Krugman Predicts the Future History of Economic Thought

It’s always nice to have a Nobel Laureate rely on something you’ve written in making an argument of his own, so I would prefer not to turn around and criticize Paul Krugman for the very blog-post in which he cited my recent posts about Milton Friedman. Now there are obviously certain basic points about Friedman that Krugman and I agree on, e.g., that Friedman relied more heavily on the Keynesian theory of the demand for money than he admitted, and second that Friedman’s description of his theory of the demand for money as the expression of an oral tradition transmitted from an earlier generation of Chicago quantity theorists lacked any foundation. Although some people, including my friend Scott Sumner, seem resistant to acknowledging these points, I don’t think that they are really very controversial statements.

However, Krugman goes beyond this to make a stronger point, which is that Friedman, unlike Keynes, is no longer a factor in policy debates, because the policy position that Friedman advocated is no longer tenable. Here’s how Krugman explains the posthumous untenability of Friedman’s position.

[A]t this point both of Friedman’s key contributions to macroeconomics look hard to defend.

First, on monetary policy . . . 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.

Krugman is making a tricky point. I agree that Friedman was wrong to focus entirely on the quantity of money in the Great Depression, but that’s because, under the gold standard then in place, the quantity of money was endogenous and prices exogenously determined by the gold standard. The Great Depression occurred because the international restoration of the gold standard in the late 1920s was driving up the value of gold and forcing deflation on all gold standard countries, not just the US, which is why leaving the gold standard or devaluation was a sure-fire way of starting a recovery even without expansionary fiscal policy, as evidenced by the spectacular recovery that started in April 1933 when FDR started devaluing the dollar. So Friedman was wrong about the nature of the monetary mechanisms then operating, but he wasn’t wrong about the ultimately monetary nature of the problem.

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.

I don’t subscribe to the natural-rate hypothesis as a law of nature, but it did make an important contribution to the understanding of the limitations of macroeconomic policy. But even the strictest version of Friedman’s natural-rate hypothesis does not imply that, if the rate of unemployment is above the natural rate, an increase in the rate of inflation through expansionary monetary or fiscal policy would not hasten the transition back to the natural rate of unemployment. For an argument against expansionary monetary or fiscal policy in such circumstances, one has to resort to arguments other than those made by Friedman.

So Friedman’s economic analysis has taken a serious hit. But that’s not the whole story behind his disappearance; after all, all those economists who have been predicting runaway inflation still have a constituency after being wrong year after year.

Friedman’s larger problem, I’d argue, is that he was, when all is said and done, a man trying to straddle two competing world views — and our political environment no longer has room for that kind of straddle.

Think of it this way: Friedman was an avid free-market advocate, who insisted that the market, left to itself, could solve almost any problem. Yet he was also a macroeconomic realist, who recognized that the market definitely did not solve the problem of recessions and depressions. So he tried to wall off macroeconomics from everything else, and make it as inoffensive to laissez-faire sensibilities as possible. Yes, he in effect admitted, we do need stabilization policy — but we can minimize the government’s role by relying only on monetary policy, none of that nasty fiscal stuff, and then not even allowing the monetary authority any discretion.

At a fundamental level, however, this was an inconsistent position: if markets can go so wrong that they cause Great Depressions, how can you be a free-market true believer on everything except macro? And as American conservatism moved ever further right, it had no room for any kind of interventionism, not even the sterilized, clean-room interventionism of Friedman’s monetarism.

Well, inconsistency is in the eye of the beholder, and, anyway, it is surely appropriate to beware of that foolish consistency which is the hobgoblin of little minds. The Great Depression was the result of a complex pattern of events, and acknowledging the inability of free markets to cope with those events is not the same thing as agreeing that free markets caused the Great Depression.

So Friedman has vanished from the policy scene — so much so that I suspect that a few decades from now, historians of economic thought will regard him as little more than an extended footnote.

I suspect that Krugman is correct that the small-minded political right-wing of our time is no longer as willing to accept Milton Friedman as their pre-eminent economic authority figure as were earlier generations of political right-wingers in the last three or four decades of the twentieth century. But to extrapolate from that sociological factoid how future historians of economic thought will evaluate the contributions of Milton Friedman seems to me to be a bit of a stretch.


