The Keynesian vision of macroeconomic policy

A market economy is subject to fluctuations which need to be corrected, can be corrected, and therefore should be corrected

Franco Modiglani

Milton Friedman’s vision is far more circumspect because of the limits on the information people have and their ability to update that information. His critique has nothing to do with his views on macroeconomics:

The central problem is not designing a highly sensitive [monetary] instrument that offsets instability introduced by other factors [in the economy], but preventing monetary arrangements becoming a primary source of instability…

Keynesians have a host of metaphors in their rhetorical arsenal; one frequently voiced is that a wise government should “lean against the wind” when choosing policy. Friedman jumped on this:

We seldom know which way the economic wind is blowing until several months after the event, yet to be effective, we need to know which way the wind is going to be blowing when the measures we take now will be effective, itself a variable date that may be a half year or a year or two from now. Leaning today against next year’s wind is hardly an easy task in the present state of meteorology

Friedman’s remarks, as even his strong critics admit, strike at the heart of any activist stabilisation policy. By meeting Keynesians on their own theoretical turf and scrutinising their practice, Friedman manages to produce objections that both Keynesians and non-Keynesians must take seriously.

A key part of any response to Friedman rests on the ability of forecasters to do their jobs with tolerable accuracy. After reading the annual reports of the Fed, Milton Friedman noticed the following pattern:

In the years of prosperity, monetary policy is a potent weapon, the skilful handling of which deserves the credit for the favourable course of events; in years of adversity, other forces are the important sources of economic change, monetary policy had little leeway, and only the skilful handling of the exceedingly limited powers available prevented conditions from being even worse

Central banks pay due to the implications of the leads and lags  on monetary policy only as an ex-post facto rationalisation for disappointment.

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