Milton Friedman on the Euro and QE3

In 2000 Milton Friedman gave the keynote address to a conference at the Bank of Canada on flexible exchange rates. A Q&A at the end of the talk featured David Laidler, Michael Bordo, John Crow and others.

Michael Bordo asked Friedman about the Euro:

Milton Friedman:…I think the euro is in its honeymoon phase. I hope it succeeds, but I have very low expectations for it. I think that differences are going to accumulate among the various countries and that non-synchronous shocks are going to affect them. Right now, Ireland is a very different state; it needs a very different monetary policy from that of Spain or Italy. On purely theoretical grounds, it’s hard to believe that it’s going to be a stable system for a long time. …

If we look back at recent history, they’ve tried in the past to have rigid exchange rates, and each time it has broken down. 1992, 1993, you had the crises. Before that, Europe had the snake, and then it broke down into something else. So the verdict isn’t in on the euro. It’s only a year old. Give it time to develop its troubles.

David Beckworth and I think a few others have already pointed to Friedman’s answer to David Laidler’s question but it is so appropos of the moment that it is worth repeating:

David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?

Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy. The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.

During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasirecession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?” It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan
needs is a more expansive domestic monetary policy.


I am not clear how this response by Friedman is in any way relevant to today's crisis. The BOJ pursued a policy of very tight money and Friedman called correctly for this policy to be reversed. The Fed has pursued a policy of very loose money and it has not worked because the transmission mechanism thru the banks is clogged. Loose money now, QE3 or whatever, will do nothing to unstop the arteries and will only make things that much more difficult down the line

I think for monetarists no policy is ever expansionary enough, so they would call the fed's policy right now contracionary.

It sort of makes the theory unfalsifiable.

Absurd comment, considering that monetarists were long associated with wanting harder money in the late 1970s and early 1980s, arguing that the Phillips Curve didn't work over the long run. To see people now saying that "for monetarists no policy is ever expansionary enough" amazes me.

What the monetarists themselves will say is that they want stable money, or perhaps, like Scott Sumner, money with a slight but steady increase.

A better generalization is that the Left usually wants looser money and the Right tighter, but even that is still not 100%.

In reality, those quasi-monetarists who are saying that the Fed's policy right now is contractionary are pointing to data, like the change in NGDP, or in the TIPS expectations of inflation.

In the last couple weeks, gold and silver have plunged, oil has plunged, and TIPS inflation expectations have plunged. That doesn't sound like loose money to me, under any theory.

Well pointing to NGDP only works if you believe the CB controls NGDP in all circumstances. Monetarists also seem to think the stock market is the same as the economy.

Also, my point wasn't that monetarists say money should always be tight - it's that when there is a [demand side] crash, they will always argue money has been tight.

Huh? DOJ "very tight money" was a policy of very low interest rates in the face of deflation. That's relevant for us because we have very low policy interest rates and below-target inflation. Sure, it's not deflation (at the moment), but it's very close to the situation in which Friedman called for more easing in Japan.

Of course, Sumner has used this quote repeatedly, and even people like Krugman have used it. I'm not totally clear why Alex is getting to it now.


On the second part of your post, it’s difficult to second guess great minds like Friedman’s. David Beckworth says on the same page:

“I suspect, however, that Friedman would have preferred that such a monetary stimulus program be done in a more systematic manner than that of announcing successive, politically costly rounds of QE.  Imagine how much easier all of this would have been had the Fed announced a level target from the start and said asset purchases will continue until the level target was hit.”

I know it’s that legal-constitutional stuff again, but really a rules-based approach to fiscal and monetary policy from the start might have avoided the need for the present discussions. In the absence of so much discretionary political economy we might be in a different position.

Sorry Alex, meant to say Alex!

I just got it. Alex is one of the Yes-men.

Does North Dakota need "a very different monetary policy from that of" California and New York?

Friedman wrote more about Japan in a WSJ Column.

The states of the USA have an advantage in a common language, and far, far greater internal migration than the EU. When the Michigan economy tanks, people move away. When the Texas economy does well, people move there. North Dakota's population, long stagnant, has been booming in the last couple years with the oil boom.

Migration worked in previous slowdowns but not too well now.. A huge fraction of Michigan's (and many other states') houses are underwater and been on the market for a long time, and this sharply limits job mobility until people can sell their homes and pay down huge debts. Apparently, according to economists at a recent Federal Reserve conference I attended in Charlotte, NC, there is no research being done on how many people are moving across state lines, so we have no way to find out how fast our labor markets are reaching equilibrium between low and high unemployment states. So this important issue is not being studied.. kind of like looking for your car keys under the street lamp even though you lost them in a dark field half a block away.

Craig---not only is there data on people moving within the US, it has even been used to estimate the effect of negative house equity on regional unemployment rates. One example of such a dataset are the Metropolitan Statistical Area Population Estimates from the US Census Bureau.

