Capitolism

Independent in All Things, Neutral in Nothing

Monetarists: Alive and Kicking

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By Guest Blogger Ryan Berg

In a recent article, Caroline Baum laments the death of “monetarists,” the economic movement inspired by Nobel-prize-winning economist, Milton Friedman.  However, the recent economic downturn proves that Friedman’s ideas remain relevant.

Monetarism advocates that the macroeconomic policy ought to focus intently on money supply and its variation in an effort to maximize economic growth.  Monetarists believe, contrary to Keynesians, variations in money supply can influence national output and price levels.  Some of Friedman’s monetarist ideas seem particularly enduring.  First, Friedman believed that monetary policy should follow a simple and prescribed policy rule.  Second, and related, Friedman believed that discretionary fiscal policy was not useful in combating and staving off recessions, and could make them worse.  Both ideas have been confirmed by the economic facts of the recent downturn.

Friedman’s principles are applicable in several ways.  His first idea is compelling because of the common consensus that the economic crisis was caused, in part, by the Federal Reserve’s failure to tether itself to stringent guidelines for setting monetary policy.  Stringent monetary policy worked well for 20 years before the crisis.  However, the Federal Reserve deviated from such a policy by keeping interest rates too low, and for too long, from 2002 to 2005.  Caroline Baum expresses an interest in having the Federal Reserve print more money to buy more securities and mortgages.  But Friedman opposed large discretionary changes in aggregate money supply.  Although not perfect, Friedman advocated a constant growth rate rule for aggregate money supply.

Friedman would have surely disapproved of the rapid increase in aggregate money supply in the past four years.  Aggregate money supply will likely decrease this year—due to inflation concerns—and Friedman always worried about monetary policy going from one extreme to the other—thereby harming the economy.  The Federal Reserve, according to Friedman, ought to be careful and incremental in its monetary expansion or contraction (during the crisis, the Federal Reserve’s balance sheet exploded with its rescue effort).  Friedman’s abiding defense of the free-market and his sentiment about the ineffectiveness of government fiscal stimulus are reinforced by the growing recognition by voters that the stimulus package did little good to bolster the economy.  Perhaps it is bad news that policy-makers did not heed Friedman’s words in the past few years.  The good news is that many of them are now heeding his words, and voters are too.

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Written by Russell S.

September 8, 2010 at 1:21 am

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