What Would Milton Friedman Have Thought of the Great Recession?

• Date: 01 March 2015
• Published date: 01 March 2015
• DOI: http://doi.org/10.1111/ajes.12097
• Author: Scott Sumner

What Would Milton Friedman Have Thought

of the Great Recession?

By SCOTT SUMNER*

ABSTRACT. Milton Friedman died in 2006, right before the onset of the

Great Recession. Unfortunately, we will never know how Friedman

would have interpreted this event. However, we can draw some

inferences from his published views on the Great Depression, as well

as his views on more recent monetary policy, especially in Japan. It

seems likely that Friedman would have blamed the Fed for

insufficiently expansionary monetary policy during 2008 and 2009, a

view that is quite different from the conventional conservative

interpretationof events.

Introduction

Milton Friedman was the most influential monetary economist of the

past half-century. Unfortunately, he died in 2006 so we don’t know

exactly what he would have had to say about the Great Recession, par-

ticularly the decisions of Federal Reserve policymakers. Friedman’s

most famous monetary study (Friedman and Schwartz 1963) was enti-

tled A Monetary History of the United States, 1867-1960.Themost

important part of this study looked at the role of the Federal Reserve in

the Great Depression of the 1930s. They argued that the Depression

was caused by excessively contractionary policies by the Federal

Reserve Board. Given the similarities between the banking crisis of the

early 1930s and the more recent 2008 banking crisis, it would be inter-

esting to have known Friedman’s view on recent events.

Friedman was the intellectual leader of a group called monetarists,

who saw changes in the money supply as being the most important

determinant of inflation and the business cycle. And yet it is surprisingly

*Professor of Economics, Bentley University. Named by Foreign Policy as a “Top

100 Global Thinker” in 2012. Website: www.themoneyillusion.com Email: ssumner@

bentley.edu

American Journal of Economics and Sociology, Vol. 74, No. 2 (March, 2015).

DOI: 10.1111/ajes.12097

V

C2015 American Journal of Economics and Sociology, Inc.

difficult to know how Friedman would have interpreted recent events.

Some of the most well known older monetarists, such as Allan Meltzer

and Anna Schwartz, offered a fairly conservative critique of Fed policy,

expressing concern about monetary stimulus. I am part of a younger

group of monetarists dubbed “market monetarists,” who have made

exactly the opposite argument. We claimed that Federal Reserve policy

was far too contractionary, and that this policy contributed to the sever-

ity of the Great Recession. The Economist (2011) called this “the first

school of economic thought created in the blogosphere,” although it is

based on ideas publishedas far back as the 1980s.

In this article I will present some evidence for both views. Not sur-

prisingly, I will end up arguing that Friedman was likely to have been

more supportive ofthe market monetarist argument,although of course

one can never be certain on this point. The next section will examine

the basic tenets of Friedman’s monetarism. Then we will consider some

problems with monetarist ideas, and how Friedman’s views shifted

slightly during his later years. The main part of the article will consider

arguments for and against the view that Friedman would have claimed

that monetary policywas too tight after 2008.

Milton Friedman’s Monetarism

In order to explain Milton Friedman’s views on monetary policy, it will

be helpful to begin by reviewing the equation of exchange as a frame-

work for thinking aboutmoney.

Money*Velocity 5Price Level*Real GDP, or more commonly,

M*V5P*Y

Often it is more useful to consider rates of change:

Money supply growth 1change in velocity 5inflation1real output

growth

The place to begin is with the simplest possible thought experiment,

attributed to David Hume ([1752] 1970). Suppose the money supply

doubles overnight: How does this affect the economy? Hume argued

that the only long-run effect would be a doubling of prices, leaving

velocity and real output unchanged. However, Hume also suggested

that in the short run increases in the money supply would tend to speed

up “trade,” which means higher real GDP in modern terminology.

The American Journal of Economics and Sociology210