Was Milton Friedman Wrong About Everything?
Paul Krugman has a piece up on Milton Friedman, who he says has “virtually vanished from policy discourse.” Here is Krugman’s theory of why:
Part of the answer is that at this point both of Friedman’s key contributions to macroeconomics look hard to defend.
First, on monetary policy: Even if you give him a pass on the 3 percent growth in M2 thing, which was abandoned by almost everyone long ago, Friedman was still very much associated with the notion that the Fed can control the money supply, and controlling the money supply is all you need to stabilize the economy. In the wake of the 2008 crisis, this looks wrong from soup to nuts: the Fed can’t even control broad money, because it can add to bank reserves and they just sit there; and money in turn bears little relationship to GDP. And in retrospect the same was true in the 1930s, so that Friedman’s claim that the Fed could easily have prevented the Great Depression now looks highly dubious.
Second, on inflation and unemployment: Friedman’s success, with Phelps, in predicting stagflation was what really pushed his influence over the top; his notion of a natural rate of unemployment, of a vertical Phillips curve in the long run, became part of every textbook exposition. But it’s now very clear that at low rates of inflation the Phillips curve isn’t vertical at all, that there’s an underlying downward nominal rigidity to wages and perhaps many prices too that makes the natural rate hypothesis a very bad guide under depression conditions.
This is a little harsh. For one thing, Friedman himself conceded that quantity money targeting wasn’t a success, so I think it’s pretty fair to give him a pass on it. For another, I’m not sure it's fair to say that “Friedman’s claim that the Fed could easily have prevented the Great Depression now looks highly dubious.” It seems worth pointing out that we didn’t have another Great Depression -- didn’t even come close -- thanks in large part to swift and decisive action by the Fed to prop up the money supply. Has monetary policy returned us to the trend growth rates of 2007? No. But neither has fiscal policy. It doesn’t look to me like Friedman is doing so bad in that fight.
You may be tempted to rejoin that Keynesianism has not been tried and found wanting, but found politically difficult, and left untried -- that another couple of trillion worth of stimulus would have done the trick. But of course one could make the same argument for monetary policy; perhaps we would be back on trend if only Ben Bernanke had gotten into an actual helicopter and started raining cash on the populace. As it stands, both the Keynesians and the Monetarists can argue that they did their part to prevent the sort of global banking crisis that helped bring us World War II.
And Krugman’s last point, while probably true, strikes me as a far too restrictive construction of Friedman’s contribution. Essentially, he’s saying that unless Friedman’s work stands up perfectly in economic conditions that occur about as frequently as Halley’s Comet, then it’s no good. But of course, eventually the Great Recession will be over, and we’ll still have an economy to take care of. Friedman and Phelps were instrumental in getting central banks to stop pumping dangerously inflationary amounts of money into economies without the spare capacity to use it. That matters a lot.
Is Friedman useful right now? Possibly he’s less useful than we thought he would be -- just as Keynes turned out to be vastly less useful than policymakers thought when we weren’t in the middle of a catastrophic global banking crisis. But one of the great lessons of the Great Recession was not to draw too many global inferences from the economic time and place you happened to be living in. (If you haven’t learned that lesson, go find one of the many, many economics graduate students who wrote dissertations on the Great Moderation, and ask him or her to explain it to you. I advise you bring earplugs.)