Monetarists Follow Milton Friedman to the Grave: Caroline Baum
Milton Friedman, Nobel Laureate in Economics, died in 2006. Monetarism, the school of thought he founded, seems to have died with him, judging from recent comments.
Academics, such as Princeton’s Alan Blinder and Harvard’s Martin Feldstein, are claiming there’s very little the Federal Reserve can do to stimulate the U.S. economy. Newspaper headlines deliver the same message: the Fed is “Low on Ammo.” The public is feted with explanations -- couched in technical terms, such as the “zero-bound” and a “liquidity trap” -- as to why the Fed’s hands are tied.
What planet are these people on?
In 2002, a new Fed governor named Ben Bernanke delivered a speech to the National Economics Club in Washington entitled, “Deflation: Making Sure ‘It’ Doesn’t Happen Here.” The former Princeton professor and Great Depression scholar told the audience that the U.S. government has a technology called a “printing press” that “allows it to produce as many U.S. dollars as it wishes at essentially no cost.”
That speech earned him -- unfairly, in my humble opinion -- the moniker “Helicopter Ben.” Bernanke, who got his Ph.D. in economics at MIT, was merely adopting a teaching tool used by Friedman and the University of Chicago economics faculty. Friedman would illustrate the money creation process to his classes by asking them what would happen if a helicopter were to fly over the city and drop $100 bills. If people were content with their current money balances, they would spend the money.
Money Multiplier
The central bank increases the money supply in much the same way. It’s not necessary for the public to want to hold more money for the Fed to create it. Money supply, in other words, isn’t dependent on money demand.
When the Fed buys securities from the non-bank public, it creates demand deposits. Unless people are going to sit with money in their checking accounts earning next to nothing indefinitely, the Fed has the same old ammunition it always had (a printing press), not “only the weak stuff,” as Blinder wrote in an Aug. 26 Wall Street Journal oped.
Where have all the monetarists gone? They are clearly an extinct species at the Fed. Bernanke has gone out of his way to explain the Fed’s purchases of $1.4 trillion of agency mortgage- backed and debt securities as credit easing, not quantitative easing.
Credit easing is by definition quantitative. It doesn’t matter what the Fed buys: Treasuries, Toyotas, toilets or Tootsie Rolls. It’s the act of buying something that creates money. If the Fed prints more money than the public wants to hold, people will spend it.
Academic Arcana
That’s Friedman’s monetarism in a nutshell. Instead we were treated to an elegant explanation of the “portfolio balance channel” in Bernanke’s opening remarks Friday at the Kansas City Fed’s annual economic symposium at Jackson Hole, Wyoming.
I had never heard that term before and was eager to learn about it. (A Google search confirmed my suspicions that interest in the PBC is limited to academics.) The way Bernanke explained it, once the nominal federal funds rate runs up against the “zero bound,” the Fed’s purchases of longer-term securities “affect financial conditions by changing the quantity and mix of financial assets held the public.”
In other words, the Fed buys Treasuries, agency debt and MBS, lowering the yields and pushing investors to buy similar assets, such as high-grade corporate bonds, depressing those yields in turn.
Long Rate Obsession
Bernanke said there was support for the idea that the Fed affects financial conditions via the “quantity and mix” of the securities it purchases, known as the “stock view,” rather than the “pace of new purchases,” known as the “flow view.” (Please direct all questions and comments on the subject to the Federal Reserve Board in Washington.)
There was no mention of the quantity of money, which in the old days used to be the measure of the degree of accommodation. Instead the Fed is now focused on the asset side of its balance sheet, not the liability side.
“Bernanke’s narrative is about the ‘easing of financial conditions,’ or lower long-term rates,” said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut, in a review of Friday’s Jackson Hole speech.
The rate on 30-year fixed-rate mortgages fell to a four- decade low last week of 4.36 percent, according to Freddie Mac. That’s done little to stimulate demand for housing, with both new and existing home sales plunging in July. Maybe another 50 basis points will do the trick?
Monetarist Wanted
In his speech, Bernanke acknowledged that financing costs aren’t the primary determinant affecting large firms’ willingness to expand and hire. Instead, expected demand for their product drives those decisions.
Perhaps it’s the same for homeowners. With housing prices artificially supported by government programs designed to help homeowners to stay in houses they couldn’t afford in the first place, potential homeowners may be waiting for prices to fall to levels that more accurately reflect supply and demand.
Bernanke promised the Fed “will do all that it can” to ensure a continuation of the recovery, and I’m sure he means it. He might start by scouring the country for the handful of monetarists remaining. Surely there are a few Friedman students willing to offer their services.
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