The feature of Friedman’s monetary theories that is most often noted is his
opposition to a too-rapid increase in prices. Contrary to Keynesians who
had a very different explanation for such an increase, and in accordance
with classical economists, Friedman maintained that it was inevitably
provoked by a monetary policy that was too expansionist.
As he famously put it: “Inflation is always and everywhere a monetary
phenomenon in the sense that it is and can be produced only by a more rapid
increase in the quantity of money than in output.”
Monetarism also offers an explanation of the causes of the Great
Depression. According to Friedman and Schwartz, the reasons the crisis
lasted so long is not because of the inherent instability of a market
economy, but rather because of the ineptitude of the Fed.
According to them, during the 1930s, the Fed did nothing to prevent—and it
even at times deliberately provoked—a substantial reduction in the money
supply.
This policy led to the bankruptcy of thousands of banks and a drop in
national income, and it nipped any burgeoning economic recovery in the bud.
At first glance, monetarism therefore appears to be a theory that
criticizes government action—central banks being monopolies established by
governments to create and manage the currency—and that defends the free
market.
Paradoxically, this explanation nonetheless makes Friedman an ally of
Keynes when it comes to monetary policy, the second aspect of stimulus
plans. Although their evaluations of the dangers of inflation diverge
considerably, Keynesians and monetarists actually agree on a crucial point:
that the central bank must, in the financial jargon, “inject liquidity”
into the economy in times of crisis. In other words, it must artificially
create currency in order to support economic activity, protect banks from
failure and prevent a temporary readjustment from turning into a recession
or an extended depression.
It is this policy that Volker’s successor, Alan Greenspan, put in place for
19 years while he was Chairman of the Fed. Each time the American economy
showed signs of slowing down or experienced any crisis (the stock market
crash of 1987, the Savings and Loan Crisis, the Mexican crisis, the Asian
crisis, the Y2K bug, the September 11, 2001 attacks, the bursting of the
tech bubble, etc.), Greenspan stepped on the monetary accelerator. An open
supporter of the free market, he took inspiration not from Keynes, but from
Friedman.
During a conference on the occasion of Friedman’s 90th birthday
in 2002, the current Chairman of the Fed, Ben Bernanke, also endorsed the
analysis of Friedman and Schwartz: “I would like to say to Milton and Anna:
Regarding the Great Depression, you’re right, we did it. We’re very sorry.
But thanks to you, we won’t do it again.”
Since 2007, Bernanke has set up, not surprisingly, a series of
“quantitative easing” programs, another euphemism for the creation of money
from nothing. According to American journalist Penn Bullock, by all
accounts, Friedman would have approved of these measures. He writes in Reason.com
that while it is true that the Obama administration is pursuing Keynesian
fiscal stimulus, the Federal Reserve under Bernanke has deliberately put in
practice the lesson of Friedman and Schwartz on the need to grow the money
supply.
It is after all the same quantitative easing policy that Friedman had
suggested to the Japanese government, itself facing an economic crisis
following the bursting of a housing bubble starting in 1990: “The surest
road to a healthy economic recovery is to increase the rate of monetary
growth,” he wrote in 1997.
The Austrian Critique
More than three years after the start of the current crisis, there are no
signs that the stimulus plans, budgetary or monetary, have succeeded in
getting the economy back on a sustainable track.
For Keynesians like Paul Krugman, this is proof that they did not go far
enough. Monetarists inspired by Friedman are, for their part, on the
defensive. It is another theory, much more intransigently opposed to
government interventionism, that is gaining influence: that of the Austrian
School of economics, represented by economists Friedrich A. Hayek and
Ludwig von Mises, among others.
For adherents of the Austrian School (who, despite their name, are found
just about everywhere in the world today), supporters of a return to the
gold standard and a denationalisation of the currency, it is the very
existence of fiat money that is the source of the problem. Monetary
creation from nothing is a fraud perpetrated by the government upon holders
of currency, which moreover entails a misallocation of resources and leads
inevitably to recessions.
We cannot, as Friedman recommends, solve the problem by resorting to the
policies that caused it in the first place. By coming to the rescue of the
markets every time there was a slowdown, Greenspan only postponed the
crisis, and made it worse. From an Austrian point of view, therefore,
monetarists are in the end just as responsible for the crisis, and for its
continuation, as Keynesians are.
The most well-known proponent of Austrian economics is undoubtedly Ron
Paul, a Representative in Congress and a current Republican presidential
candidate. The author of a book entitled End the Fed, he warned
Americans about the danger of an overly expansionist monetary policy and of
a potential crash years before it happened, as did other commentators
inspired by the Austrian School.
According to Ron Paul, “Friedman’s very, very libertarian—except on
monetary issues.” Indeed, almost all of Friedman’s body of work was in
defence of individual liberty and the free market. He would no doubt have
denounced the Keynesian-inspired budgetary stimulus plans put in place for
the past three years.
However, if we take him at his word, he would have sided with the
Keynesians in favour of the monetary stimulus plans. Perhaps the current
crisis will bring about a paradigm change on this subject in favour of
another school of thought.
*This article was originally published in French on January 21, 2012, in
the Montreal daily paper Le Devoir.
Translation by Bradley
Doucet.
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