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David Wessel Sends Us to Bill Poole on Milton Friedman

Milton Friedman's monetary framework--his idea that the nominal money stock growth rate should be pegged, and that the government should either shovel reserves into the banking system at a furious rate or pull them out in order to keep the nominal money growth rate stable--was always clearly a second or even a third-best. Positive or negative shocks to velocity would cause episodes of inflation or depression which Friedman's rule would ignore.

William Poole now thinks that Friedman was wrong, and too pessimistic, and that the Fed has done better over the past quarter century than the Friedman rule would allow. David Wessel blogs:

Economics Blog : Milton Friedman Wasn’t Right About Everything: William Poole, a self-described “card-carrying monetarist” who is now president of the St. Louis Federal Reserve Bank, says the Fed’s track record over the past 25 years is better than it would have been had it followed Milton Friedman’s prescription of maintaining steady growth in the money supply.

[Poole:] “I believe that the Fed’s actual adjustments of its federal funds rate target have yielded superior outcomes since 1982 to what we would have observed under steady money growth,” he said in the prepared text of a speech to delivered today – behind closed doors — at the University of Missouri to mark the 95th anniversary of the late Milton Friedman’s birth. “I also believe that advances in knowledge permit us to say with some confidence that these gains are not just an accident of Alan Greenspan’s special skills and intuition,” Mr. Poole said.

So what’s the secret? Persuading the public, businesses and the markets that the Fed won’t let inflation get out of control or, in the jargon of economists, “anchoring inflationary expectations.”

“Everything Milton argued about money stock control is true,” he added, “but the effect of inflation expectations on the practice of monetary policy itself was, I believe, a missing element in the analysis. The economy functions differently when inflation expectations are firmly anchored. If a central bank allows expectations to become unanchored, then interest-rate control becomes a dangerous and potentially destabilizing policy. But should the practice of monetary policy depend on how well inflation expectations are anchored? I do not recall Milton discussing this question, perhaps because he believed that the best way to maintain well-anchored expectations over time was for the central bank to commit to steady and low money growth under all circumstances.”