Was Friedman a "Great Conservative Partisan"?

Amid all of the deserved praise given to Milton Friedman recently, there is a detectable undercurrent that disagrees with the reverence his work receives.

I've made my soft-spot for Friedman evident, but I thought it would be worthwhile to present another view for discussion. This also touches upon the "economics as religion" arguments discussed here recently. Here it is:

Milton Friedman: The Great Conservative Partisan, by Thomas I. Palley: Milton Friedman died on November 16, 2006 at the age of 94. Without doubt, Friedman was one of the most influential (perhaps the most influential) economists of the second half of the twentieth century. Not only did he contribute to reviving belief in the economic efficacy of the market system, he also had a profound political impact by linking capitalism with freedom.

Friedman’s treatment of capitalism and freedom colored understandings so that many among America’s elite now see a simplistic identity between the two. However, the reality is a complicated tango whereby free markets promote certain dimensions of freedom but can also bruise others – including democracy, meritocracy, and equality of opportunity. To paraphrase George Orwell, in market systems we are all free but some are (a lot) freer than others.

In 1976 Friedman was awarded the Nobel Prize in economics for his contributions to scientific economics. These contributions are marked by two characteristics. First, they are imbued with an underlying conservative partisanship characterized by profound animus to government. Second, Friedman achieved public standing through his macroeconomic work, much of which has been discredited. In a sense, Friedman is the economist who lost the battle but ended up winning the war, convincing society to adopt his view of the world.

One of Friedman’s most widely recognized contributions is monetarism, which recommends that central banks target money supply growth. Monetarism flourished in the late 1960s and 1970s and was briefly adopted by central banks as a policy framework in the late 1970s and early 1980s. That experiment produced devastating interest rate volatility, prompting central banks to revert to their traditional practice of targeting interest rates.

Monetarism was supported by Friedman’s joint work with Anna Schwartz in which they argued that the Federal Reserve caused the Great Depression through mistaken monetary tightening. This was Friedman’s first major salvo in his crusade against government, implicitly blaming government for the Depression. Friedman’s claim has always smacked of the tail wagging the dog since the Fed’s tightening was modest and brief, suggesting an underlying instability of the 1929 economy. The 1929 stock market was characterized by feverish speculation, and the Fed would indeed have done better to provide easy liquidity when investors rushed to exit. However, that also proves the dangerous instability of financial markets and makes the case for an active government regulatory presence, the very opposite of Friedman’s philosophical perspective.

At the theoretical level, monetarism asserts that central banks control the money supply and should aim for steady money supply growth. Friedman even recommended replacing the Fed with a computer that would mechanically manage the money supply regardless of the economy’s state. ...

These monetarist propositions reflect a flawed understanding of money. Money is a form of credit - an IOU. If central banks try to control the narrow money supply, the private sector just moves to create other forms of credit. That is why the Fed was unsuccessful in targeting the money supply, and why predicating economic policy on the relationship between the money supply and economic activity is a will o’ the wisp. ...

Monetarism’s most famous aphorism is that “inflation is always and everywhere a monetary phenomenon.” This saying reflects Friedman’s polemical powers, capturing for monetarists what all sensible economists already knew. Inflation is about rising prices, and prices are intrinsically a monetary phenomenon since they are denominated in money terms.

Sustained inflation requires that the money supply grow in order to finance transacting at higher prices. For Friedman, this made villainous central banks the exclusive cause of inflation because of his belief that they control the money supply. However, the reality is that the private sector can also inflate the money supply through its own credit creation activities. Additionally, central banks (viz. the Bernanke Fed) may be compelled to temporarily accommodate inflationary private sector pressures to avoid triggering costly recessions. The implication is that inflation can have different causes, something Friedman denied. Sometimes inflation is caused by excessively easy monetary policy or large budget deficits financed by central banks. Other times it is due to private sector forces...

Monetarism asserts that monetary policy is all-powerful. Subsequently, Friedman changed his view and argued that monetary policy had no long-run real economic impacts. Friedman cleverly termed his later theory the natural rate of unemployment, thereby enlisting nature on his side.

His new theory supported an extreme conservative policy agenda that still lives. ... [S]ince central banks supposedly have no long run effect on unemployment and wages, they are not responsible for labor market outcomes. Natural rate theory thereby allows the Fed and European Central Bank to take full employment policy off the table while protecting them from charges that their policies may contribute to wage suppression.

Close inspection reveals natural rate theory to be akin to a religious doctrine. This is because it is not possible to conceive of a test that can falsify the theory. When predictions of the natural rate turn out wrong (as they repeatedly have), proponents just assert that the natural rate has changed. That has led to the most recent incarnation of the theory in which the natural rate is basically the trend rate of unemployment. Whatever trend is observed is natural – case closed.

