04 Sep 2009

Apologies to My Two Favorite Economic Bloggers

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In an extraordinarily rare occurrence, this week I have criticized both Paul Krugman and Tyler Cowen in separate blog posts. But last night I realized I was a bit too harsh. (I am not being sarcastic here, again another extraordinarily rare occurrence.)

This 8-page Krugman essay is actually really good, in terms of history of (mainstream) economic thought. (I had only had time to skim the first page when I ranted about it yesterday afternoon.) I don’t have any problem with his explanation of the battle lines in academia. Of course, the only flaw is that he totally ignores the niche in “theory-space” held by the Austrians. Krugman thinks you have to either believe that markets are flawless and bubbles are literally impossible, or you have to believe that capitalism is flawed and requires government oversight. Of course he is overlooking the possibility that government intervention can cause bubbles and other problems in market economies.

As for Cowen, in this post I flipped out because he first had said, “(By the way, some libertarians like to pretend that Milton Friedman blames the Fed for “contracting” the money supply by one-third in that period but in reality Friedman blames the Fed for having let the money supply fall by one-third and not having run a bank bailout.)”

But then in response to people who challenged this assertion, Tyler clarified by saying, “When I perused Friedman’s writings lately, I found that, as far as I could tell, he never discussed how to deal with widespread bank insolvency. I interpret him as believing that [lender of last resort] and loose money and the FDIC could deal with banking crises…”

As I say, I flipped out here, because it seemed Tyler’s interpretation of Friedman was precisely what the knee-jerk libertarians were “pretending” that Friedman believed.

However, I thought about it some more, and I realized that the case is not as open-and-shut as I originally thought. To say someone thinks the Fed should act in a crisis in its “lender of last resort” capacity can mean all kinds of things. Indeed, you could say that Bernanke himself (except for the outright purchases of some assets) is “bailing out” AIG and others through emergency loans. I think Brad DeLong was the first person I saw who brought up the point that the dividing line between an institution that is merely illiquid as opposed to insolvent is not as clearcut as we normally think. In our example, if the Fed is willing to give “loans” at 0% interest no matter the condition of the borrower, does that mean the Fed is acting as lender of last resort, or is it bailing out that institution?

Anyway, I still think Friedman did NOT advocate massive bank bailouts in the Great Depression, and I also think Tyler is contradicting himself when he says (a) Friedman DID advocate bank bailouts in the Great Depression but (b) Friedman never discussed widespread bank insolvency. (If [b] is true, how can [a] be true?) But my first reaction–where I accused Tyler of admitting that Friedman held precisely those views that Tyler had earlier chastised libertarians for attributing to Friedman–was unwarranted. It all depends on what activities we allow to the Fed when it’s wearing its “lender of last resort” hat.

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