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Friedman Economics

Is Fed chairman Ben Bernanke a follower of John Maynard Keynes or Milton Friedman?

Penn Bullock
September 1, 2009

Ben Bernanke just had a fine month. For allegedly saving the world from a second Great Depression, President Barack Obama awarded the Federal Reserve chairman a second four-year term. "As an expert on the causes of the Great Depression, I'm sure Ben never imagined that he would be part of a team responsible for preventing another," the president said. "But because of his background, his temperament, his courage and his creativity—that's exactly what he has helped to achieve."

"Mission Accomplished," the banner might have read.

Missing from Obama's speech was any mention of Bernanke's economic ideology. The New York Times and Bloomberg News have called him a strict Keynesian—a liberal fan of fiscal stimulus—and that label has stuck.

In reality, Bernanke is following the monetarist depression-prevention model hatched by Nobel laureate and libertarian patron saint Milton Friedman. Bernanke has repeatedly invoked the late libertarian economist in support of lowering interest rates to zero, bailing out banks, and pumping untold trillions of dollars into the financial system. The implicit goal of these policies is to ignite artificial inflation.

The story begins in 1963, when Friedman and co-author Anna Schwartz published The Monetary History of the United States. Their chapter on the Great Depression was spun off into a standalone book, The Great Contraction: 1929-1933, an epic revisionist history that changed America's understanding of the causes of the Depression. Friedman and Schwartz contended that the Federal Reserve—not capitalism or Wall Street—was to blame for the dismal '30s. "The fact of the matter is that it was the decision to tighten credit policy in 1928 that produced the Great Contraction," the 93-year-old Schwartz said by phone from her office at the National Bureau of Economic Research in New York City. Interest rate hikes had been undertaken in 1928 to curb what the Fed saw as rampant speculation on Wall Street—a conflagration of leveraging, margin buying, and outright Ponzi scheming fueled by cheap credit that was supplied in the first instance by the Federal Reserve. (Goldman Sachs' pyramid schemes of the era, when they collapsed, would generate losses of $475 billion in today's dollars.)

Friedman and Schwartz, however, denied that speculation had ever posed a problem, or that there had even been a credit bubble in the 1920s. In their narrative, a paranoiac Federal Reserve had needlessly constricted the money supply and thereby crashed an otherwise prosperous economy.

After the Great Crash of 1929, the Federal Reserve drastically cut interest rates; but, on occasion, the Fed was forced to abruptly raise them again in complicated maneuvers to stem outflows of gold into Europe. Friedman and Schwartz blamed these sporadic interest rate hikes for smothering several incipient recoveries, opening a vortex of deflation, and turning a recession into the Great Depression.

Friedman and Schwartz's overarching thesis was that the Depression would have never happened if the Federal Reserve had inflated the American economy. As Schwartz told me, "What the Fed had to do was increase the money supply. By taking that action, it would've revived the economy. That's the lesson of the Great Depression." In The Great Contraction, she and Friedman argued that the Fed had an infinite capacity to inflate. "The monetary authorities," they wrote, "could have prevented the decline in the stock of money—indeed, could have produced almost any desired increase in the money stock."

Which brings us back to the question of Ben Bernanke's economic ideology. When it comes to the Great Depression, Bernanke is a disciple of Friedman and Schwartz. In 2002, at Friedman's 90th birthday party at the University of Chicago, Bernanke was effusive. "Among economic scholars," he began, "Friedman has no peers." He developed the "leading and most persuasive" explanation of the Depression, whose impact on economics and the popular mind "cannot be overstated."

At the conclusion of his encomium, Bernanke made a stunning and ominous apology on behalf of the Federal Reserve. "I would like to say to Milton and Anna...regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again."

Schwartz was also present at the birthday party. "I'm sure he was sincere when he said that," she recalled. And Bernanke stayed true to his word. In 2006, he replaced Alan Greenspan as chairman of the Federal Reserve. Greenspan had engineered an era of non-inflationary loose credit that won Friedman's endorsement: "There is no other period of comparable length in which the Federal Reserve System has performed so well," Friedman declared in The Wall Street Journal.

