many and too decentralized for Fed Central planners to control supply. That is, the Fed doesn’t really have sufficiently monopolistic control over money creation. So Friedman’s big monetary policy exception to laissez faire is undone by the fact that rational monetary central planning isn’t really possible. That’s a neat argument, and I suspect it’s true.
Here’s Brad:
The power of Friedman’s theory was, in part, rhetorical. “Keep the money supply growing smoothly” sounds like it means to keep the presses in the Bureau of Engraving and Printing rolling at a constant pace, printing out a steady flow of pictures of George Washington. But that is not how “money supply” actually works. In economic reality, “money supply” means not just cash money but also credit entries the Federal Reserve has made in commercial banks’ accounts at the Fed; plus all the credit entries commercial banks have made in households’ and businesses’ checking accounts; plus savings account balances; plus (usually) money market mutual-fund balances; plus (sometimes) trade credit and the ceilings between credit card limits and consumers’ current balances.
No central banker controls all these vast and varied sluices of the money supply – at least not in economic reality. When banks and businesses and households get scared and cautious and feel poor, they take steps to shrink the economic reality that is the “money supply.” Businesses extend less trade credit. Credit card companies cut off cards and reduce ceilings. Banks call in loans and then take no steps to replace the deposits extinguished by the loan pay-downs. Without a single bureaucrat making a single decision to slow down a single printing press, the money supply shrinks—disastrously in episodes like the Great Depression. Thus in emergencies, to say that all the central bank has to do is to keep the money supply growing smoothly is very like saying that all the captain of the Titanic has to do is to keep the deck of the ship level.
[...]
Friedman thought (a) that the central bank could exercise enough influence over the money supply to effectively control it, and (b) that banks and other financial intermediaries would be regulated tightly enough that what is now happening would be impossible. But he never resolved the tension between his view that banks need controls and the Chicago view that business must be unfettered.
There are a couple ways to go from here. One conclusion we might draw is that successful control over the money supply requires heavier regulation of the financial sector–to in effect centralize control over alternative sources of money supply. It’s not clear to me whether Brad is calling for that or not. He seems primarily to be pushing the idea that when Monetariasm has to give way to Keynesian fiscal demand priming when monetary responses to recession get tapped out. But I think one could just as easily infer from Brad’s argument that since ideal monetary central planning isn’t really possible, we ought to give up trying and fully legalize markets in privately-issued money.
Delong’s essay is a caricature of Friedman, masquerading as a plain-English summary. For one, no one has ever claimed (at least not in the last 100 years) the “money supply” was defined as currency in circulation. Thus the various M’s (M1, M2, etc.) capture a increasingly broad definition of “money”. And financial innovation in the last 20 years has certainly changed the relationships in a way that makes the task of steady money growth more technically challenging. But, Delong seems to imply that the Fed was quietly following Friedman’s prescription in the “normal times” that preceded the current crisis. Nothing could be further from the truth – monetary policy was expressly activist and loose for several years following the dot.com implosion and 9/11, giving rise to a credit expansion that certainly fed (if not directly caused) the real estate bubble, the bursting of which has landed us here. Friedman also cautioned that the impact of monetary policy changes was long and variable (hence the danger in Mr. Greenspan attempting to “fine tune” macro variables), so Delong may be premature in assuming that the massive infusion of credit that central banks have been making “has not been enough”. And to imply that guaranteeing bank debts or nationalizing banks is an extension of monetary policy (rather than acts of fascism) is an outright howler. Will, I think you give this statist a bit too much credit – and I doubt his subtext is an advocacy of free banking.
Maybe I'm missing something but I don't get DeLong. He seems to have an ever-present agenda of knocking down Chicago School and Friedman.
But his piece implies more than it actually says with regard to the general ideological point he seems to be making with his title and following content.
He opens on Friedman by saying:
Friedman proposed that with one minor, technocratic adjustment a largely unregulated free-market would work just fine. That adjustment? The government had to control the “money supply” and keep it growing at a steady, constant rate–no matter what. Since money was what people used to pay for their spending, a smoothly-growing money supply meant a smoothly-growing flow of spending and, hence, no depressions, Great or otherwise.
That is accurate I suppose.
But then he goes on and on about money supply with obvious intent of showing why Friedman was wrong….which he doesn't actually do.
After all that, he closes with this:
So now the central bankers…have run out of means to “keep the money supply growing smoothly.”
Today, we have reached the end of the line for the Chicago view of financial deregulation. Friedman thought (a) that the central bank could exercise enough influence over the money supply to effectively control it, and (b) that banks and other financial intermediaries would be regulated tightly enough that what is now happening would be impossible. But he never resolved the tension between his view that banks need controls and the Chicago view that business must be unfettered.
But what he said between these two quotes didn't bring him to that natural conclusion. Not only that, but the premises he stated for Friedman in the first quote are different than in the second.
He never actually established that central bankers have been using Friedman's ideas in practice…at least for any certain length of time or recently or as Friedman prescribed.
