Krugman, Fox, McCain, Prescott, and Company
The State of Macro Today

Tyler Cowen's Ultimate Milton Friedman Post

Tyler writes:

Marginal Revolution: What did Milton Friedman favor?: Responding to my initial post, David Henderson gets himself into a bit of trouble when he writes:

He's [Tyler] correct that Friedman wanted the Fed to increase the money supply. I don't think I'm pretending when I say that I don't think Friedman advocated bailing out banks during the Depression. As I think Friedman would have, last fall I advocated an increase in the money supply while opposing a bailout. Those two, contra Cowen, are separable.

When it comes to 1929-1931, Friedman favored the Fed a) buying up a lot more bonds, and b) serving as a lender of last resort to failing banks. They are separable but Friedman favored both.

In the Monetary History, Friedman and Schwartz approvingly quote Walter Bagehot about the need to do whatever is required, however bold or desperate, to stop a banking panic.  Part of the passage runs like this:

The way in which the panic of 1825 was stopped by advancing money has been described in so broad and graphic a way that the passage has become classical. “We lent it,” said Mr. Harman [one of the Bank’s more senior directors] on behalf of the Bank of England, “by every possible means and in modes we have never adopted before;...

Here is Charles Goodhart quoting Friedman on why the Fed should have been a lender of last resort to troubled banks.  Or see p.269 of the Monetary History, where Friedman and Schwartz explain how it was too difficult for banks to borrow from the Fed at favorable rates in the early 1930s.  Or read this Friedman interview.

In the comments Bruce Bartlett, channeling Friedman, responded:

There's no way the Fed could have expanded the money supply in the early 1930s without bailing out the banks. How do you think the money supply declined in the first place? It's because banks failed and their deposits disappeared. To keep those deposits from disappearing in an era before deposit insurance would have required keeping bankrupt banks afloat.

Friedman's model was not one of allowing a boost in currency to substitute for the broader monetary aggregates.  An article in The Freeman is clear, if perhaps even a bit exaggerated:

Friedman and Schwartz argued that all this was due to the Fed’s failure to carry out its assigned role as the lender of last resort.

You might try to draw a distinction between "lender of last resort" and "bailout" but Bernanke's emergency lending is usually considered part of the bailout package.  No one is suggesting Friedman would have favored each and every part of the bailouts that we have seen.  The point is that Friedman favored some bailouts in the past and probably would have favored some this time around as well.  You don't have to think he would have voted for the first Paulson proposal.

Oddly, Henderson in his post takes offense because I suggest that libertarians try to run away from the idea that Friedman favored Fed action beyond simple monetary policy.  Henderson then tries to run away from the idea that... Friedman favored Fed action beyond simple monetary policy.

I now recall that a related point was made by Paul Krugman, although I find that piece problematic in some other ways. 

Here are a few sounder history of thought claims:

  1. Friedman and Schwartz argued that if the Fed had been more on the ball with monetary policy earlier on, the lender of last resort actions would not have been needed. That is distinct from opposing such actions in the time of necessity, when necessity comes.

  2. At times Friedman suggested that the rise of deposit insurance limited the importance of the lender of last resort role.  (How he would have thought about rescuing the shadow banking system is an interesting question.)  A related issue hovers here, namely whether support for deposit insurance constitutes support for bailouts.  It seems to me it does, though my original point does not rely on this judgment.

  3. Friedman thought that "simple" monetary policy, combined with "simple" Fed lending would go pretty far in stopping a banking panic, yet this view was not borne out in the very recent crisis.  In any case it's wrong to conclude that Friedman was necessarily opposed to more vigorous action, if such action would turn out to be needed.  If you read Friedman as a whole his focus is not on drawing particular lines to circumscribe Fed action, but rather doing whatever is needed to keep the banking system up and running. 

One problem is that "Friedman" is underspecified. There are many Friedmans, including:

  1. The Keynesian Friedman of "A Framework for Monetary Analysis"
  2. The incredibly rigid financial regulatory straightjacket Friedman of "A Program for Monetary Stability"
  3. The pro-bailout Friedman of "The Great Contraction"
  4. The late Friedman who concluded that money stock-targeting had not lived up to expectations.
  5. The early Friedman who believed that keeping the nominal money stock on a smooth growth path would eliminate any possibility for large disturbances in velocity.

These guys are not all consistent, not all the time.

Comments