Scott Sumner vs. Milton Friedman
By Arnold Kling
Professor Sumner’s views differ from the monetarism of Milton Friedman by emphasizing expectations rather than any particular measure of the money supply.
Allow me to expand on the history of monetary thought embedded in that statement.In Capitalism and Freedom, Milton Friedman wrote,
The rule that has most frequently been suggested…is a price level rule; namely, a legislative directive to the monetary authorities that they maintain a stable price level. I think this is the wrong kind of a rule because it is in terms of objectives that the monetary authorities do not have the clear and direct power to achieve by their own actions.
Friedman’s view was that changes in monetary growth rates affect nominal GDP with a “long and variable lag.” As a result, if the Fed tries to target nominal GDP (or a similar target, such as the price level), it will proceed to overshoot and undershoot, in the words of James Tobin, “like an amateur shower tuner.”
This brings up the topic that Benjamin Friedman (no relation) referred to as that of targets, instruments, and indicators. Nominal GDP or the price level are potential targets of monetary policy. However, the Fed only has certain instruments–open market operations, the discount rate, and reserve requirements being the traditional three. Finally, the Fed can use indicators, which could be any economic data, to decide how well it is doing at hitting the target.
To change from Tobin’s metaphor, consider a hockey metaphor. Businessmen are fond of citing Wayne Gretsky to the effect that a great hockey player does not skate to where the puck is now but instead skates to where it will be soon. A hockey player who does nothing but skate in the direction of the puck will simply waste energy skating all over while the puck gets passed around the rink. Similarly, in Friedman’s view, if the Fed tries to hit a price target, the economic environment will keep changing so rapidly that the Fed may wind up destabilizing. Right now, for example, you might say that the economy is weak and we need more money growth. However, if today’s money growth affects the economy two or three years from now, by then the problem may be excess inflation.
In Sumner’s model of the economy, monetary policy takes effect more quickly because monetary growth targets affect expectations. I do not buy that model, for reasons I have occasionally suggested, although I probably owe people a fuller explanation. Not today.
What I find most troubling right now is that fiscal policy is subject to long and variable lags. I am willing to bet that the majority of the fiscal stimulus enacted earlier this year will actually hit the economy after positive economic growth has been restored. Furthermore, the multiplier effects of fiscal policy tend to hit with a lag, so we will be getting even more stimulus late in the game.
It is true that employment growth will be sluggish (if my guess is right), so it might not seem as though stimulus in 2011 is so bad, but the sluggish employment growth will reflect structural problems (mismatch between growing sectors and the employee skill base), not cyclical problems. The bottom line is that I think that in 2011 and 2012 we may be experiencing increased inflation while unemployment is high. This would be true whether we tried using monetary policy to stimulate the economy or using the unfortunate delayed-action fiscal policy to stimulate the economy.
Incidentally, in the chapter on fiscal policy in Capitalism and Freedom, written in 1963, Friedman bemoans the fact that the push for fiscal stimulus always leads to permanently higher levels of government spending. It reads as if it were written yesterday.