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.