Friedman’s absence is mourned today because he was one of these awesome combinations of experience, accomplishment, intellect and brilliant communication.
The last few questions in the Q&A can probably be summarized as a prescient combination of all the sensible present-day views on the 08-12+ crises:
- The Euro is Effed
- Japan has had tight money for a long time
- We know that about Japan because they have low interest rates, which are often a sign of recently tight money, except when they’re not.
- By the way interest rates are a terrible ‘tool’ for managing the economy.
- nominal aggregates should be monitored/targeted.
What strikes me most about Friedman’s analysis is his experience. He had lived through and studied just about every conceivable macroeconomic situation. What understanding he must have had.
He does make one point that he later appears to contradict (big quotes because, again, the dude was just so lucid):
Now, my preference, of course, would be to abolish the central bank altogether and to simply have a computer that would churn out—well, I have two variants of it. In one of them, I would freeze the amount of the highpowered money and let the market go. In the other, I would assist the market by printing out a speciﬁed amount of high-powered money every month or quarter and have a steady rate of monetary growth
In 1989, the Bank of Japan stepped on the brakes very hard and brought money supply down to negative rates for a while. The stock market broke. The economy went into a recession, and it’s been in a state of quasirecession ever since. Monetary growth has been too low. Now, the Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?”
It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the highpowered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.
One interpretation of this is that he believes that his rules would have prevented the crisis today. The thing is that this view implies that the crisis was actually caused by tight money. Which is a bit controversial.
How would we have measured that tight money? This touches on his elaboration on the first point:
In recent years, that has not looked as good as it did much earlier, because the actual relationship in the world between monetary growth and inﬂation in the economy has become much worse in the last 10 or 20 years. But, that’s partly because there’s been so much ﬁnancial innovation and adaptation and, ultimately, it is the money supply that rules the roost and that will determine what long-term inﬂation will be.
So, the problem with money supply targeting or, indeed, with any DERIVATIVE rule is that the market will find a way to innovate past your rule. Money, after all, isn’t what we care about. What we care about is GDP! And what we need to target some kind of aggregate, because that’s the only thing we can measure.
Enter the Sumner synthesis.
The Sumner synthesis says that we target what we care about, NGDP. Crucially, we also target the level. This makes up for the problem that the central bank isn’t particularly good at doing anything in two important ways.
First, levels means that in a liquidity trap the bank can wait. And wait. And wait.
Eventually we’re going to get out of the trap and when that happens, KA-BLAMMO, out comes the money.
My second point is related to the first. The central bank isn’t just ineffective in a liquidity trap, the central bank is kinda ineffective all the time.
Think about Friedman’s problem with the shadow banking system and their shadow monetary aggregates that we don’t know how to measure well. The central bank can’t control that money, so the central bank can’t loosen it up or reign it in at will. Let’s say the shadow banking system has taken the central bank from something like 50% effectiveness to 30% effectiveness.
Doesn’t matter with level targeting. Over a long enough time span, you’re going to hit your level right, even with the wobbliest of levers. The promise remains credible.