13 Jul 2010

Inflationist, Heal Thyself

Federal Reserve, Financial Economics 11 Comments

I was reading Scott Sumner and came across this:

Benjamin Strong was President of the New York Fed during the 1920s, which effectively made him the Ben Bernanke of his time. According to Liaquat Ahamed (p. 293-94), Strong favored a policy that attempted to stabilize the economy by looking at “the trend in prices and the level of business activity.”…

A good example occurred during the very mild recession of 1927. Contrary to the Austrian view, policy wasn’t particularly easy by modern standards. Short term rates were cut to 3.5%, but that would be like 5.5% under our modern 2% inflation regime. (In those days the trend rate of inflation was roughly zero.) In any case, this policy insured that the recession was very mild, and the economy soon recovered.

Now if you know Scott, the part I’ve put in bold above should be funny. Scott has quite possibly forfeited eight years off his lifespan from all the angst he holds over economists who can’t get it out their thick skulls to STOP evaluating monetary tightness or looseness based on interest rates. Why, here’s an example of what I mean. Notice how thick Scott lays it on, for people who haven’t learned this elementary lesson:

Milton Friedman died on November 16, 2006, one year before the sub-prime crisis.  I’d like to suggest that his death was the closest equivalent to the death of Strong in 1928.  In 1998 Friedman pointed out that the ultra low interest rates were a sign that Japanese monetary policy was very contractionary, at a time when most people characterized the policy as highly expansionary.

There is little doubt that Friedman would have recognized the low interest rates of late 2008 were a sign of economic weakness, not easy money….

Why was Friedman so important?  I see him as having played the same role among right-wing economists that Ronald Reagan did among conservatives.  Reagan was really the only conservative that all sides respected; social conservatives, economic conservatives, and foreign policy (or neo-) conservatives.  After he left the scene, the conservative movement cracked-up.

Friedman was respected by libertarians, monetarists, new classicals, etc.  Last year I criticized Anna Schwartz for adopting the sort of neo-Austrian view that she and Friedman had strongly criticized in their Monetary History.  If Friedman was still alive, and strongly insisting that money was actually far too tight, then I doubt very much that Schwartz would have gone off in another direction.  It would be like Brad DeLong disagreeing with Paul Krugman on macroeconomic policy.  Once in a blue moon.

Today there is no real leadership among right wing economists.  They are all over the map.  There are new classical types focusing on the role of labor market imperfections.  Well-known monetarists like Schwartz and Meltzer insist that the real danger is easy money, not tight money.  It is true that a few monetarists such as Robert Hetzel, Mike Belongia and Tim Congdon have spoken out against the view that low interest rates imply money is easy, but they aren’t as influential as Friedman.  Austrians are split, with the loudest voices on the internet often drowning out the more thoughtful Austrians who recognize the dangers of a “secondary deflation.”  Inflation hawks at the Fed seem to think this is a good time to get inflation down closer to 0%, where it should have been all along in their view.  When a conservative like John Makin does speak out, it is treated as a sort of freak occurrence.

If only Milton Friedman had lived a few more years, and made the sort of bold clear statement he made in 1998 about the situation in Japan:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

.   .   .

After the U.S. experience during the Great Depression, and after inflation and rising interest rates in the 1970s and disinflation and falling interest rates in the 1980s, I thought the fallacy of identifying tight money with high interest rates and easy money with low interest rates was dead. Apparently, old fallacies never die.


I can’t say every conservative would have accepted his view.  But they couldn’t ignore it the way they ignore me and Earl Thompson and David Beckworth and David Glasner and Robert Hetzel and Bill Woolsey and Tim Congdon.  Milton Friedman was an intellectual giant, and his voice is dearly missed.

So now you see why the first quotation from Scott is so funny.

BTW, these two quotations come from the same blog post. There is a space of four paragraphs between them.

11 Responses to “Inflationist, Heal Thyself”

  1. Bob Roddis says:

    Are Sumner’s theories purely a posteriori, based allegedly upon pure historical evidence? Does he have any familiarity with Austrian a priori style arguments, subjective value, subjective prices, the knowledge problem etc…?

