Friday, September 27, 2013

When Milton Friedman Confessed to Being Mesmerized by Keynesianism

I'm reading some of Inside The Economist's Mind: Conversations with Eminent Economists edited by Paul Samuelson  and William A. Barnett. I'm specifically reading interviews of James Tobin and Robert Shiller, who were/are part of the "Yale tradition" in economics. It's the same tradition that has influenced Janet Yellen. I'm trying to get a sense for her thinking, but the book has a number of other interviews. One interview is of Milton Friedman. He was interviewed in 2000 by John Taylor and one part of that interview I found very fascinating. Friedman seems to confess that, for no good reason, during one period he was mesmerized by Keynesian economics. Of note, during the interview Friedman distinguishes between fiscal policy and monetary policy, since at the time Keynesianism did not have a monetary component to it, that was mixed in with Keynesian theory later. But here's Friedman, seemingly befuddled, about how he bought into Keynesianism:
In the summer of 1941, I participated in a research project with Carl Shoup and we wrote a book, Taxing to Prevent Inflation. It's not something I am proud of now. It was in the style of a model and it had to do with how much taxation was required to prevent inflation, which I now believe was a wrong issue.[...]

As a result of the Keynesian revolution, money has almost dropped out of the picture. I look back at that and say, how the hell could I have done that? I had good training in monetary history at Chicago and yet, once the Keynesian revolution came along, everything was on fiscal policy, and that's why I was trying to answer the question about the level of taxation needed to stem inflation. With a sufficiently expansive monetary policy, no amount of taxes could do it. It was the wrong question. The right question was,"What monetary policy do we need?" That was the result of the mindset we had.

It should be noted that the monetary theory Friedman turned to was a very simple quantity theory that misses most of the nuances of the more complex Austrian School monetary theory that explains both the business cycle and the complex manner in which money supply increases can impact different prices at different times.

Also, Friedman, although distancing himself from his brush with  Keynesian theory in 1941, never did completely cut the cord from Keynesian theory. Indeed, Murray Rothbard points out that the Chicago school, of which Friedman was a member, always held three key ideas, among them:
[A] proto-Keynesian policy of stabilizing the price-level through expansionary fiscal and monetary programs during a recession.
This Keyensian-type thinking, Friedman never shook off completely, although his 2003 North Beach confession suggests that he was beginning to see problems with his monetary theory.

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