Friday, June 17, 2011

Brad DeLong, Jim Grant, and Milton Friedman

Brad DeLong and Jim Grant debate whether the Fed should do QE3.  DeLong makes the case for QE3 and invokes Milton Friedman in support of his view:
We have seen something like this--but worse--twice before: the Great Depression, and Japan's lost decades. A collapse in trust in the solvency of financial institutions induces the hoarding cash as part of the safe-asset tranche of portfolios. The economy's cash disappears from the transactions money stock--and so, for standard monetarist reasons, spending declines and unemployment rises... Expansionary monetary policy even at the zero lower bound via quantitative easing is what Milton Friedman recommended for the Great Depression and for Japan. 

That's what Friedman would be recommending were he with us today--keep doing rounds of quantitative easing until we get the economy's transactions cash balances and the flow of spending back to normal levels.
So did 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?  This 2003 WSJ article indicates he might have liked a nominal GDP level target.

Update: Here is a piece I wrote for Investor's Business Daily in 2010 on the Bernanke-Friedman relationship.


  1. I really don't know what the Keynesians such as yourself and de Long think can be achieved with more money printing. How is that going to improve input growth or TFP growth, which as you must teach your kids, are the ultimate drivers of GDP.
    Again, I'd say America's situation post-2000 has looked decidedly Olsonian, not Friedmanian.

  2. ecb,

    I should let David (who I don't think is actually a Keynesian) answer for himself, but I, for one, would be happy to get the Fed entirely out of the business of dealing with real GDP. In my opinion, the only way to do that is to have the Fed target nominal GDP. Otherwise, the Fed's policy, for example if the objective is to stabilize the inflation rate, has to compensate for expected changes in "input growth or TFP growth" so that spending will rise along with potential output. That should not be the Fed's job. The Fed should be isolated from the real economy and only adjust the supply of money to the demand given a target path for nominal spending. To do so, however, the Fed has to make sure that its actions don't change the demand for money in such a way as to offset its changes in supply, which means it has to buy something other than short-term government securities, which are nearly perfect substitutes for bank reserves. By a criterion that takes away the Fed's involvement with the real economy, QE2 is not only necessary but woefully inadequate. And if adequate QE would result entirely in inflation rather than real growth, so be it: that should not be the Fed's problem.

  3. The right-wing has lost its marbles, braying for tight-money when the current need is for stimulus.

    The left-wing doesn't know the argument is going on.

    These are frustrating times.

  4. AH: using Keynesian as broad brush for those who think our problems today are about aggregate demand..

    Nominal GDP targeting...fine. Have it. Its deckchairs on the Titanic.
    My concern is with the supply side issues of financial regulation, what we want the financial sector to be doing, political reform (public financing of all political campaigns perhaps) and educational reform, and credible fiscal reform.
    Ultimately these will determine whether or not US becomes the new Argentina.

  5. "The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity."

    Japan's real rates were consistently positive throughout the ZIRP period. Our real rates are substantially negative, even out five years. I wonder what Friedman would have said about this. Should they be more negative? Negative for longer? Would they matter to him at all?

  6. Paul Kedrosky talks in an interview about the concept of "baseline drift". Its the idea that events unfold at a pace somewhat out of synch with human perception. Think about say April 1999 as the Dow hits 10K. If you had argued that over the next decade the US would not even achieve 2% trend real growth, have 10% unemployment and an insolvent banking system, deficit at 11% of GDP - you would have been declared certifiably insane.
    Things are deteriorating at a shocking rate and focusing on nominal GDP targeting and QE2 are urinating into the wind to be gross.

  7. Sorry esb, but that isn't Keynesianism. In a very general view:

    Keynesiansim basically believes we are in a liquidity trap and only government spending through public investment and job programs, will break the trap.

    Nor is any "printing" going on. Everything is based on liquidity curves with QE.

    Keynesians may believe QE could help, but only if the liquidity trap is broken.

    I believe a "market adjustment" won't work because income is so saturated at the top with offshoring, that is what caused the speculative bubble in the first place.

  8. It still puzzles me why people think that monetary policy can improve things when the economy has substantial excess capacity. If a business has excess capacity it has no reason to borrow money, and so making it easier to borrow money will have no effect on spending. Horse. Water. Drink. It seems to me that monetary policy should only be effective when business spending is being constrained by the price and availability of loans.

  9. AndyfromTucson, I agree that interest rate adjustments are near useless, and for no less than ten reasons I set out in detail here (which include the reason you cite):

    But that is not a reason to throw out ALL forms of monetary policy.