14 Responses to “Krugman Predicts the Future History of Economic Thought”

  1. 1 sumnerbentley August 11, 2013 at 3:42 pm

    David, Good post. I see you linked to my newest post on Keynes. But you didn’t tell me what was wrong with it.

    I would add that the post you linked to did not claim there was an oral tradition at Chicago that provided Friedman with the basics of his theory. The issues I addressed were different. Did Friedman intentionally lie as many claim. And did the idea of the demand for money being a function of the interest rate get developed long before Keynes. I haven’t seen anyone refute either argument.


  2. 2 David Glasner August 11, 2013 at 5:25 pm

    Scott, Thanks, glad that you liked it. I am going to post something soon replying to your new post about Friedman. Since we are now in a quotation duel, I am calling on Mark Blaug from his book Economic Theory in Retrospect. My main point about Hicks in “Mr. Keynes and the Classics” is that his focus was on the larger Keynesian macro-model and not the demand for money. So he was crediting Pigou and Lavington for seeing that the demand for money is a function of the interest rate even though their version of it was not as advanced as Keynes’s. That the demand for money is a function of the interest was not a completely new discovery, but it was not a widely known and accepted idea either. The idea that money is one of many possible assets to be held, and the demand for any of those assets is derived from an optimization decision in which an optimal portfolio is chosen, was not articulated until Hicks in 1935 and Keynes very shortly thereafter in chapter 17 of the General Theory. That was Friedman’s starting point in his restatement of the quantity theory, so he didn’t acknowledge the contributions on which he was relying. I don’t say that Friedman deliberately lied, only that he misstated the facts, and didn’t acknowledge the contribution that he was relying on.


  3. 3 Ray Newton August 11, 2013 at 5:46 pm

    You cannot have a meaningful rational argument, if it is based on an irrational assumption. Your article displays such an assumption here in the following quote. However, I merely use this as an example of how so many here (all) continue to make these assumptions, which result from academia’s view of macro economics, which controls all economies, and econonomics down throught the chain.

    ” 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. ”

    First: Why do you assume that it was not the Fed’s effective control of ‘broad’ money (whatever that is) in adding to bank reserves and having it sit there ( at least, until they were ready for the next move)?

    In the comment re the 1930’s, why do you assume that Friedman’s claim, or any of the others who are aware of the power of the Fed and have voiced the same that they could have prevented the Great Depression, now looks dubious?

    The Fed moves in mysterious ways, its wonders to perform. Click your heels and repeat three times. This just does not appear to sink in, no matter how many times they show you.

    Actually they are not mysterious when viewed with a free unfettered mind.

    The great mother of all false assumptions is to view the Fed as the US Central Bank, and that its raison d’etre is there to serve the United States, solely. It is not even owned by the US government. It is not controlled by the US government, and its agenda reaches far beyond its interests being those only of the United States.

    There are obviously some very smart, educated minds here, but like Holmes often remarked to Watson when he responded to an explanation -‘I see’.
    “Yes, you see Watson, but you don’t observe.”

    I will add to that Einstein’s observation that ‘Imagination is more important than knowledge’. Imagination permits one to see outside the box that conditioning confines. It allows one to see the BIG picture.

    I know this is all going over the head. You will all continue to argue old theories, and new ones as they are added. Their only relevance is to serve as excuses, or to predict with reasonable certainty the outcome of any engineered cause for which there is a planned effect that fits the economic agenda of the world’s Central Banks, Central bank, that sits on 33 Liberty Street NY, and sometimes affectionately referred to as ‘the Temple’.


  4. 4 Greg Ransom August 11, 2013 at 6:38 pm

    I thought some version of the portfolio theory was already found in Keynes’ Treatise, and some version of it is clearly assumed by Hayek in Prices and Production. When you have a variety of things with various and changing degrees of moneyness, you’ve got an adjusting portfolio, and you’ve got that in Keynes’ Treatise and Hayek’s P&P.