The leaders keep trying to put Humpty Dumpty back together again and they will keep trying until their credibility is destroyed and markets/currencies collapse (imagine what happens when average people realize the politicians and central bankers are powerless), or there is a political revolution that accelerates the economic re-balancing. See Hungary nailing foreign banks on Swiss franc mortgages for a taste of what will come.

As I understand this, operation twist is sterilized buying of long term bonds, unlike MF's recommendation. This could encourage lower long term rates, but it is not creating more high powered money for the banking system. Could undermining the banks carry trade really help the growth on monetary aggregates? Sounds unlikely.

One of the reasons various people are interested in what Friedman would have prescribed now is that they view him as a free-market anti-Keynesian voice. But first, his monetary policy was not necessarily connected to his free-market advocacy. One can favor monetary expansion in current circumstances without advocating vouchers, for example. Second, while he was not a Keynesian in one sense, he accepted the basic Keynesian aggregate demand framework (he said as much many times). He looked at the macro-economy in highly aggregated ways. No particular need to worry about sectoral imbalances and the like. Third, he was quite narrow in his monetary vision -- perferring the simple analytics of Irving Fisher to anyone else in the history of monetary theory. As is well-known, Fisher was no classical liberal.

On the other hand, his free-market views would haver caused him to strongly oppose buying mortgage-backed or other special-sector securities as a kind of industrial policy.

Would he have regarded real interest rates as too high right now? Well, we don't have deflation or anything close (as in the Japan case). Well, who knows? That would have been a judgment, and not an implication of a theory.

I wonder what Anna Schwartz thinks.


Thanks for the useful clarification.

I found the link on your site to the statement by Thomas Mayer the chief economist of Deutsche Bank absolutely fascinating. He seems to lean towards the liquidationist viewpoint in a civilized way saying “The best incentive is to make failure possible” and “we need to accept that economic policy cannot fine-tune the cycle”.

I just came across an old article from 1991 by Brad De Long (you probably all know) which I was surprised to find gives qualified and reluctant but nevertheless fairly decisive support to the liquidationist argument, saying that despite the superficial barbarism of the proposals they were “not unreasonable”, because, after all:

“there will be times at which new information reveals that recent investments will not repay their costs. In such situations, the correct policy is indeed to help the process of structural readjustment and reallocation along, and not to delay reallocation by pumping up demand to freeze production in its old pattern”.

I wish he and other Keynesians remembered this in 2007/8 when it was already so obvious.

Jesus Christ. Cut the bullshit:

"It was, therefore, bad advice that academic economists like Robbins and Schumpeter gave central banks and treasuries during the Depression. It is disturbing that so many smart economists could give such destructive policy advice.

"It is also disturbing that the advice they gave was not unreasonable, given the business cycles that they had experienced. The market economy’s allocation of resources between consumption and investment does involve the market’s solving a dynamic problem in a stochastic environment. The arrival of news about future productivities and opportunities does imply that there will be times at which new information reveals that recent investments will not repay their costs. In such situations, the correct policy is indeed to help the process of structural readjustment and reallocation along, and not to delay reallocation by pumping up demand to freeze production in its old pattern. To the extent that late nineteenth-century railroad cycles fit this pattern of speculation and overbuilding, it would have been counterproductive from a long-run perspective for the government to try to keep railroad construction at a high pace in a recession.

"The advocates of the “liquidationist” point of view during the Great Depression were mistaken, but not crazy. In many histories (Chandler, 1973; Galbraith, 1965), the pronouncements of liquidationists appear to be incoherent barbarisms that were, inexplicably, believed. Such interpretations get the history of economic thought wrong. It is one thing to compare past barbarism to present enlightenment. It is another to reflect that Robbins and Schumpeter were as smart and as hard working as anyone in more recent generations—and were as sure that they knew the key to managing a fast- growing market economy."

In that case, Brad, the proof of the pudding would appear to lie in the sentence (about the business cycle) that follows the one I quoted.

“To the extent that late nineteenth-century railroad cycles fit this pattern of speculation and overbuilding, it would have been counterproductive from a long-run perspective for the government to try to keep railroad construction at a high pace in a recession.”

By “freezing” in the previous sentence I think you (like Schumpeter) meant keeping something alive, keeping it going, rather than letting it be eliminated by a disequilibrium market process.

Would you now consider giving some latitude to the view that it has been a mistake for governments to keep on pumping up demand which in effect freezes (rather than liquidates) old patterns of “speculation and overbuilding” in financial service industries and in the production and service sectors that grew interwoven with them, and a mistake to initiate demand pumping which similarly seeks to freeze costly institutional patterns in the nature and provision of welfare state activities that constitute the other major part of the public debt problem?

