Arnold Kling  

Paging Scott Sumner

Where Does Monopoly Power Come... Could Freddie Come Baaaack?...

He needs to clear up some confusion. I think that Penn Bullock, is quite confused about Milton Friedman, monetarism, and the current crisis. In fact, Bullock is so confused that I searched in vain for something to excerpt. On the other hand, I may be the one who is confused, in which case Scott is the right one to set me straight.

The main point of the Bullock article is to link Ben Bernanke's policies to Milton Friedman and Anna Schwartz's monetarist account of the Great Depression. I don't see that link.

The Friedman-Schwartz lesson of the Great Depression is, "Don't let the money supply collapse." It is not, "Bail out big banks, but don't bail out small banks, but do bail out an insurance company and some investment banks, but not Lehman Brothers, and make sure to buy mortgage-backed securities..."

A grain of truth in the article is that if driving the Fed Funds rate to zero is not sufficient to keep the money supply from collapsing, the Fed has to buy some other assets, and presumably Friedman and Schwartz would want this to happen. But the Fed could buy short-term Treasuries or long-term inflation-indexed Treasuries. It could (I learned this from Scott) not choose this moment in history to pay interest on reserves--which is a contractionary move (but good for bank profits).

Another grain of truth is that one can divide the world into a camp that wants to abolish the Fed and a camp that doesn't. An interesting article could be written comparing and contrasting the two camps. In such an article, you might be able to put Bernanke and Friedman in the same camp, namely the one that doesn't want the Fed abolished. (Even that is arguable, since Friedman sometimes expressed the view that the Fed could be replaced by a computer program.) But that does not make Bernanke an intellectual disciple of Friedman. Unless Scott Sumner tells me I should think otherwise.

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CATEGORIES: Monetary Policy

COMMENTS (18 to date)
E. Barandiaran writes:

You may be interested in this paper on TARP

dWj writes:

Not the Friedman and Schwartz program:

Patrick R. Sullivan writes:

Scott is in China right now, and not blogging much.

Arnold Kling writes:

EB, thanks. that does look interesting

Don the libertarian Democrat writes:

He did reply to one of my idiotic questions, showing that he's a first class person:

"Don, First, I’m not sure the job losses do outpace the fall in RGDP. Krugman has a recent post where he says they don’t, and while I often disagree with Krugman, he has pretty good judgment about technical issues like Okun’s law.

I don’t have strong view on the whole debt-deflation thing. I think one of Bernanke’s mistakes was to focus too much on the banking system and not enough about directly stopping the fall in NGDP. But that doesn’t mean debt-deflation is not an important transmission mechanism, it may be important. And the assistance he gave banks may have helped a bit. But my “off the top of my head” view is that the government got LTCM, Bear Stearns, and Lehman all wrong. The first two should have been allowed to fail (to scare investors and reduce moral hazard) and given the first two were rescued, Lehman also should have been rescued because the shock was just too great, and at the worst possible time (when the economy was already starting to fall fast.) That’s a provisional view, and I would gladly reconsider with more information.

I doubt this answers your questions, but it gives something of my perspective."

My view about having the Treasury Dept. sweeten the deal for the B of A to buy Lehman or, second best, having the Fed advance some funds, is purely pragmatic, and follows this new Vox post:

Don the libertarian Democrat writes:

From Allan H. Meltzer in the WSJ:

"The Federal Reserve also shared this Keynesian viewpoint. It provided unprecedented monetary stimulus, increasing the monetary base by more than $1 trillion. Much of this increase corrected for its major mistake: allowing Lehman Brothers to fail. After 30 years of bailing out almost all large financial firms, the Fed made the horrendous mistake of changing its policy in the midst of a recession. That set off a scramble for liquidity and heightened the public's distrust in the market.

This had world-wide repercussions. For four months, many financial markets remained frozen and real activity collapsed. Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history ( NB DON ). Extrapolation caused many market participants to conjecture that we were in a depression. The New York Times and others piled on, speculating foolishly about the end of capitalism."

I don't agree with everything that he says, but I agree with the general points being made above.

Penn writes:

Nowhere do you address in this post Bernanke's assertion before Congress that he literally acted on the lesson of Friedman and Schwartz's book to lower interest rates to zero. I suppose we should just ignore the Chairman's own words and trust you?

Friedman and Schwartz wanted more than just the maintenance of the money supply. They wanted an increase in the money supply. Schwartz says so in the article.

You 'search in vain for something to excerpt.' That's an excuse for not addressing the article at all, except on your own - confused - terms.

BlackSheep writes:

Friedman says "abolish the FED": youtube video.