When the economy collapsed two years into Bernanke's watch because of a massive credit bubble, Bernanke slashed interest rates to zero and ordered the money-printing presses to full steam. He also embarked on a course of "quantitative easing," whereby a central bank convolutedly buys its own government's bonds with printed money so as to sink interest rates even further.

This approach was nothing new. Friedman had recommended quantitative easing, combined with ultra-loose credit and inflation, as a panacea for Japan's slump in the 1990s, which he described as an "eerie, if less dramatic, replay of the Great Contraction." As he did with the Depression-era Fed, Friedman emphasized that, "There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so." In 1998, a year after Friedman penned his advice in The Wall Street Journal, Japan introduced monetary stimulus: a cocktail of zero interest rates and quantitative easing. But deflation continued. Today, Japan's exports are down an unthinkable 36 percent from last year and prices are plummeting at an all-time record pace.

Stateside, in light of the Fed's multi-trillion dollar balance sheet, it has been all too easy to mistake Bernanke for a Keynesian supporter of public works projects, socialistic safety nets, and government-led consumption. And while it's true that the Obama administration is pursuing Keynesian fiscal stimulus, the Federal Reserve, as an independent, semi-private institution owned by America's banks and largely walled off from the executive and legislative branches, has developed its own agenda. That agenda is monetarist. Yet the media consistently gets this crucial fact wrong.

The New York Times, for instance, has identified Bernanke as "a student if not necessarily a devotee of the British economist John Maynard Keynes." But Bernanke actually spent most of his academic career elaborating on Friedman's interpretation of the Great Depression. Though his research sometimes strayed into non-monetary subjects, it was always "an embellishment of the Friedman-Schwartz story... and no way contradict[ed] the basic logic of their analysis," as Bernanke assured Friedman at his birthday party.

Bernanke's infamous moniker, "Helicopter Ben," came about when he quoted Friedman on the importance of conjoining fiscal and monetary policies. In a 2002 speech, "Deflation: Making Sure ‘It' Doesn't Happen Here," Bernanke described the ideal fiscal stimulus as a shower of tax cuts "equivalent to Milton Friedman's famous 'helicopter drop' of money." Friedman had originally used that phrase to counter Keynes' idea of the "liquidity trap," where zero-interest rates lead to bank hoarding and leave the Federal Reserve no maneuvering room. Friedman suggested that countries could escape the liquidity trap by handing out money to consumers, and he laid out his argument in a tale about a helicopter unloading cash on a town. To that effect, Bernanke's Federal Reserve has created special "vehicles" to disburse consumer credit.

In February of this year, Bloomberg News added to the confusion by reporting, "Federal Reserve Chairman Ben S. Bernanke is siding with John Maynard Keynes against Milton Friedman by flooding the financial system with money." Of course, Bernanke has said precisely the opposite. He's flooding the financial system with money as Friedman would have him do.

On February 10, Bernanke further revealed his allegiance to Friedman in an overlooked Capitol Hill Q&A session with Rep. Ron Paul (R-Texas). Their exchange is worth dusting off and quoting at length.

"Chairman," Paul began, "you have written a lot about the Depression. There was a famous quote you made once to Milton Friedman, apologizing for the Federal Reserve bringing on the Depression. But you assured him it wouldn't happen again....But the key to this discussion has to be: was it too much credit in the ‘20s that created the conditions that demanded a recession/depression; or was it lack of credit in the Depression that caused the prolongation?...Here we're working frantically to keep prices up. What's wrong with allowing the market to dictate this...and prices to go down quickly so we can all go back to work again?"

In response, Bernanke repeated the lesson of The Great Contraction and asserted that he was acting on it: "Milton Friedman's view was that the cause of the Great Depression was the failure of the Federal Reserve to avoid excessively tight monetary policy in the early ‘30s. That was Friedman and Schwartz's famous book. With that lesson in mind," Bernanke continued, "the Federal Reserve has reacted very aggressively to cut interest rates in this current crisis. Moreover, we've tried to avoid the collapse of the banking system."

