The Mercatus Center has just published a new symposium looking at how Milton Friedman might have reacted to recent monetary policy issues. Here is a list of the papers:
Essays
Beckworth, David. “What Would Milton Friedman Say about Financial Stability?” April 2022.
Hendrickson, Joshua. “What Would Milton Friedman Say about the Coordination of Monetary and Fiscal Policy?” April 2022.
Horan, Patrick. “What Would Milton Friedman Say about the Fed’s New Framework?” April 2022.
Ireland, Peter. “What Would Milton Friedman Say about the Recent Surge in Money Growth?” April 2022.
Probst, Julius. “What Would Milton Friedman Say about Business Cycles? The Plucking Model View.” April 2022
Sumner, Scott. “What Would Milton Friedman Say about Market Monetarism?” April 2022.
In his paper, Julius Probst discusses Friedman’s view of what’s called the “plucking model” of the business cycle:
A building block of modern macroeconomic theory is that economic activity tends to bounce around above and below the sustainable speed limit of the economy. This understanding of a symmetric business cycle, where the economy moves around the so-called natural rate of output and unemployment, drives decision-making in many central banks today.
An alternative view of the business cycle is Milton Friedman’s plucking model. It sees the economy following the natural rate of output and unemployment during normal times and deviating only during recessions—that is, economic activity can only weaken below its full potential. There are no artificial booms but only shortfalls from full employment and natural output. Recent history and much empirical evidence increasingly favors the plucking model over the standard macroeconomic view. The plucking model also has huge implications for macroeconomic risk management and macroeconomic policy. It suggests that we need to aggressively counter recessions and minimize shortfalls from potential output, especially if there are scarring effects (known as hysteresis) that damage the economy’s capacity to produce goods and services in the long run.
My own view is somewhere in between the standard symmetric business cycle model and the plucking model. I believe that the business cycle is highly asymmetric, with output falling sharply below potential during recessions and rising only slightly above potential during booms. But I would not go so far as to claim there is no such thing as output above potential.
Although the plucking model and the natural rate model are often seen as being in conflict, I believe that both are useful models, both are useful approximations of reality.
Should the Fed “aggressively counter recessions”? That depends. A stimulative policy is often appropriate during recessions, but that’s not because the Fed should be targeting employment or output, rather because aggressively countering NGDP shortfalls would often have the additional effect of aggressively countering recessions.
But not always. In 1970, 1974, 1980, and 1982, the US experienced recessions that coincided with reasonable NGDP growth. The Fed should not have aggressively countered those recessions, and instead should have maintained 5% NGDP growth—even if it made the recession worse.
READER COMMENTS
Rodrigo Escalante
May 4 2022 at 7:35am
Professor,
Does this mean you don’t mind the fed causing a recession today? Bringing down ngdp to levels you suggest are adequate will surely do so. Or at least it would put us in a scenario where the fed needs to cut rates shortly after going above neutral, how would the fed feel about doing this?
Scott Sumner
May 4 2022 at 10:32am
“Bringing down ngdp to levels you suggest are adequate will surely do so.”
This is too strong. Slower NGDP growth increases the risk of recession, but it’s far from certain. NGDP slowed sharply in 1985 with no recession.
Garrett
May 4 2022 at 8:19am
In the past you’ve described AD as a downward sloping rectangular hyperbola. Would you then describe AS as an exponential curve?
Scott Sumner
May 4 2022 at 10:35am
That seems plausible, although I don’t have strong views on the exact shape. In contrast, a hyperbola is something I view as the most useful way to think about AD, not a fact about nature.
TGGP
May 4 2022 at 10:54am
If we take the plucking metaphor literally, there is typically inertia so that a string continues to travel upward after it has returned from the position it was plucked down toward. It then vibrates until the energy dissipates. But just what it means for an economy to be “above potential” is less clear (despite Austrian attempts to base busines cycle theories on that), and when Friedman talked about NAIRU I don’t think there was as much emphasis on there being some clear line of “potential”.
Spencer Bradley Hall
May 4 2022 at 12:17pm
re: “Under the leadership of Paul Volcker, the Fed abandoned interest rate targeting and began focusing on the money supply”
That’s a myth. Volcker eschewed non-borrowed reserves and the money stock increased at a 20% rate after the DIDMCA. He exacerbated the boom/busts causing two recessions.
The 1992-1995 increase in velocity was predicted in May 1980. Securitization took place after Greenspan dropped legal reserves by 40%.
Friedman was colorfully smart but still didn’t know a debit from a credit.
Spencer Bradley Hall
May 4 2022 at 12:23pm
If economists knew what they were doing, they’d target real variables. But they don’t, so targeting N-gDp is the optimum strategy.
Garrett
May 4 2022 at 12:27pm
How do you target a real variable?
Spencer Bradley Hall
May 4 2022 at 1:46pm
re: “EPSTEIN: You are saying, in effect, that the relationship between the money supply and nominal gross domestic product broke down. The old rules no longer held.
FRIEDMAN: It has always been a very loose relationship.
Tripe. It never broke down.
Monetary Flows { M*Vt }: Monetary Flows { M*Vt } 1921-1996
Charles N Cranmer
May 7 2022 at 10:16am
This blog post from last year (April, 2021) predicted today’s inflation. It also predicted that last year’s bull market would come to an abrupt end once investors realized that the Fed was irretrievably behind the curve.
(“Ain’t Nothin’ but a Party” at cantercap.wordpress.com. I couldn’t figure out how to copy the link.)
Things have turned out pretty much as forecast. It’s not that complicated. For anyone familiar with Milton Friedman’s work, the outcome was unsurprising, if not inevitable. But Friedman has pretty much been written out of orthodox economics. Monetary aggregates were never mentioned at Jerome Powell’s recent press conference nor any of the previous ones . As the article argues, I am convinced that neither the Fed nor any neo Keynesian economists have any grasp on how the monetary system actually works.
What happens next? I think that Jerome Powell is like a deer in the headlights. He will slam on the brakes, inducing a recession. My big concern is that longer term rates will go far higher than anyone now expects and remain there. This will make it impossible to make any progress on our budget deficit.
Charles N Cranmer
May 7 2022 at 10:26am
By the way, this looks like a terrific set of articles. I can’t wait to read them. Thank you.
Michael Sandifer
May 8 2022 at 8:05pm
Will there ever be a time when enough has been written and discussed about old, dead economists like Friedman, Keynes, and Hayek?
Comments are closed.