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Thursday, June 26, 2003

On Some Minor, Secondary, Non-mainstream Disputes Which May Turn Out to be Important

There's been quite a party going on this week with Brad , dsquared and even Krugman all getting in on the act. The topic, the 'naievity' of Milton Friedman. Now by hazard of circumstance yours truly also has a part in this little saga since I, as an inveterate Roach reader, stumbled upon his reference to the FT interview which has provoked all the fuss, and immediately posted. Such is the pathway to fame and fortune.

However, I wouldn't like to miss the thrash completely, so since I have nothing especial to add to the debate about his personality (frankly my dear I have no idea, although the times I did see him on TV, he did seem incredibly basic and dogmatic), I will try and hijack things off along the lines of his other major 'contribution' to economic debate, his study of the Great Depression. In fairness Brad has set the scene:

And the fight over whether the Federal Reserve caused the Great Depression? Purely a dispute over definitions. Did the Federal Reserve walk into the middle of a well-functioning market economy and wreck it? No. Should the Federal Reserve have taken the decline in the money stock as a signal that there was a real problem and that it needed to shovel liquidity into the banking system as fast as possible? Yes. Did the Federal Reserve do so? No...............

The way I put the bottom line is that the Federal Reserve did not cause the Great Depression, but that it bears responsibility for the Great Depression because it allowed the money stock to decline and so did not block the vicious cycle of deflation at the beginning. But the serious mainstream disputes** over the "cause" of the Great Depression are semantic and definitional only................

**Serious mainstream disputes: there are (a few) people who believe that the Great Depression was caused by the fact that the Federal Reserve did not deflate the American price level back to its pre-WWI level in the 1920s, or who blame the Great Depression on the Smoot-Hawley Tariff or the New Deal. The tariff certainly didn't help, but it was a minor factor. Some elements of the New Deal retarded recovery (and others accelerated recovery), but the Great Contraction was completely over when Roosevelt's 100 Days began.
Source: Semi Daily Journal

The matter in question is Friedman and Schwartz's Monetary History (1963). Chapter 7 of this book is entitled 'The Great Contraction', but in fact it is not clear to which 'contraction' we are referring at times, to the monetary or to the output contraction. The impression is that the two are inextrically intertwined, but the innocent mind might draw the conclusion that this impression is in fact never justified with anything amounting to precision. The point being, there could well be plenty of debate as to whether the monetary contraction was the cause or the effect of the real contraction.

What seems preoccupying in the F&S view is that they never seem to actively consider the possibility that banks may have been held back by factors other than their reserve position. This appears to be because they take virtually no account of the assett side of the bank's balance sheets. Indeed it seems to be the case that their conceptual framework leaves little place for a consideration of the role of the banks as financial intermediaries between two types of client: depositors and borrowers. Nor do they seem to put great store by the fact that the banks as intermediaries operate in a world of uncertainty, that banks assessment of their clients' creditworthiness varies, and that in the short trem their lending determines the size of the money stock. (And how do I know all this: because my brother used to be a banker, and he has spent years perforating my eardrums with this and other relevant information as to the realities of money stock fluctuations).

Now why is any of this of any real importance today, and why is the problem more than merely a semantic one: because right now, in Japan, there is a problem, and many economists once more failing to listen to what the bankers are telling them, imagine that there is a simple monetarist solution to the problem: dramatically expand the money stock. And why may the problem assume even more importance: because right now in Germany and the United States deflationary pressures may well be raising their ugly head, and because, once more the simple monetarist solutions are going the rounds without giving sufficient consideration to the question as to in which direction the causal chain may in fact be operating.

Another (non-trivial, and definitely non-semantic,) problem which to avoid argument I will relegate to the level of secondary non-mainstream dispute, would be to open an examination of what impact the US decision to effectively close the doors to mass immigration in 1922 might have had on the extent and duration on the depression. Or, for that matter, to look a little harder (going back to another Friedman core theme) what impact the demographic profile of the OECD population had on theintensity and duration of the 1970's inflation.

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