Salerno Compares Rothbard and Friedman

And finds Milton Friedman wanting as a monetary theorist. You can watch Joseph Salerno's lecture "Who was the Better Monetary Economist? Rothabard and Friedman Compared" below:




In this provocative lecture, Salerno reminds us that in 2002 Friedman advocated what we now call quantitative easing to prevent deflation after the recession of 2001. He also documents how, throughout the mid-2000s, Friedman utterly failed to see the investment imbalances that were building toward the housing bubble and resulting recession.

While listening, it occurred to me that the Fed did essentially what Friedman suggested. It would be interesting to know, if Friedman was still living, what he would think about his theory and policy now. Pursuing a policy in general agreement with Friedman produced the greatest period of financial upheaval in this country since the Great Depression. Would he, positivist economist that he was, take the Great Recession of 2008 as a giant data point which fails to verify his theory?

Are Nobel Prizes in Economics Enough to Make One a Good Policy Maker?

Peter A. Diamond complained in Sunday's New York Times that, even though he won a Nobel Prize in economics, senate approval of his nomination to serve on the board of the Federal Reserve is being held up. In doing do, he makes the case that in order to do monetary policy right, it is important to know something about unemployment, his own area of expertise.

I, for one, am not so sure that winning the Nobel Prize in economics should be taken as prima facie evidence of sound overall economic analysis. Paul Krugman, Joseph Stiglitz, and Paul Samuelson all won Nobel Prizes and I find most of their economic analysis abysmal. Even the work of Milton Friedman, another Nobel Laurette greatly disappoints when it comes to economic method and monetary analysis.

It turns out that a main reason to maintain a healthy skepticism about the pronouncements of Nobel Prize winners is that the committee awarding the prize has demonstrated decidedly destructive biases in their awards. That is the conclusion of economist Nikolay Gertchev, a PhD economist now working for the European Commission in Brussels. In his article "The Economic Nobel Prize," Gertchev first documents the bias toward mathematical economics and the relativism that results from empirical positivism.

About research programs of Prize recipients, he notes

The vast majority of rewarded contributions, while pertaining to different fields ofscientific investigation, and hence raising different questions, share in common two basic views, which will be addressed separately in the next two sub-sections. According to the first view, the market process is inefficient. According to the second view, the failures of this inefficient market process need to be corrected, and government policies are potent and well suited for achieving this goal.

Gertchev explains the destructive practical consequences of such a bias in his conclusion:

The most fundamental problem that such a pro-government and anti-market bias is causing for a Prize that claims to be scientific is its relation to truth. The single goal of scientific research should be the discovery of new knowledge, either through correcting past errors or through the discovery of previously unknown truths. Truth, however, does not appear to be a primary concern for the Prize committee in economics.

You can watch Gertchev's presentation of his article here:


PFS 2010 - Nikolay Gertchev, Not New, Not True, Irrelevant or Evil: How Economic Nobel Prizes Are Won from Sean Gabb on Vimeo.

Given such a track record, perhaps not only is it not enough for a Fed Governor to be a Nobel Prize winner. Perhaps it is undesirable.

Did Raising the Reserve Requirments in 1936 and 1937 Prolong the Great Depression?

Since the publication of Milton Friedman and Anna Schwartz's A Monetary History of the United States 1867-1960, the conventional answer has been yes. Richard Timberlake has called the Fed's raising the legal reserve requirements three times during 1936 and '37 a "debacle" that ushered in monetary contraction and a second recession within the Great Depression.

In his essay "Money and Gold in the '20s and '30s" originally published in The Freeman and reprinted in the new book Money Sound and Unsound, Joseph Salerno offers a different perspective. Salerno notes that "the money supply (M2) continued to grow from June of 1936 to June of 1937, the year the policy was implemented." Hardly a deflationary contraction.

Two other articles published in the Journal of Post Keynesian Economics also argue against the notion that the 1937-38 contraction was due to higher reserve requirements. The first is L. G. Telser's "Higher member bank reserve ratios in 1936 and 1937 did not cause the relapse into depression." The abstract reads as follows:

Examination of both sides of member banks' balance sheets reveals evidence that refutes the claim that higher member bank reserve ratios imposed by the Federal Reserve Board of Governors in 1936 and 1937 caused the re- lapse of the U.S. economy into depression. Member banks responded to higher reserves by selling some of their U.S. Treasury paper and did not reduce their loans to business.