BlackSheep writes:

Bill Woolsey writes:


Sumner believes that the Fed could have maintained nominal expenditure on its 5% growth path by purchasing T-bills and not paying interest on reserves. He argues that the reason T-bill rates were near zero was expectations of low and falling nominal income. A committment by the Fed to purchasing as many T-bills as necesary to raise base money as much as necessary to keep nominal income on target would result in higher short term interest rates (or prevent their fall in the first place) as well as spending levels consistent with nominal income being on target.

If nominal income was maintained, and some banks and investment banks do fail, any resulting supply-side shock and stagflation would be mild, in Sumner's judgement.

If buying all T-bills is not sufficient, Scott does believe that the Fed should by other sorts of assets, starting with longer term government bonds. Bills, then notes, then bonds, is the way he explains it to me. The Fed should make it clear that it will do this if necessary. But that committment should make it unnecessary.

I don't dispute the long quote by Don the libertarian Democrat. I would focus on the first sentence.

Ken Silber writes:

Another confusing item in the Reason article is the description of the Fed as "semi-private." While it's not downright false, as is the assertion that the Fed is "private," it refers to a fairly meaningless technicality that has generated a blizzard of conspiracy literature. The Fed's regional banks are nominally owned by banks in their districts, but have to turn over all their profits to the Treasury, and the system is designed so the Board of Governors, a clearcut government agency, has the final say on policy.

And btw Milton Friedman was very good at clearing up that confusion.

winterspeak writes:


Can you please help me understand why taxing reserves (or not paying interest on them) is stimulative?

Banks are not constrained by reserves in any way when they lend.


Penn writes:


Perhaps you're not aware of the fact that the Board Governors, when they return to their regional banks, call themselves presidents and are executives of a private corporation. As the press agent at the Philadelphia Fed explained, the presidents are only known as governors when they set foot in Washington D.C. and put on the robes of a civil servant.

Yes, the System is that obfuscative.


Ken Silber writes:


Actually, the Board of Governors does not include any presidents of the regional Fed banks. You are presumably thinking of the Federal Open Market Committee, which is designed to have a majority (7 of 12) from the Board of Governors, and a minority from the regional banks (4 rotating, and permanent membership by the New York Fed president).

Here's a fun site on the subject.


Ken Silber writes:

Scott Sumner writes:

I think the Reason article oversimplifies things, but Bernanke was almost certainly influenced by Friedman and Schwartz. I think Bernanke accepts their view that a more expansionary monetary policy could have prevented the Great Depression. Bernanke's own work emphasized banking turmoil as a separate causal factor, even apart from its role in reducing the money multiplier. So in that respect he goes beyond F&S, and I think this is why he favored such an aggressive bailout strategy. I believe Bernanke is also a bit more Keynesian than Friedman, less ideological, more pragmatic, more Keynesian. Thus he supported a fiscal stimulus, whereas Friedman would probably agree with me that monetary stimulus was the way to go. It is not clear how Friedman would have reacted to the current crisis. I have a couple posts arguing that he might well have agreed with me. But it is also possible that he would have agreed with Schwartz and Meltzer, who have argued money is too easy. Even in Money Mischief, his last major work on monetary economics, he supported several very different options, each having very different implications for the current crisis. Naturally I fixated on the one that supported my position--his support for Hetzel's "targeting the forecast" proposal.

Bill writes:

I thought it was a great article. What I took away from it - and I don't know if this was Penn's intent - is that regardless of the ideological underpinnings of the chairman, a monopoly central bank is a monster that will eventually torch the economy. The theory and reality can seemingly never be aligned.

We can debate all day about the recipe for the sausage, but in the end it is the whole sausage making process that is rotten. I want steak!

Drewfus writes:

"For four months, many financial markets remained frozen and real activity collapsed. Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history."

So, something bad happened, therefore we should not have let that bad thing happen. But at what cost? Implicitly, no cost, its another free lunch. As it turned out, most of us to pay for it anyway - and we were not given a choice.

Is this the state of human thinking in the 21st century? What happened to cost-benefit analysis? What would people prefer, a bit of 'chaos' in the bloated financial markets for a while, or 20 years of zombie financial firms and economic stagnation like Japan? Why has our thinking become so short-term? Our horizon so close? Have we peaked as a species?

It would appear that, no matter what Milton Friedman's view on bailouts would have been (who cares?), the monetary policy mistakes theory of the great depression is now so dominant and entrenched, that bailouts of any nature are now regarded as standard practice for any sort of financial system trouble, no matter the cost, or their resentment by the public.

I would suggest, as an alternative, that the monetary view of the GD is largely incorrect, and that the real culprit of the great depression is to be found in the labor markets - namely, the large wage deflation that occured generally, and that has not been repeated in any significant sense, since then.

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