Photo: Wikimedia Commons
Ben Bernanke gave an excellent speech today, rebutting some of the myths about monetary policy, and the Q&A afterwords was also really good.The highlight of the Q&A was probably when he was asked what Milton Friedman would have thought about today’s Fed.
His answer was excellent. He pointed out that Friedman advocated QE for Japan during its struggle against deflation and weak growth. He also recalled one of Friedman’s most important lessons, that low interest rates are not the same as loose policy.
This point — and again this goes back to Evans this morning — can best be grasped by thinking about the ’70s inflation, when rates were high. Surely nobody thought those high rates were an indication of overly tight money. Ultra-low rates are evidence that money is still too tight, since it means monetary policy is failing to induce the desired inflation.
Bernanke said specifically, when citing the lesson of Milton Friedman: “We didn’t allow the fact that interest rates were very low to fool us into thinking that monetary policy was accommodative enough.”
Anyway, it seemed that at least among some traders, this was the most controversial part of the entire speech.
A trader emailed: “Can you link to something that shows that Friedman would be supporting this? People are howling about that in my neck of the woods.”
We can see why people might be surprised by this. Milton Friedman is a conservative hero. Conservatives are opposed to loose money these days. Thus, based on a simple logic, one might also surmise that Friedman himself would be critical of the Fed right now.
But Bernanke really does seem to be on solid ground by claiming the mantle of Friedman.
Economist David Beckworth has the 2000 Q&A that really seems to bolster a lot of what the Fed is doing:
David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?
Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.
During the 1970s, you had the bubble period. Monetary growth was very high. There was a so-called speculative bubble in the stock market. 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 quasi recession 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 high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.
There’s so much meat in there that’s apropos.
First the line about “it shows how unreliable interest rates can be as an indicator of appropriate monetary policy” means that low interest rates do not necessarily mean loose policy.
And then Friedman explicitly says that when the Fed gets to zero rates, “They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion.”
This is just one quote, but it definitely seems representative of his overall ideas, based on most economists’ interpretation of his work.
Elsewhere, David Beckworth has argued that Friedman’s theory could also apply to a NGDP targeting approach by the Fed.
And it isn’t just academics who have said this about Friedman. Conservative pundit Ramesh Ponnuru recently made the same point, noting that many other conservatives were glossing over Friedman’s potential academic contribution to this moment in monetary policy.
Meanwhile, Rick Santelli just flipped out over the Bernanke-Friedman section, so it does seem clear that this part really struck a nerve among some traders.