Since natural rate theory cannot be tested, a sensible thing would be to examine its assumptions for plausibility and reasonableness. However, Friedman’s early work on economic methodology blocks this route by asserting that realism and plausibility of assumptions have no place in economics. With most economists blindly accepting this position, the result is a church in which entry is conditional on accepting particular assumptions about the working of markets. ...

Lastly, Friedman was an early proponent of flexible exchange rates. Whereas the argument that flexible exchange rates facilitate macroeconomic adjustment has worn well, Friedman’s arguments against the dangers of destabilizing speculation have not. In line with his ideological predisposition for markets and against government intervention, Friedman ruled out destabilizing speculation. His argument was there exists a fundamental equilibrium price, and if prices depart from this speculators see a profit opportunity and drive prices back. However, experience has shown that exchange rates and asset markets are prone to speculative bubbles, and it has been extremely difficult to find a relation between exchange rates and fundamentals – whatever they are.

While such findings do not support fixed exchange rates, they do support a case for sensible exchange rate management by well-informed officials who can do a better job than speculative casino markets. Yet, the triumph of Friedman’s anti-government economics means that this sensible policy approach has been ignored by U.S. policymakers.

In sum, Milton Friedman’s political economy helped provide a corrective to the excessive disregard of markets and the price system engendered by the Great Depression, and his advocacy of the power of economic incentives abides. However, Friedman was not a lone defender of markets. Keynes, himself, always held an enormous regard for the market system – what he termed the Manchester System. Leading American and British Keynesians also shared that regard. However, whereas these Keynesian economists understood the limits of the market and the importance of government in making capitalism work for ordinary people, Friedman did not. By all accounts, Milton Friedman was a considerate and compassionate person, and he was a revered teacher. However, his fame rests on his ideas, and those ideas suffer from an excess of conservative partisanship.

Comments

[pgl]

Trying to blame Friedman for the crony capitalism of the Bush crowd is sort of like calling Keynes a big spending Marxist simply because Keynes noted that changes in government purchases may impact aggregate demand. Now no sane person would do the later - oh wait, I forgot about the Corner Kids over at the National Review.

[kthomas]

True. NR would blame Jesus for socialism if they could.

[dissent]

Well I'll put aside blame then and focus on resentment.

I resent the fellow that warped the meaning of freedom so that now its most important attribute is a weak regulatory climate.

How far is this really from (gasp) Ayn Randism?

[evagrius]

That's what I was thinking of. What does Friedman mean by "freedom"?

Is it freedom to do whatever it takes to make a "profit", damn the consequences?

Is it "freedom of choice", a rather peculiar sort of fredom that may or may not be logical, ( "Would you like gold or brass chains to tie you up, sir?").Is it more freedom when one has the choice of twenty toilet papers rather than ten?

Is it freedom to think, or create, or start a business?

Is it freedom when you belong to the top 1% or the bottom 1%?

[Rafe]

Friedman's contribution really needs to be disaggregated to sort out (at least) the strengths and weaknesses of his methodology, his monetarism and his general political economy.

His methodology as outlined in his famous paper of 1953 is crap (to use a technical term), simply instrumentalism, though no worse than the conventionalism of Samuelson. Larry Boland is the best commentator on these issues.
http://www.sfu.ca/~boland/

I will not attempt to add to the discussion of his monetarism.

His political economy is simply classical or minimum state liberalism which is both intellectually and morally robust. The point about the regulatory regime is to be effective, however this has been obscured by the counter-productive interventions that appear to have birpartisan support.

[Winslow R.]

"These monetarist propositions reflect a flawed understanding of money. Money is a form of credit - an IOU. If central banks try to control the narrow money supply, the private sector just moves to create other forms of credit."

When I read this board, many disagreements seem to stem from a flawed understanding of money creation and thus miss the direct connection between politics and economics. No fiat money (narrow) can be created without Tsy Secs first being created through the political process.

Politics and economics are inseperable in a fiat currency system since fiat currency production is a 'politically regulated' activity.

While there are hard financial limits to the bank form of private money creation due to capital requirements, public fiat money creation is only limited by politics.

Gold, a slow steady growth monetarist system, does not work in an economy that desires real growth rates greater than 1.5% per year (growth rate of gold) especially when savers prefer to save gold.

[Bruce Wilder]

Winslow R.: "While there are hard financial limits to the bank form of private money creation due to capital requirements, . . . "

1. Who is "requiring" capital?

2. What's really hard, in the absence of a central bank following a public-interest rule, is the absence of limits on money destruction. Very, very hard.

[DRR]

Well that was kind of a mushy read.

[Winslow R.]

1. Who is "requiring" capital?

Fed requires banks to meet minimum capital ratio's. Nonbanks don't have these Fed limits (Fannie Mae, Ford, etc.) and are only limited by the willingness of people willing to trade their bank or fiat money for nonbank money (purchase Ford bond with BofA or U.S. dollars).