That’s one point. The second is that Schumpeter would now be asking, what’s the technological or sectoral wave pattern underlying the business cycles experienced in the last 20 years?

Brad, your prime exhibit was the railroads. Schumpeter explained the novel multiplier of railways. It “upsets all conditions of location, all cost calculations, all production functions within its radius of influence, and hardly any ‘ways of doing things’ which have been optimal before remain so afterwards” (Schumpeter [1939] 1964:76).

Not unlike the impact of innovations in the financial sector!

I’m not up to date with Schumpeterian techno-economics. And I’m sure the data is not in yet. However last I heard the finance/banking sector was a candidate to succeed rail, electrification, motorization, and (perhaps) computerization as the leading techno-economic carrier in the present-day periodization and mechanics of long waves.

Thirdly, let’s leave aside all that disputation about schools in economic theory and bring it down to basics where qualitative rather than statistical evidence may be sufficient.

Brad, will you now revise your support for the Keynesian hemorrhage of public funds into pumping up demand and instead take account of the fact that there has since 2007/8 been clear evidence of an equivalence to the speculation and overbuilding which you say did justify liquidation policies (creative destruction) in the past?

I'm certainly not qualified to speak for Brad, but it seems to me that you are jumping from what he said about pumping up an individual industry to an inference about not pumping up aggregate demand.

I take the quote to mean don't use subsidies to keep building railroads when you've just realized that railroads are overbuilt. At most that might mean don't bail out banks that are overexposed to the housing bubble, but I don't see how that implies not spurring overall demand, and I don't see how your assertion that banks are "interconnected" with everything else (which is both a truism and a stretch) changes that. Or to put it differently, having overbuilt railroads, that doesn't mean to can't try to stimulate the buggy whip industry (that's a joke, if it's not clear).

I'm starting to think the only question is whether Europe implodes before Nov 2012 and the U.S. exposure sends Obama into the 20% approval realm.

There was no jumping, just reading sentences in the order they were written. The connection is made by Brad DeLong not me. You should look at what he says above. He discusses the relative merits of pumping demand in response to “a pattern”, and then (inappropriately or not, I really don’t care) gives railroads as an example of that “pattern”. The only relevant issue is that DeLong was criticizing Schumpeter’s overall position on the patterning of recessions or depressions and how to respond to them. DeLong suggests Schumpeter could be right in some cases but rejects Schumpeter’s theory that all the cases have the same underlying dynamic. I think DeLong is wrong and Schumpeter is right. I thought it interesting how close DeLong came to accepting the Schumpeterian position. That would have been the end of the story had DeLong not had a hissy fit. I’m just glad it gave me an excuse to thumb through my Schumpeter books again!

I'm going to give my understanding of the Chicago Plan of 1933 again. If the Fed keeps shorter bond yields low, and aims for inflation going forward, then it creates a Disincentive to Hold Cash/Buy Safe Assets and an Incentive to Invest in Riskier Investments, such as Stocks and Corporate Bonds ( Which are, in effect, Loans for Investment ). The same reasoning applies to Consumption. This is intended to counter the Flight to Quality and its associated problems. By the very fact that the Fed announces its intention to do this, it influences current Investment and Spending. If you argue that the Fed cannot guarantee inflation or will pull back prematurely, then you at least have to understand that you've made an Investment Decision. People such as myself and Bill Gross are inclined to believe the Fed could do this, and so would shift our portfolio accordingly. Right now, with Stocks already having a bit of a run, we're inclined to do nothing.

It is an open question as to how the Fed would accomplish this ( My favorite paper is by Buiter on Helicopter Drops ), meaning there are various proposals, but it seems to me a number of them could work. The Reinforcing Stimulus is Govt Borrowing, meant to reinforce Inflation Expectations and avoid Increasing Taxes during a recession. The Stimulus includes a number of choices ( Payroll Tax Breaks, a Dated Coupon, Tax Breaks for Investment, Infrastructure Spending, a Sales Tax Holiday, UI Benefits, etc. ). In the Chicago Plan of 1933, they basically wanted to give money to people who were struggling.

They Chicago Plan also attempted to deal with Banks by requiring 100% Reserves. My favorite plan that accomplishes these goals is put forward by Milton Friedman in A Monetary and Fiscal Framework for Economic Stability. Whether or not you agree with me, I hope I've given a coherent explanation of what is intended by QE with a Reinforcing Stimulus.

I should also point out that this cure has nothing to do with the Ultimate Size of Govt. The Size of our Govt is determined by the jostling of Special Interests and how they play out against each other.

BTW, my view also follows James Buchanan's Views about the differences between the Old Chicago School's ideas and the New Chicago School's ideas of how to deal with during Economic Downturn featuring Debt-Deflation, although I'd be an ass to assume Buchanan would in any way want to associate himself with me.

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