Robert Stauffer draws on Tesler's work in his article, "Another Perspective on the Reserve Requirement Increments of 1936 and 1937." The abstract is as follows:

The purpose of this analysis is to investigate three issues surround- ing the Federal Reserve's doubling of reserve requirements between August 1936 and May 1937. First of all, arguments are offered that strengthen and complement L.G. Telser's analysis of how bank lending was affected by reserve ratio increases. Second, a unique money multiplier model is utilized to mea- sure the impact of these policy changes on excess reserves and the money sup- ply. Finally, the possible relationships between Fed policy changes and the recession of 1937-1938 are discussed, including the Friedman and Schwartz perspective.

The issue of increased legal reserve requirements is important because that is one avenue, and perhaps the best one, the Fed could take to exit from the aftermath of all the quantitative easing so as to avoid actual hyper-inflation.

Leonard Read's "I Pencil"

Leonard Read

Leonard Read was born on this day in 1898. Read, an important figure of the post-war free market/libertarian movement of last century, was founder and president of the Foundation for Economic Education for many years. His most famous work was a rather brief essay entitled "I, Pencil" in which Read explains the division of labor necessary to produce a single solitary pencil. His point is that only in a free market can such activity be coordinated in a way so that all of the different factors from all over the world come together to produce something as common as pencil.

"I, Pencil" was the basis of an important section of Milton and Rose Friedman's Free to Choose that was subsequently turned in to a film series. Here is Friedman using a pencil as "exhibit A" to explain the benefits and operation of the free market price system.

Bernanke II: Bad Economics Yield Bad Policy

As I tell students in my Foundations of Economics class, our evaluation of the efficacy of various economic policies will only be as good as the economic theory we use to do the evaluation. If our theory is bad, that will lead to bad policy analysis.

This fact was also strikingly revealed in Ben Bernanke's remarks to the annual Economic Symposium in Jackson Hole, Wyoming I discussed yesterday. When discussing what the economy needs to achieve sustainable recovery and what the Fed can do to help the process along, Bernanke affirmed that the Fed would inflate as necessary to ward off falling prices. I have written many times about the negative economic consequences of such inflationary monetary policy.

As my students will often ask, if it is true that monetary inflation provides no social benefit, but actually stimulates capital consumption because of malinvestment undertaken during an inflationary boom, why would smart people like Ben Bernanke advocate such policy? Such policy advocacy is partly explained by the different economic framework used by Bernanke and his comrades in inflation.

In his speech to the Economic Symposium he revealed that he operates within a Keynesian/Monetarist world view. Now given the potted history of 20th Century economic thought, most people would say it is impossible to possess a world-view that is both Keynesian and Monetarist. After all were not Paul Samuelson and Milton Friedman always at odds with one another? Many times, perhaps, but not always.

As Jesus Huerta de Soto points out in his magisterial treatise Money, Bank Credit, and Economic Cycles, there are enough fundamental similarities between Keynesians and Monetarists to place them both in a single category he simply calls "Macroeconomists." These modern macroeconomists tend to ignore the influence of time in production, see the economy as a circular flow of goods rather than a complex structure of production, and focus on macroeconomic aggregates which prevents analysis of underlying microeconomic factors such as malinvestment. In this modern macro framework, economic downturns are understood as being due to insufficient aggregate demand resulting from exogenous causes such as pessimistic animal spirits, technological glitches, or monetary policy mistakes.

Keynes' plan A for maintaining full employment was to fully socialize credit markets, so that all saving and investment would be controlled by the state. Recognizing the political unpalatablilty of that plan, he recommended monetary inflation as his plan B. Inflation would lower interest rates and stimulate investment in production. Milton Friedman's views on the efficacy of inflation during recessions were similar. He said the Great Depression was due to the Fed's not being activist enough to restore liquidity and recommended inflation for Japan's 20-year "lost decade." Friedman's position was that the central bank had to maintain liquidity (i.e. inflate the money supply enough) to provide economic stability.

This is the mindset revealed by the remarks of Bernanke. Discussing the economic outlook Bernanke said "For a sustained expansion to take hold, growth in private final demand--notably, consumer spending and business fixed investment--must ultimately take the lead." He later adds net exports as a third source of aggregate demand.

The notion that aggregate demand drives the economy is one of the most troublesome popular economic fallacies. It tends to mistake money income with wealth as if money is what we eat, wear, and live in. In fact, more money might raise monetary incomes, but it will not necessarily make us more wealthy because more money does not equal more land, labor, or capital goods. Therefore more money does not generate more consumer goods. More money generates prices that are higher than they would be otherwise.

What is required for real recovery is a rebuilding of the capital stock, which requires saving and investment, and a reallocation of convertible capital out of unsound investments and into projects producing what people really want. Bernanke's policy of inflation will not accomplish this. The reason he persists with that policy, however, is because of his faulty economic framework. As the title of Richard Weaver's most famous book says, ideas have consequences.