2. What's really hard, in the absence of a central bank following a public-interest rule, is the absence of limits on money destruction. Very, very hard.

Our terminology could probably use an alignment. Fiat money which the Fed can convert (not create) from long-term tsy secs to cash is only destroyed by government taxes. Bank money is destroyed by people paying off bank loans. Nonbank money is destroyed by nonbanks paying off loans.

I see the CB's role (and sometimes failure) is to create zero interest paying money (cash) which will then search for nonbanks (Ford) willing to pay interest. The Fed cannot force cash holders to loan to nonbank entities. Government steps in with aggregate demand when nonbanks no longer borrow.

[reason]

My short take:
Friedman was right the man to listen to at a particular time (the 70s) but he was not "right" in a larger sense (how could he be with his rather silly methodological ideas). It is a shame so many seem to have forgotten his really worthwhile negative income tax idea however.

[Adrasteia]

Are the opinions of someone who calls Milton Friedman a 'great conservative partisan' in their articles byline something to be taken seriously?

Clearly they know nothing of the man and have zero interest in reading any of his work.

[Dave Iverson]

Winslow R: "Fiat money which the Fed can convert (not create) from long-term tsy secs to cash is only destroyed by government taxes."

Let's cut it down to this essence: Fiat money ... is only destroyed by government taxes.

An oversimplification on my part, but also I think on Winslow's part. Great contraction episodes, the likes of which precipitate liquidity traps are prestaged I believe by great credit creation episodes (irrational exuberance) that ought to have beeen nipped in the bud by prudent bankers, but were not (or are not in the case of the current episode).

So when the credit bubbles collapse, money disappears rapidly without taxation. See, "Derivatives Mania" for example.

OR maybe I missed the point Winslow was trying to make.

[fiskhus jim]

I maintain that Friedman's great contributions were not to "scientific economics" but to "scientistic economics", after Popper's assertion that a slavish imitation of the scientific method in the social sciences is worthless.

Friedman's value, then, lay in his ability to manipulate his "calculations" in support of the partisan result he promoted. And, at that, he was head and shoulders above all other economists.

[Winslow R.]

"So when the credit bubbles collapse, money disappears rapidly without taxation. See, "Derivatives Mania" for example.

OR maybe I missed the point Winslow was trying to make."

My point - to discuss the system intelligently, people should understand the inner gears of the money transmission mechanism and its limitations. There also needs to be an accepted vocabulary. Is the quantity of money measured by M1, M2,....? Is money credit? Is money any financial asset, including stocks?

The confusion almost seems intentional and leads to political gridlock.

Fiat money (fed note, tsy sec) does not disappear unless the government taxes them out of existance or the government is overthrown as the government does not default on its own currency.

Bank/Nonbank money (or financial instruments) is what you are referring to as having the ability to collapse through bankruptcy. These instruments are created by bank/nonbank loans.

see Ferguson on nonbank/bank money creation:

http://www.federalreserve.gov/boarddocs/speeches/2004/20040517/default.htm

" A second trend is the steadily increasing share of total credit provided directly through markets rather than through intermediaries like banks. For example, in the United States, the share of bank loans in the total outstanding debt of domestic nonfinancial corporations has declined from about 21 percent at the end of 1990 to 12 percent at the end of last year....

The steadily increasing importance of markets and nonbank instruments as the primary vehicles for borrowing and lending has several important implications for monetary policy transmission and strategy...."

[piglet]

I found this statement interesting:

"Since natural rate theory cannot be tested, a sensible thing would be to examine its assumptions for plausibility and reasonableness. However, Friedman’s early work on economic methodology blocks this route by asserting that realism and plausibility of assumptions have no place in economics." Is this true? Several commenters seem to agree. So how do scientific economists justifiy the methodological basis of some of their most successful (in the sense of being accepted among economists) theories?

"With most economists blindly accepting this position, the result is a church in which entry is conditional on accepting particular assumptions about the working of markets." Is this another creationist mindlessly ranting against evolution? ;-) Another "non-economist" who "just doesn't understand"?

« Dr. Thomas Palley is an economist living in Washington DC. He holds a B.A. degree from Oxford University, and a M.A. degree in International Relations and Ph.D. in Economics, both from Yale University. »

[piglet]

Here's an other review:
http://commentisfree.guardian.co.uk/richard_adams/2006/11/post_650.html

Milton Friedman, who has died aged 94, was not the most important economist of the post-war era - that title belongs to the brilliant Paul Samuelson - but he was certainly the most controversial. Yet despite his views being championed by so many politicians on the right, it may come as a surprise that Friedman's career as a policymaker largely ended in failure.

[EB Gal]

Alan Meltzer, who was once tasked with revising the Britannica article on money originally written by Friedman, has posted a bit on Friedman's legacy and influence over on the Britannica Blog.