First, Rand Paul told Bloomberg Businessweek that he would prefer a deceased Milton Friedman in charge of the Federal Reserve “because then you probably wouldn’t have much of a functioning Federal Reserve.” Now as a follow-up, he writes over at National Review Online that it “is a disservice to Milton Friedman’s memory … to assert that he would be a Krugman-like advocate for quantitative easing.”
1. Based on the BBW interview and his NRO piece, Paul doesn’t seem to know or understand much about Milton Friedman’s views on the Fed or monetary policy. The NRO piece is particularly egregious since Paul and his staff had time to research the issue and still failed to mention that Friedman had addressed specifically what a central bank should do when faced with a stagnant economy and very low interest rates. Here is what Friedman said back in 2000 during a Q&A with economist David Laidler:
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.
… 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.
2. And this quote from Friedman also doesn’t make it sound like he was someone who would have preferred tighter money right about now:
Defenders of the Bank of Japan will say, “How? The bank has already cut its discount rate to 0.5 percent. What more can it do to increase the quantity of money?”
The answer is straightforward: The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.
There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will 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.
3. Friedman was a fierce promoter of economic freedom who challenged the postwar consensus that markets are inherently unstable and need control and regulation by government. The Concise Encyclopedia of Economics calls him “the twentieth century’s most prominent advocate of free markets.” His books Capitalism and Freedom and Free to Choose are must-reads for any conservative and libertarian.
But many on the right have forgotten his scholarly work on monetary policy. The Nobel Prize committee called his analysis of the Great Depression in the Monetary History of the United States, 1867 – 1960, “one of Friedman’s most profound and also most distinguished achievements. Most outstanding is, perhaps, his original and energetically pursued study of the strategic role played by the policy of the Federal Reserve System in sparking off the 1929 crisis, and in deepening and prolonging the depression that followed.”
Friedman understood the power of monetary policy, for both good and ill. He would almost certainly have been aghast that the Fed blew it again in 2008 by its tight money policies that possibly turned a modest downturn into the Great Recession. And he almost certainly would have been appalled at Republicans pushing for tight money — or, heaven help us, a return to the gold standard — with the economy barely growing and inflation low. It is certainly inconvenient for Paul that Friedman — a libertarian, Nobel-laureate economist — would have little use for the senator’s supposedly Hayekian take on the Fed or monetary policy. Although the Bernanke Fed has imperfectly executed its QE programs, they are a big reason why the US is growing and adding jobs — despite President’s Obama’s regulatory onslaught and tax hikes — and the EU (and the inflation hawk ECB) is back in recession. Paul is wrong on Friedman and wrong on the Fed. It’s not even close.