  5. 5 JP Koning August 11, 2013 at 7:28 pm

    “The idea that money is one of many possible assets to be held, and the demand for any of those assets is derived from an optimization decision in which an optimal portfolio is chosen, was not articulated until Hicks in 1935 and Keynes very shortly thereafter in chapter 17 of the General Theory.”

    David, like you I am a big fan of chapter 17, but I’m not sure I agree that previous economists did not articulate a theory of money in which it was one of many possible assets to be held. For instance, what do you think about this quote from Lavington? It comes from his chapter entitled The Demand for Money which can be found in his book the English Capital Markets, written in 1922:

    “As a person extends the application of resources in any particular use, the yield from each successive unit of resources so applied satisfies a less and less urgent need. Accordingly he presses their employment in each use up to that point where in his judgment the marginal yield is equal all round ; for if this yield differed as between any two uses it would pay him to transfer resources from one to the other. Resources devoted to consumption supply an income of immediate satisfaction; those held as a stock of currency yield a return of convenience and security; those devoted to investment in the narrower sense of the term yield a return in the form of interest. In so far therefore as his judgment gives effect to his self-interest, the quantity of resources which he holds in the form of money will be such that the unit of resources which is just and only just worth while holding in this form yields him a return of convenience and security equal to the yield of satisfaction derived from the marginal unit spent on consumables, and equal also to the net rate of interest.”

    I could provide more quotes from the chapter, but none is quite as succinct as the one above.


  6. 6 David Glasner August 11, 2013 at 7:49 pm

    Greg, Yes, Hicks in his Suggestion for Simplifying the Theory of Money, explicitly refers to Keynes’s analysis in the Treatise as the inspiration for his argument. Interestingly, Hicks did not refer to Hayek with whom he was, I think, still in very close touch. At any rate, do you have a specific page reference in Prices and Production?


  7. 7 David Glasner August 11, 2013 at 8:09 pm

    JP, It’s a wonderful quote, which shows what a superb economist Lavington was. The question is did Keynes in chapter 17 do nothing more than restate more fully what Lavington already had said in 1921? I think that he did go beyond Lavington, but if you think otherwise, perhaps there is a paper to be published demonstrating that Lavington in 1921 anticipated everything (or at least the main points) that Keynes said in chapter 17.


  8. 8 Blue Aurora August 12, 2013 at 12:28 am

    Although Professor Krugman is harsh in his judgement, I do see where he is coming from and why he’s making his arguments.

    BTW, David Glasner, although I agree that Chapter 17 of The General Theory was excellent, I think that you will find Chapter 21 even more sophisticated and impressive. Keynes’s generalisation of the Quantity Theory of Money via elasticity analysis in that chapter appear to be impressive and state-of-the-art for the time.


  9. 9 Mitch August 13, 2013 at 7:09 am

    Given all this discussion about Milton Friedman, I wonder if anyone pays any attention to the work of his son, David Friedman, also an economist.

    It’s not entirely fair to either man to say that Milton might currently believe what David now believes, but it might be instructive.

    David is an anarcho-capitalist – someone who believes in abolishing government entirely and having the free market do everything including establish law. He wrote a book outlining this, called “The Machinery of Freedom”. I think it actually represents a fair amount of right-wing thought nowadays, even if it’s not what many would actually say.

    Are there readers of this blog who are familiar with it? I read it a while ago and found it profoundly silly – but it does have a following.


  10. 10 Tas von Gleichen August 17, 2013 at 5:09 am

    I’m a much bigger fan of Milton Friedman compared to Krugman. Friedman just made sense to me.


  11. 11 AldreyM August 17, 2013 at 8:52 am

    Why Krugman and you are focusing in a small part of the republican party that has never won the nomination?


  1. 1 Isn’t Economic History grand | TVHE Trackback on August 11, 2013 at 4:52 pm
  2. 2 Links for 08-12-2013 | Symposium Magazine Trackback on August 12, 2013 at 12:16 am
  3. 3 On Friedman's Keynesianism Sumner Just Can't Let it Go | Last Men and OverMen Trackback on February 19, 2017 at 8:59 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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