    It all looks to me to be big ol’ globs of aggregates. Thankfully I learned my Austrian School stuff back in the early seventies when all “progressives” were Democratic Marxists and my mind was never polluted with Keynesian “ideas”.

    I made a playlist of Bob Murphy’s 23 Greatest Hits on my iPod for the long drive to Nashville, such as these:


    I wasn’t careful and found I had dragged David Lee Murphy into the mix:


    • bobmurphy says:

      Heh be careful: If I play too much of a group before their concert, I get sick of them.

      • Bob Roddis says:

        I’m so old that I usually forget by the next day what I listened to the day before.

      • Bob Roddis says:

        I’m sure that once I get into that southern state of Ohio, I’ll be switching to stuff like this:

        If you ever get south of Cincinnati down where the dogwood trees grow
        If you ever get south of the Mason Dixon to the home you left so long ago
        If you ever get south of the Ohio River down where Dixieland begins
        If you ever get south of Cincinnati I’ll be yours again

        and this:

        I found myself in a roadside barroom
        I was drinking my time away
        Kentucky woman and Tennessee whiskey
        It’s gonna be hell to pay

  2. Greg Ransom says:

    Bob, do the math for us.

    I don’t have the time to figure out what you are talking about here.

    “So now you see why the first quotation from Scott is so funny.”

    No, I don’t.

    • Bob Roddis says:

      How about this:

      1. That 1927 rate of 3.5% was more like 5.5% under our modern 2% inflation regime. So rates were high and money wasn’t easy.


      2. Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

  3. Jonathan Finegold Catalán says:

    I have a question. I am writing an article comparing Krugman’s theory of depressions and the general Austrian theory of depressions. I want to avoid commenting too much on the differences between 100-percent reservists and free bankers, as I don’t think it’s too pertinent to the topic, but I am currently writing on “secondary deflation”.

    I know that free bankers suggest that an increase in demand for inside money, or bank notes, should be met by an equal increase in supply of inside money. Hülsmann argues that an increase in demand for base money (in his example, gold) would be met by an increase in the supply of gold, as it would be more affordable for miners to produce gold, and so this in a way is a method by which the market maintains “monetary equilibrium” in base money.

    In any case, even conceding (this is not the right work, since I am becoming more sympathetic towards free bankers than I am to 100-percent reservists) that a demand in money should be met by an increase in supply, what would free bankers do about to a decrease in the supply of money due to a contraction of credit (a contraction of outstanding loans). An inflationary policy concerning this would result in malinvestment, and so I feel that even the “more thoughtful Austrians” (as Sumner calls them) would agree that if this was to occur it would be a natural process and it would be far worse to intervene through inflationary monetary policy (and, in fact, in a free market banks would not inflate, because this contraction is due in large part to voluntary tight monetary policy by banks fearing bankruptcy).

    Is this true, or am I missing something?

  4. Gringo says:

    I believe Scott contradicts himself.


    1) Evaluate monetary tightness or looseness using interest rates.

    2) Extensively quotes Milton Friedman to lay thick on those who evaluate monetary tightness or looseness using interest rates.


  5. Bob Roddis says:

    In the Sumner post, he writes:

    “Austrians are split, with the loudest voices on the internet often drowning out the more thoughtful Austrians who recognize the dangers of a ‘secondary deflation'”.

    I’m just going to have to face facts. I’m never going to be considered a “thoughtful Austrian”.

    Is Sumner talking about price deflation or money supply deflation or both?

    Also, Sumner states in one of his comment responses:

    12. July 2010 at 18:40

    John, No, I am simply pointing out that extremely tight money is usually associated with ultra-low interest rates. Therefore we definitely should not blindly assume low rates mean easy money.”

  6. Scott Sumner says:

    I sure served up a softball. Of course what I meant was that even for those poor benighted souls who still think low rates equal easy money, real interest rates weren’t especially low in 1927.

  7. Ash says:

    I’m not sure, but is this not very similar to Robert Wenzel’s claim that because the return on Treasurys is 10 times lower than the Fed funds rate, we’re actually in a tight money period right now?