The greatness of Milton Friedman
By Scott Sumner
I normally try to avoid responding to the monetary “analysis” in Forbes magazine. But since potential Fed nominee Judy Shelton once tweeted approval of a particularly weak example by Nathan Lewis (calling it “brilliant”), I need to set the record straight. Here is Lewis (in 2016):
However, after World War II, conservatives have tended to be split between Stable Money gold-standard advocates, and some form of conservative-flavored “soft money.” Before 1985, this was dominated by Milton Friedman’s “monetarism,” which postulated a fixed rate of expansion of the monetary base (to be enshrined in a Constitutional Amendment), and later focused on measures of M2 and similar statistics. The first notion didn’t get much traction, perhaps because it was obvious to more than a few people that it would result in Bitcoin-like volatility of value. The second idea was basically trashcanned after Paul Volcker attempted a variant of it beginning October 1979, and caused all kinds of ruckus before he publicly abandoned it in September 1982. . . .
Today, nobody takes Milton Friedman’s big ideas very seriously. Too many car wrecks.
I assumed the Bitcoin link would back up his claim with analysis from “more than a few people”. But it was merely another Nathan Lewis hit job, restated in an even more insulting fashion and without any evidence:
In A Program for Monetary Stability, he proposed this wording:
Congress shall have the power to authorize non-interest-bearing obligations of the government in the form of currency or book entries, provided that the total dollar amount outstanding increases by no more than 5 percent per year and no less than 3 percent. . . .
Bitcoin is an entertaining little trading sardine, which might have within it some templates for use in the creation of a much better currency unit. But, to propose this for the U.S. dollar? And make it a Constitutional Amendment?
Ha ha ha.
Friedman was a dope. It’s funny that decades have gone by, and practically nobody has figured this out.
His entire argument against targeting the monetary base is that the demand for base money can and does fluctuate (something Friedman obviously understood.) But Lewis (and Shelton) advocate the gold standard, and in recent years the demand for gold has been more volatile than the demand for zero interest US base money.
So let’s take a closer look at all the “car wrecks” created by this “dope”. In the 1960s and 1970s, Friedman had three big ideas in the field of monetary economics:
1. The Phillips Curve was not a reliable policy tool, and attempts to manipulate it would fail. Unemployment would return to the natural rate once expectations caught up with actual inflation. So don’t try to run inflationary policies to reduce unemployment.
2. High interest rates are not a reliable indicator of tight money, due to the Fisher effect.
3. Don’t worry about interest rates; to control inflation you need to slow the growth in the money supply. Non-monetary policies such as wage/price controls and fiscal austerity will not work.
When I was at the University of Wisconsin in the 1970s, some of my Keynesian professors agreed with Lewis’s claim that Friedman was a dope, partly because he held these three views. But subsequent events showed that Friedman was “magnificently right” about the big issues, and Friedman’s critics were wrong.
Fiscal austerity in 1968 failed to stop inflation. Wage/price controls also failed. The Phillips curve relationship in America almost completely broke down soon after Friedman published his natural rate model in 1968, just as Friedman predicted. High interest rates did not slow inflation in the 1970s, because they did not represent tight money. Only when the Fed stopped targeting interest rates and directly slowed growth in the money supply did inflation fall back to reasonable levels (in the early 1980s).
It’s not clear how monetary base targeting would have worked, as it was never tried. I do not favor that policy for the same reason I do not favor the gold standard. I’d prefer a money with a stable rate of change in value, to a money with a stable rate of change in quantity. (Gold increases in quantity at about 2%/year.) Late in his life, Friedman approved of Greenspan’s low and stable inflation policy.
Lewis’s article also criticizes NGDP targeting, in an equally unpersausive fashion. Over at TheMoneyIllusion I respond by showing that the same ridicule he uses to attack traditional and market monetarism could equally well be used against his version of the “gold standard”, which in his view ended in 1971!
But conservatives are still divided. Stable Money advocates still favor a gold-standard system – the proven method that served as the foundation for prosperity in the U.S. and around the world for nearly two centuries before being abandoned, after two wonderfully prosperous decades, in 1971.
It’s really disappointing that Judy Shelton calls Lewis’s analysis brilliant. It’s not even close.
PS. I’ve never really understood how twitter works. So I’m relying on others for the claim that Shelton was approving of Nathan Lewis’s Forbes piece. The link seems out of date.
HT: Sam Bell