It's a rather weak article in that respect.
Look, I don't know whether Friedman is right on these ideas. And being more sympathetic to Austrians on this point, I tend to not put a whole lot of stock in Monetarism anyway. But regardless, I don't see where Monetarism has provided the guiding principles at the Fed…nor do I see where the conditions Friedman demanded where even respected.
I don't know…maybe I'm honestly misisng something here.
Agreed. DeLong writes quite a bit on free-market economists like Friedman and Hayek. He writes with such authority about them as well. He tends to come across as if he fancies himself as an expert on these guys. However, virtually everything he's ever written screams of howlers to me. He makes statements about them and what they think that are drastically different then the positions you would think they hold by reading Hayekians, Chicago School types…and even there own work!
Bizarre.
No human's version of anything remotely comprehensive will ever be entirely coherent. We try to make our approximations sensible and know to which domains they best apply, and sort of paper over the cracks in between areas where we actually feel like we know what we're talking about.
Friedman's contribution was to show inflation stabilization was the best policy. This means technocratic interventions, exploiting long-run trade-offs between inflation and unemployment, weren't. The economic question is which policies bring about constant inflation.
The best argument for fiscal stimulus is that traditional and untraditional monetary policy have failed. In my opinion, people in support of this fiscal policy too easily dismiss untraditional forms of monetary policy or assume monetary policy comes just in its traditional, “normal” times form. Delong gets Friedman's views on policy wrong in just this way:
“In Friedman's view, if the task of monetary stabilization could be accomplished via technocratic manipulations by a non-political central bank, there would be no need for much of the apparatus of the post-World War II social insurance state.”
This misrepresents Friedman's views in both its antecedent and its consequent. First, Friedman didn't insist on a particular implementation of his optimal policy. His “helicopter drop” is the ultimate in untraditional monetary policy (notice in its implementation, this would be considered fiscal policy). Second, he wasn't against social insurance. For example, he originated the idea of the negative income tax, aka EITC. In that famous video, he said he shared the goal to help the less well off. He just complains that usually policies aimed at doing this have the unintended consequence of hurting the people they're trying to help.
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You should think about DeLong's criticisms of Dan Mitchell in his blog today. I've long thought the same — the guy belongs in National Review along with that bozo Pilon.
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I must say this is a very good post not because of the information, but mostly for the analytical presentation. As two individual have different mindset, they must have different opinion. I think, this is the main reason behind the deviation on the thought of Friedman and DeLong. Another point I want highlight here is “decentralized money supply”.
Debt is a form of money that isn't included in M0, M1, M2, or M3. For a thorough discussion of debt-as-money, see:
http://www.debtdeflation.com/blogs/2009/01/31/t…
The money supply isn’t expanding, it’s collapsing.
Few will agree with that, because M0, M1, M2 are all moving upwards. But none of these include newer debt instruments.
Debt is traded and transferred like other forms of money. Over 60 TRILLION dollars of credit default swaps (CDS) alone existed at their peak. The value of this form of money is plummetting, and this represents a rapid collapse of the effective money supply that is an order of magnitude greater in the downward direction than the upwards movement of M2 and other measures.
The Federal Reserve is expanding the more traditional measures of money supply to compensate for the collapse of the total real money supply. The seemingly-reckless expansion of M2 is a result of attempting to compensate for the far-larger collapse of the real money supply.
Thus, the “asset deflation” is really no different from price deflation and reflects the contraction of the money supply. Welcome to 1929, relived.
What the Federal Reserve is doing (quantitative easing) is absolutely correct, but probably still too small to achieve the needed effect.
The fiscal stimulus of big federal budget deficits is also perfectly appropriate, but probably too small to achieve the needed effect.
Steve
Debt is a form of money that isn't included in M0, M1, M2, or M3. For a thorough discussion of debt-as-money, see:
http://www.debtdeflation.com/blogs/2009/01/31/t…
The money supply isn’t expanding, it’s collapsing.
Few will agree with that, because M0, M1, M2 are all moving upwards. But none of these include newer debt instruments.
Debt is traded and transferred like other forms of money. Over 60 TRILLION dollars of credit default swaps (CDS) alone existed at their peak. The value of this form of money is plummetting, and this represents a rapid collapse of the effective money supply that is an order of magnitude greater in the downward direction than the upwards movement of M2 and other measures.
The Federal Reserve is expanding the more traditional measures of money supply to compensate for the collapse of the total real money supply. The seemingly-reckless expansion of M2 is a result of attempting to compensate for the far-larger collapse of the real money supply.
Thus, the “asset deflation” is really no different from price deflation and reflects the contraction of the money supply. Welcome to 1929, relived.
What the Federal Reserve is doing (quantitative easing) is absolutely correct, but probably still too small to achieve the needed effect.
The fiscal stimulus of big federal budget deficits is also perfectly appropriate, but probably too small to achieve the needed effect.
Steve