Milton Friedman argued that the Great Depression occurred despite massive QE
By Scott Sumner
The Great Recession has exposed the fact that many economists believe things that just aren’t so. They believe that low interest rates suggest that money is easy. They believe that monetary stimulus is ineffective at the zero bound. And recently I’ve discovered than many people believe that Friedman and Schwartz argued (in their Monetary History of the United States) that the Great Depression happened because the Fed cut the monetary base, or at least refrained from increasing it. Nothing could be further from the truth.
In their famous 1963 study, Friedman and Schwartz show that the base increased almost 4 fold over 12 years:
December 1929: $6,978 million
December 1941: $23,738 million
Indeed it grew by about 20% during the Great Contraction that ended in March 1933.
I think the problem here is that people either read the Monetary History so long ago that they’ve forgotten the details, or they read a sort of “Cliff’s Notes” version of the book. The actual book is very nuanced in its interpretation of the evidence, and is full of brilliant analysis. And I say this despite the fact that I don’t buy two of its key assumptions:
1. The claim that M2 growth is the best indicator of the stance of monetary policy (I prefer the gold/base ratio under the gold standard, and NGDP growth expectations under fiat money).
2. The assumption that the Great Depression in the US is best analyzed by looking at US monetary policy (I prefer a global perspective).
Over at TheMoneyIllusion a commenter named Lord Kelvin made the following observation:
As part of my efforts to be a better-informed econ undergrad, I recently read the Monetary History and was surprised by how much more sophisticated the narrative was than I expected.
Friedman and Schwartz were quite clear that the decline in M2 was due mainly to changes in the deposit and reserve ratios. They blamed the Fed for having assured banks that it would be a sound lender of last resort, then doing nearly nothing in the face of the Great Depression; they claim earlier suspension and the Aldrich-Vreeland act would have worked better. So I agree that Delong reads them incorrectly: they blamed the Fed for replacing a superior system; while you may disagree with this assessment, it’s certainly reasonable.
Why does any of this matter? Because people like Paul Krugman and Brad DeLong don’t just argue that Friedman had a simplistic view of the Great Depression, they also argue that the Great Recession has somehow discredited his views. After all, the Fed did lots of QE. Wasn’t that supposed to prevent a depression?
Obviously if Friedman and Schwartz document a lot of QE during the Great Depression, they could not possibly have believed that the Great Depression was caused by a failure to do QE. A better argument would be that the Great Recession occurred despite the fact that (unlike in the early 1930s) the Fed insured that M2 kept growing. However by the last few years of his life Friedman had moved beyond simply money supply targeting, and shifted to inflation targeting. In 1992 he endorsed Robert Hetzel’s proposal to peg TIPS spreads. Both TIPS spreads and actual inflation fell sharply during late 2008, and hence money was too tight either way.
Speaking of Robert Hetzel, he has a nice piece at the Richmond Fed on NGDP targeting. He discusses both the pros and cons, but ends on a positive note:
At the same time, articulation of a benchmark path for the level of nominal GDP would be a useful start in formulating and communicating policy as a rule. An explicit rule would in turn highlight the importance of shaping the expectations of markets about the way in which the central bank will behave in the future.
A benchmark path for the level of nominal GDP would encourage the FOMC to articulate a strategy (rule) that it believes will keep its forecasts of nominal GDP aligned with its benchmark path. In recessions, nominal GDP growth declines significantly. During periods of inflation, it increases significantly.
The FOMC would then need to address the source of these deviations. Did they arise as a consequence of powerful external shocks? Alternatively, did they arise as a consequence either of a poor strategy (rule) or from a departure from an optimal rule?
This is quite similar to the points I made in my recent post about Fed accountability.
One small quibble with the article is that Hetzel overlooks the fact that recent NGDP futures targeting proposals are not susceptible to the circularity problem.