“There is no limit to the extent to which the Bank of Japan can
increase the money supply if it wishes to do so. Higher monetary
growth will have the same effect as always. After a year or so, the
economy will expand more rapidly; output will grow, and after
another delay, inflation will increase moderately….”
Milton Friedman 1998
It took the Bank of Japan 15 years to take Friedman’s advice and now their great experiment is on. Our Federal Reserve Board responded almost immediately to the current crisis and quantitative easing has been the order of the day since interest rates hit an effective lower bound. Currently the Fed is purchasing assets at the rate of about ½ of one percent of GDP per month and they have pledged to continue until a strong recovery is in evidence. The Bank of Japan’s purchase rate is double the Feds, but they have had 15+ years of deflationary pressure and economic stagnation to overcome.
The current economic reality is not incipient inflation, but potential re-recession in the U.S. and stagnation in Europe. The low interest rates for U.S. securities and declining gold prices are evidence that the market expectations are not for economic expansion and inflationary pressures but quite the opposite. Even the gold bugs are getting a whiff of reality.
There are many who deny the wisdom of the Federal Reserve’s response to the financial crisis, even though the response has been well within the framework proposed by Milton Friedman, an economist they revere in another context. What accounts for this philosophical schizophrenia?
The truly antediluvian conservatives have never accepted macroeconomics as a legitimate discipline. Therefore they have ignored Friedman’s monetary research and theoretical arguments for monetary policy. These conservatives believe in what is known as “The Treasury View.” This was the view of British Treasury (the Exchequer) post WW1.
Simply put, this view regarded monetary and fiscal stimulus as unable to increase real output and employment, but only crowd out private spending. This view only makes sense if the economy’s resources are fully employed. The policies generated by this view resulted in persistent deflation and high levels of unemployment. Great Britain suffered through the 1920’s in a continual recession. We now call that “austerity”.
Since the resurrection of the Treasury View during the current crisis cannot be based on theory or evidence, it must be the result of ideological fantasy. Unfortunately the real world is not Fantasy Island and real people are unemployed and real output is being lost, not just delayed
.
There are two salient observations from the Great Depression. First, there is a direct correlation between countries leaving the gold standard and the beginning of their recovery. Second, there is a direct correlation between the aggressiveness of their monetary and fiscal policies (as measured by share of GDP) and their rate of recovery. Sweden had fully recovered by 1934. The US and France were the slowest to recover and had the most conservative economic policies.
The same general observations hold true today. Western Europe’s relatively conservative approach to economic recovery has stalled their growth prospects. The US economic recovery, buttressed by a Federal Reserve’s comparative aggressiveness and modest fiscal stimulus, has the US on a slow growth path, but it is a growth path.
The current legislative impasse in the other Washington will remain an effective impediment to economic growth. They are not at fault; after all we elected them.
