Not too long ago, while introducing an interview with Milton Friedman, I said:
When I was younger, a little before the time I was going up for tenure, Friedman sent me a long, detailed letter about one of my papers (he liked it and his comments were, of course, insightful and helpful). I'm still amazed that he took the time to do that...
As I noted, the letter arrived unexpectedly. Greg Mankiw had a similar experience, and had the same kind of reaction I had. So perhaps being "a classically liberal, applied macroeconomist" is not required to fully appreciate and receive Friedman's wisdom:
Letter from Milton, by Greg Mankiw: For a classically liberal, applied macroeconomist like me, getting an email from Milton Friedman makes one feel like Moses must have felt when God tapped him on the shoulder to deliver wisdom to the masses. A couple days ago, I had a Moses moment, when Milton sent me some comments on my paper The Macroeconomist as Scientist and Engineer.
Two of Milton's commandments show his continued commitment to small government and passive monetary policy: Thou shalt abolish the Federal Reserve. Thou shalt maintain a constant level of high-powered money.
Here is the letter in its entirety, followed by my response:
...August 14, 2006
Professor N. Gregory Mankiw Department of Economics Harvard University Cambridge, MA 02138
I enjoyed reading your working paper article on the macroeconomist. It is an excellent survey and well written. But you will not be surprised that I come not only to praise but also to suggest and criticize.
My suggestion has to do with the early work on business cycles. You have omitted the person who I believe played the greatest role in the early work , namely Wesley C. Mitchell whose book Business Cycles was published in 1913. As you know, Mitchell went on to found the National Bureau of Economic Research primarily to study cycles. At the Bureau he published two more books on business cycles, the second jointly with Arthur Burns.
As to comment or criticism, I take a slightly different view than you do of the reason for the better performance in monetary policy over the past twenty years or so. I believe it derives primarily from the recognition by central banks worldwide that they have responsibility for inflation. The Great Depression on the one hand and the inflation of the seventies on the other reinforced earlier theoretical and historical work . My aphorism, “Inflation is always and everywhere a monetary phenomenon,” was converted from an object of derision to a near truism. This experience was of course strongly reinforced by the leadership shown by Alan Greenspan in the United States, but also I believe by the leadership shown by Donald Brash in New Zealand.
New Zealand was the first country to introduce inflation targeting... Brash introduced the term “inflation targeting”
In the great deflation of the 1930s there were many economists and non-economists who were aware of the deficiency of monetary policy, but it was not the main explanation which was offered for the depressed economic conditions. That was attributed to a market failure. Similarly, in World War II, inflation was attacked primarily by price controls and was not widely attributed to excessive increase in the quantity of money. Of course what is important is not only that the central bankers learned the lesson and came to accept responsibility for inflation, but that the public at large did and will hold the monetary authorities responsible if and when any significant inflation develops. ...
One more side point. I have come to the conclusion that the central bankers did a marvelous job of pulling the wool over the eyes of economists. They led us all to believe that maintaining a relatively stable price level is a very difficult problem that requires the judgment of the wisest of experienced bankers and business people. The ease with which New Zealand, Australia, Britain, etc., have maintained relatively stable prices, have reduced greatly the variability of inflation, suggests that maybe it isn’t such a hard job at all, that the cycles of the past were not attributable to the difficulty of achieving price stability, but to the mistakes of the central bankers in not achieving price stability. Nothing that I have observed in recent decades has led me to change my mind about the desirability of a monetary rule which simply increased the quantity of money at a fixed rate month after month, year after year. That rule would get rid of the mistakes and that is probably about all you could expect to get from a monetary system.
Even better would be to abolish the Fed and mandate the Treasury to keep high powered money at a constant numerical level.
Best wishes and regards.
Milton Milton Friedman Senior Research Fellow
Here is my response:
August 15, 2006
Thank you for your comments. ... I appreciate your taking the time to write me. ... You are right that I should have mentioned Mitchell. That was an oversight on my part.
Let me make a few points about monetary policy.
I agree that the historical events of the 1970s taught central bankers about the importance of keeping inflation under control. But, more precisely, what did they learn? Here are two possible lessons:
(1) Central bankers should give inflation a greater weight in their objective functions. (2) Central bankers can control inflation only with a commitment to a policy rule.
I believe the Greenspan experience argues for lesson (1). Some economists argue for lesson (2). ...
Although I agree with you about the importance of controlling inflation, I am not persuaded that the task is quite as easy as you suggest. In another paper, called “A Letter to Ben Bernanke,” I write that Burns’s bad outcomes and Greenspan’s good outcomes were in part attributable to the fact that Burns had to deal with more adverse shocks than Greenspan did. Perhaps Burns played a bad hand badly, and Greenspan played a good hand well. I wonder how Greenspan would have handled the circumstances that Burns faced...
Your comments on the virtues of constant high-powered money surprised me. On the one hand, high-powered money is the measure with the clearest definition, especially in light of the growth of many “near monies” that complicate the measure of broader aggregates. On the other hand, I would have thought that the experience of the 1930s argues against such a rule. If I recall correctly, most of the decline in the monetary aggregates during that period was attributable not to high-powered money but to inside money and the money multiplier. If we abolished the Fed and kept high-powered money constant, it seems that a similar set of events could potentially unfold.
Again, thank you for your comments...
With best wishes, Greg ...
The increased stability of the economy since the mid 1980s (graph here) could be due to better monetary policy, but it could also be due to better technology, or better luck in terms of the large shocks that hit the economy. Some also cite financial innovation as a contributing factor. My reading of the evidence is that this is not yet sorted out. I would be happy to learn the increased stability is due to improved monetary policy, the augmented Taylor rule and inflation targeting in particular, but the evidence that improved monetary policy is the source of the increased macroeconomic stability observed in recent decades is not beyond challenge.