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DeLong Smackdown Watch: Ghost of Milton Friedman Edition

David Beckworth writes:

Macro and Other Market Musings: Brad DeLong, Jim Grant, and Milton Friedman: [D]id Milton Friedman actually recommend doing successive rounds of quantitative easing until nominal spending returns to normal levels? Let's have Milton Friedman speak for himself.  Here is an excerpt from a Q&A following a 2000 speech he delivered at the Bank of Canada (my bold below). 

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.

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 quasi recession 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.

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.

So yes, Milton Friedman did call for buying longer-term securities until a robust recovery takes hold.  He also notes that policy interest rates can be a poor indicator of  the stance of monetary policy.   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.  There would have been no need to announce the large dollar size of the asset purchases up front that attracts so much criticism.  There would also have been no need to announce successive rounds of QE that make it appear the previous rounds did not work.  More importantly, it would have more firmly shaped nominal expectations in a manner conducive to economic recovery.  The question is what type of level target would Friedman have supported?...

David is, of course, correct. Successive rounds of limited amounts of quantitative easing would have given Friedman hives--even though they would push policy in the right direction.