Regular readers of this blog will not be surprised to learn that I am not one of Milton Friedman’s greatest fans. He was really, really smart, and a brilliant debater; he had a great intuitive grasp of price theory (aka microeconomics), which helped him derive interesting, and often testable, implications from his analysis, a skill he put to effective use in his empirical work in many areas especially in monetary economics. But he was intolerant of views he didn’t agree with and, when it suited him, he could, despite his libertarianism, be a bit of a bully. Of course, there are lots of academics like that, including Karl Popper, the quintessential anti-totalitarian, whose most famous book The Open Society and Its Enemies was retitled “The Open Society and its Enemy Karl Popper” by one of Popper’s abused and exasperated students. Friedman was also sloppy in his scholarship, completely mischaracterizing the state of pre-Keynesian monetary economics, more or less inventing a non-existent Chicago oral tradition as carrier of the torch of non-Keynesian monetary economics during the dark days of the Keynesian Revolution, while re-packaging a diluted version of the Keynesian IS-LM model as a restatement of that oral tradition. Invoking a largely invented monetary tradition to provide a respectable non-Keynesian pedigree for the ideas that he was promoting, Friedman simply ignored, largely I think out of ignorance, the important work of non-Keynesian monetary theorists like R. G. Hawtrey and Gustav Cassel, making no mention of their monetary explanation of the Great Depression in any of works, especially in the epochal Monetary History of the United States.
It would be one thing if Friedman had provided a better explanation for the Great Depression than Hawtrey and Cassel did, but in every important respect his explanation was inferior to that of Hawtrey and Cassel (see my paper with Ron Batchelder on Hawtrey and Cassel). Friedman’s explanation was partial, providing little if any insight into the causes of the 1929 downturn, treating it as a severe, but otherwise typical, business-cycle downturn. It was also misleading, because Friedman almost entirely ignored the international dimensions and causes of the downturn, causes that directly followed from the manner in which the international community attempted to recreate the international gold standard after its collapse during World War I. Instead, Friedman, argued that the source, whatever it was, of the Great Depression lay in the US, the trigger for its degeneration into a worldwide catastrophe being the failure of the Federal Reserve Board to prevent the collapse of the unfortunately named Bank of United States in early 1931, thereby setting off a contagion of bank failures and a contraction of the US money supply. In doing so, Friedman mistook a symptom for the cause. As Hawtrey and Cassel understood, the contraction of the US money supply was the result of a deflation associated with a rising value of gold, an appreciation resulting mainly from the policy of the insane Bank of France in 1928-29 and an incompetent Fed stupidly trying to curb stock-market speculation by raising interest rates. Bank failures exacerbated this deflationary dynamic, but were not its cause. Once it started, the increase in the monetary demand for gold became self-reinforcing, fueling a downward deflationary spiral; bank failures were merely one of the ways in which increase in the monetary demand for gold fed on itself.
So if Paul Krugman had asked me (an obviously fanciful hypothesis) whether to criticize Friedman’s work on the Great Depression, I certainly would not have discouraged him from doing so. But his criticism of Friedman on his blog yesterday was misguided, largely accepting the historical validity of Friedman’s account of the Great Depression, and criticizing Friedman for tendentiously drawing political conclusions that did not follow from his analysis.
When wearing his professional economist hat, what Friedman really argued was that the Fed could easily have prevented the Great Depression with policy activism; if only it had acted to prevent a big fall in broad monetary aggregates all would have been well. Since the big decline in M2 took place despite rising monetary base, however, this would have required that the Fed “print” lots of money.
This claim now looks wrong. Even big expansions in the monetary base, whether in Japan after 2000 or here after 2008, do little if the economy is up against the zero lower bound. The Fed could and should do more — but it’s a much harder job than Friedman and Schwartz suggested.
Krugman is mischaracterizing Friedman’s argument. Friedman said that the money supply contracted because the Fed didn’t act as a lender of last resort to save the Bank of United States from insolvency setting off a contagion of bank runs. So Friedman would have said that the Fed could have prevented M2 from falling in the first place if it had acted aggressively as a lender of last resort, precisely what the Fed was created to do in the wake of the panic of 1907. The problem with Friedman’s argument is that he ignored the worldwide deflationary spiral that, independently of the bank failures, was already under way. The bank failures added to the increase in demand for gold, but were not its source. To have stopped the Depression the Fed would have had to flood the rest of the world with gold out of the massive hoards that had been accumulated in World War I and which, perversely, were still growing in 1928-31. Moreover, leaving the gold standard or devaluation was clearly effective in stopping deflation and promoting recovery, so monetary policy even at the zero lower bound was certainly not ineffective when the right instrument was chosen.
Krugman then makes a further charge against Friedman:
Beyond that, however, Friedman in his role as political advocate committed a serious sin; he consistently misrepresented his own economic work. What he had really shown, or thought he had shown, was that the Fed could have prevented the Depression; but he transmuted this into a claim that the Fed caused the Depression.
Not so fast. Friedman claimed that the Fed converted a serious recession in 1929-30 into the Great Depression by not faithfully discharging its lender of last resort responsibility. I don’t say that Friedman never applied any spin to the results of his positive analysis when engaging in political advocacy. But in Friedman’s discussions of the Great Depression, the real problem was not the political spin that he put on his historical analysis; it was that his historical analysis was faulty on some basic issues. The correct historical analysis of the Great Depression – the one provided by Hawtrey and Cassel – would have been at least as supportive of Friedman’s political views as the partial and inadequate account presented in the Monetary History.
PS Judging from some of the reactions that I have seen to this post, I suspect that my comments about Friedman came across somewhat more harshly than I intended. My feelings about Friedman are indeed ambivalent, so I now want to emphasize that there is a great deal to admire in his work. And even though he may have been intolerant of opposing views when he encountered them from those he regarded as his inferiors, he was often willing to rethink his ideas in the face of criticism. My main criticism of his work on monetary theory in general and the Great Depression in particular is that he was not well enough versed in the history of thought on the subject, and, as a result, did not properly characterize earlier work that he referred to or simply ignored earlier work that was relevant. I am very critical of Friedman for having completely ignored the work of Hawtrey and Cassel on the Great Depression, work that I regard as superior to Friedman’s on the Great Depression, but that doesn’t mean that what Friedman had to say on the subject is invalid.
Uneasy Money 