    Re David Beckworth’s article and the rest of the comments above, no one seems to have got the point that the effect of a monetary base expansion is CRUCIALLY dependent on WHO receives the extra money.

    In the case of QE, all that happens is that wealthy individuals get $X of cash in exchange for $X worth of bonds. Why in God’s name should that induce them to go on a spending spree? There is no reason at all. The monthly spending of the rich does not vary much given a rise or fall in their income or assets. But worse still, QE has little effect on the net assets of the rich.

    In contrast, if extra money is fed into the economy via an unfunded payroll tax reduction, the effect on demand will ten times bigger because the recipients of the money are PRECISELY the people who are not spending: ordinary households who are scared of spending because they’ve seen the value of their homes crash compared to the debts they owe.

    Advocates of Modern Monetary Theory, Warren Mosler in particular, have been advocating the latter remedy for some time.

  10. This complements your post. And Andy Harless has it precisely right:
    "The Fed should be isolated from the real economy and only adjust the supply of money to the demand given a target path for nominal spending".

  11. Blimey anon June 17, 5:52, Keynesianism is now such a hackneyed term practically anybody can use it I think.
    Anyway, I was it using it to cover those like de Long/ Krugman who believe we are just having some temporary aggregate demand issues.
    It looks a lot more like we have had both a gdp level and maybe a growth trend shock that suggest aggregate supply is the problem. The Schumpeterian models of growth are based on innovation from new businesses. Government policy has been geared to supporting incumbents, which will inexorably impoverish America. High unemployment arises due to the dreadfully ill-prepared lumpen product of what is jokingly called American education.

  12. Ralph Musgrave:

    I have been advocating national lotteries, in which payouts exceed pay-ins.

    If ticket sizes are limited to some amount, and winning amounts (ie, lots of people win $7,000) this might be a way to put money where it will be spent, and yet avoid moral hazard--you cannot have a capital gain, without risking capital.

    So far, I have not even convinced my wife this is a good idea.

  13. Mr.Musgrave shows a lot more perceptiveness than most in his recommendation that monetary policy be used in support of fiscal transfers, or maybe even an employer of last resort program. After all, this is one perspective on what our military program is. In terms of social justice, Musgrave's suggestions are valuable.
    Provided it is done as part of a reform package which addresses the supply-side issues, such as financial, political and education reform.

  14. It seems to me that we're all so consumed with the complexity and erudition of economic thought and policy that we have gotten the cart ahead of the horse.

    When collective monetary policy directly or indirectly controls the direction of prices, the pooling of capital, and the rate of growth, then your society is not free.

    Policies that are beyond the reach of average citizens affect the worth of their labor and the goods they both create and consume.

    Money is a medium for the valuable exchange of labor and goods.

    Forget money supply. Forget TFP growth. Occupation choice. Financial deepening. Easing. Capital heterogeneity.

    These are modern forms of bondage -- controlling people's decisions and actions through policy.

    Empirical evidence the world round shows that any benefit from economic meddling comes from redistribution -- stealing from some to give to others -- or the veneer of prosperity built on unsustainable expansions of money without a corresponding increase in labor or goods.

    How about we expend our energies on adapting to change rather than trying to manufacture outcomes with money?

  15. Would it be fair to say that Grant won this debate? I don't see much support for DeLong in the comments. Nobody is buying the connection between continued ultra-easy money (a QE3 similar to QE2) and productive investment that will foster real GDP growth. I think that was the gist of Grant's argument.

  16. Way to go, Ralph.
    The oft maligned and misunderstood Friedman's ideas on monetary initiatives included the specific reforms needed today more than ever in his much earlier publication: A Fiscal and Monetary Framework for Economic Stability.

    In this piece he picks up where the Chicago Plan and 1939 Programs for Monetary Reform left off - that is having the government DIRECTLY create the stimulus needed by creating the new money needed for eliminating boom-bust cycles(economic stability) and paying it directly into the economy at the M1 level where we all live and work.
    Actually one-upping the MMTers.
    Today, it appears that the progressives haven't a clue on what to do with our un-monied economy.
    The monetary paradigm understood by Friedman remains in play, and we move toward a deeper entrenched poverty because progressives fail to grasp the significance of these direct government initiatives.
    For the Money System Common.

  17. Great post. I'd like to introduce this post in my Japanese blog.
    BTW, BoC link seems to be not working. Current link seems to be: