Why I disagree with Milton Friedman on monetary policy

Milton writes to Greg Mankiw:

Nothing that I have observed in
recent decades has led me to change my mind about the desirability of a
monetary rule which simply increased the quantity of money at a fixed
rate month after month, year after year. That rule would get rid of the
mistakes and that is probably about all you could expect to get from a
monetary system.

Greg counters that the lender of last resort function of the central bank may interfere with a fixed monetary rule.  Fair enough (in fact I think the earlier Milton admitted this point, although the later Milton may agree with Larry White’s comment on Greg), but my objection is more day-to-day.  Hardly anyone is willing to live with the consequences of a strict rule for the monetary base.

In particular, the resulting short-term interest rate volatility would be much higher than, prior to experience, most people had expected.  Liquidity is quite scarce.  The demand for funds goes up and sometimes, in the absence of Fed smoothing, the supply just isn’t there.  Price has to adjust.  No, interest rate volatility is not the end of the world but few people believe this makes for a better marketplace.  That is why hardly anyone in the world of central banking defends monetary base targeting these days, even though the idea was fairly popular twenty-five or thirty years ago.

The Swiss tried to target their monetary base, briefly, in the mid 1980s.  No one was willing to live with the resulting interest rates and especially the exchange rates; the latter is an additional problem for small open economies.  So they stopped.  Times since then have not exactly been the Weimar hyperinflation in Bern and Zurich.  The Swiss are better off for having a multitude of targets.

We shouldn’t target the monetary base either.  If we have enough discipline to stick to a base target, we also have enough discipline to endure a regime of acceptable "muddling through."

Addendum: Correct me if I am wrong, but didn’t Milton repudiate the money target idea a few years ago and suggest inflation targeting as an acceptable substitute?


In early July of this year, Alistir Bull of Reuters reported on
a set of speeches given by Friedman with William Poole of the
St. Louis Fed, long a monetarist bastion. Friedman is reported
to have supported inflation targeting for the post-Greenspan era
at the US Fed.

Friedman's 'repudiation' of Monetarism was based on a misunderstanding by a journalist who'd lunched with him. There was a thread on it over at DeLong's, which I can't access right now--his blog is every bit as erratic as he is.

Pity about George Smith and Antony Flew; they've been fairly effectively answered by people like Richard Swinburne, Alvin Plantinga, and others.

The Financial Times piece was by Simon London and merely said:

'Hold on to your hats and prepare to be amazed: Milton Friedman has changed his mind. "The use of quantity of money as a target has not been a success," concedes the grand old man of conservative economics. "I'm not sure I would as of today push it as hard as I once did." '

London blew Friedman's remarks way out of proportion, and Paul Krugman picked it up and inflated it further to score points in his feud with Ben Stein.

London, btw, in the article, betrayed abysmal ignorance of Friedman's theory and the history of attempts to implement it.

Here's a cached version of one of the discussions at DeLong blog,

Did anyone catch Charlie Rose's interview with Milton Friedman last year? It seemed that he was very high on Volker and especially Greenspan. I'm not sure how attached he is to his monetary rules anymore. Maybe he believes that we know economics better than we did in the 30s, 40s, 50s, 60s, and 70s, and we'll screw up a lot less now. Or, maybe he believes a monetary rule will avoid catestrophic mismanagement like that which caused the Great Depression.


"There has been no similar period in history like the last 15 years in which you’ve had little fluctuation in the price level."

I think Freidman was having a "senior moment", the period from 1952 to 1967 had only 3 years with the inflation rate greater that 3% the highest in 1966 of 3.3%. The average was less than the last 15 years.

'So my question is has anyone ever clearly demonstrated that the causal relationship runs from money supply to interest rates rather then the other way around?'

It can be either. Depends on what the Fed is using as a guide. In the brief experiment with targeting monetary aggregates by Volcker that caused interest rates to rise.

After that, and especially during Greenspan's tenure, the Fed used the Fed Funds rate to control money.

Friedman is well aware of this, and still says he doesn't like working through interest rates. I think because that's what led the Fed to its disastrous policies in the 1930s; they thought interest rates were low--and NOMINAL rates were low--so monetary policy was 'loose'. When in reality, REAL interest rates were high, and monetary policy was 'tight'.

The fed targets interest rates but must add or subtract money from the system to meet the targets. They do this buying or selling in the overnight market.

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