For her part, Schwartz is now conflicted about Bernanke's application of her and Friedman's theories. "You don't have to lower the interest rates to the extent that he has in order to increase the money supply," she informed me. "The essential action should be increasing the money supply. That's the lesson of the Great Depression."

She upholds the analogy between today's crisis and what she and Friedman prescribed in The Great Contraction. "There's nothing contradictory in The Great Contraction with reference to what the Fed should be doing currently.... And I don't believe there's any contradiction between what The Great Contraction was reporting and the current condition of the banking system in this country."

Schwartz sounded alarmed, though, at the zealousness with which Bernanke has put "monetary expansion" into practice. She berated the Fed for going too far and predicted that it will have to raise interest rates "in the near future" to arrest inflation. Asked if she sees hyperinflation on the horizon, she exclaimed, "Oh, yes!"

But Schwartz also seems to have undergone a late-life conversion to Keynesian theory. Asked to offer a solution to the crisis, she repeated the ultimate Keynesian maxim: the government should pick up slackening demand in the private sector.

"People are saving, not spending. In order to revive this economy..." she paused, hesitating on the thought, "the government will have to resume spending. By spending, the government will require that the current inventory will be depleted and have to be replenished. And that will bring on additional production and jobs."

Paul, a libertarian like Schwartz and Friedman, worries that the Federal Reserve is bringing the pair's monetarist model into reality. In a phone interview, he noted, "In essence, Bernanke is following Friedman's advice. He's a Friedmanite when it comes to massively inflating. Bernanke was able to justify [his policies] by using Friedman."

Asked if Friedman's enthusiasm for inflation flouts libertarianism, Paul answered: "Absolutely. The monetarists said that you could overcome a natural market correction of a collapsing system by inflation—print money faster! Which contradicts Friedman's whole thesis. He wanted a steady, managed increase in the supply of money of about 3 percent." Here Paul is alluding to Money Mischief, Friedman's 1991 book in which he called on the Federal Reserve to grow the money supply at 3 percent annually, presumably forever. "Yet, at the same time, Friedman said the Depression could've been prevented by massively inflating."

Paul has kind words for Friedman, whom he praises as a staunch defender of economic liberty, but his final summation is damning: "Friedman's very, very libertarian—except on monetary issues."

With Bernanke at the helm, the Federal Reserve has unleashed monetary expansion, the polite term for inflation—and Friedman's catchall remedy for economic depression. And if Bernanke, Obama, and scores of economists are correct, it may be working. But with 300,000 more people having foreclosed on their homes in July, widespread hunger in Detroit, dust bowl conditions in the California valleys, a stock market crash in China, and unemployment projected to crack double digits later this year, the much-vaunted recovery is no certainty. And if it isn't working, we might still be in for a depression, or worse.

On top of that, the total price of the Fed's monetarist program is a mystery beyond human reckoning. Paul, whose bill to audit the Fed has stalled despite co-sponsorship from more than half of the House, declared, "We don't know for sure how much the Fed has spent—I've heard it could be six trillion dollars. But we have no knowledge of what the Fed's doing. All these dealings are very secret." Earlier this year a Bloomberg estimate pegged the number at around $13 trillion—an amount roughly 1,300 times the age of the universe. (We may soon find out the exact number. On August 25, a Manhattan court ordered the Federal Reserve to open its books.)

Friedman and Schwartz, in other words, have helped to spawn the grandest expansion in the Federal Reserve's history, a program of limitless market interventions and tireless money printing whose unstated aim is all-out inflation. For two libertarian champions of free markets and limited government, this legacy has the ring of a world-historic irony.

Penn Bullock is a freelance writer for Village Voice Media. He lives in Florida. This column first appeared at Reason.com.

Correction: This article originally misidentified the concepts of qualitative and quantitative easing.



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