What Would Milton Friedman Do Now?: Enough about John Maynard Keynes.... What would Milton Friedman, the University of Chicago champion of monetary discipline, do now? What would he say—reversing the charges when he returned a reporter's call, as he always did—if asked about Federal Reserve Chairman Ben Bernanke's imminent move to print hundreds of billions of dollars to buy more U.S. Treasury bonds to put more money into the economy?... [T]his seems a ripe moment to contemplate Friedman's views and those of his disciples—though they don't agree among themselves.
Friedman believed in the power of money: the more money, the more income.... Friedman would have scoffed at the notion that the Fed is out of ammunition. He believed in the potency of "quantitative easing," or QE—printing money to buy bonds:
The Bank of Japan can buy government bonds on the open market [e wrote in 1998.]... Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand…loans and open-market purchases. But whether they do so or not, the money supply will increase.... Higher money supply growth would have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately...
But how would he decide if the Fed should buy bonds now? He would look at the growth of the money supply, though he and his followers always had trouble identifying which measure was the right one.... He would warn, as he often did, about "erratic swings" in the money supply..... He would look at velocity, the number of times a dollar turns over in a given year, to gauge demand for money. "To keep prices stable, the Fed must see to it that the quantity of money changes in such a way to offset movements in velocity and output."... When velocity is stable, the Fed should keep money growth steady. When velocity swings widely, the Fed shouldn't be passive.... He would look at growth in income:
He considered stable nominal [unadjusted for inflation] income growth desirable because sudden swings in it (and thus in spending) cause huge macroeconomic disturbances when wages and prices fail to adjust quickly," says economist David Beckworth of Texas State University. Income is growing well below historical norms. POINT: For QE.
He would look at bond-market inflation expectations.... Markets anticipated low and falling inflation—until Mr. Bernanke began talking about QE2 in late August, a sign that markets believe Fed's bond-buying will boost inflation, as the Fed desires. POINT: For QE....
The Friedman logic, though, makes the case for QE2.