Most political disagreements are about the predicted effects of competing policies, not basic values – Milton Friedman
07 Aug 2014 Leave a comment
Keynesian analysis implicitly assumes that a fiscal deficit does not have any effects on other spending
01 Aug 2014 1 Comment
in budget deficits, fiscal policy, macroeconomics, Milton Friedman, monetarism Tags: budget deficits, fiscal policy, fiscal stimulus, Milton Friedman
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The shape of recoveries from recessions
28 Jul 2014 Leave a comment
in business cycles, macroeconomics, Milton Friedman, monetarism Tags: boom and bust, Milton Friedman, plucking model, recoveries from recessions
Milton Friedman (1993) proposed a model of the depth of recessions and steepness of recoveries built on two empirical regularities:
- output is on average below a ceiling defined by supply capacity and tends back to this ceiling; and
- large contractions are followed by large expansions and mild contractions are followed by mild expansions.
The strength of a recovery should be positively correlated with depth of the recession but there should be no correlation between expansions and recessions (Friedman 1993; Alchian 1969).
The figure below illustrates Friedman’s model, which likens the time path of output to a string on the underside of an upward sloping board that is plucked downward at random intervals to various extents into busts that are followed by booms.
Source: Garrison (1996).
The upward sloping board plotted as a thick line in the figure represents a ceiling on feasible output and employment in a given year that is set by resource and technology availabilities. The upward slope of this board accounts for trend real GDP growth over time due to technological progress and other factors.
The business cycle starts with a bust caused by an adverse policy or other shock and is then followed by a boom as the market self-adjusts and the policy errors are reversed. Without the initial adverse policy or other shock, there would neither be a bust nor a boom.
The correlation between busts and booms arises from the monetary contraction that caused the bust eventually inducing an offsetting correction in monetary policy.
The monetary contraction that pushed or plucked output below the upward sloping ceiling is later followed by a monetary expansion that offset the earlier contraction. With the amplitude of monetary expansions correlated to offset the prior contractions, GDP growth will have similar plucks or falls and rebounds to the upward sloping output ceiling because of the link albeit with a lag between monetary growth and output fluctuations. The increases and decreases in monetary growth are independent policy choices with unique causes.
The associated upward and downward movements in GDP growth are not correlated with each other but should be correlated with the prior fluctuations in monetary growth. There would not be a bust and later boom if there is no monetary contraction to start the cycle. This is why Friedman (1993) proposed that the depths of busts are unrelated to the duration and strength of prior economic booms.
The business community as an enemy of capitalism
26 Jul 2014 Leave a comment
in applied price theory, Milton Friedman, rentseeking Tags: competition and monopoly, corporate capitalism, Milton Friedman, rent seeking
The leads and lags on monetary policy are long and variable
25 Jul 2014 Leave a comment
in business cycles, inflation targeting, macroeconomics, Milton Friedman, monetarism, monetary economics Tags: leads and lags on monetary policy, Milton Friedman, monetary policy
Many Keynesians, Friedman notes, advocate “leaning against the wind.” By this they mean, in some sense, that the monetary (and fiscal) authorities should try to balance out the private sector’s excesses rather than passively hope that it adjusts on its own.
There are large uncertainties about the size and timing of responses to changes in monetary policy. There is a close and regular relationship between the quantity of money and nominal income and prices over the years. However, the same relation is much looser from month to month, quarter to quarter and even year to year.
Monetary policy changes take time to affect the economy and this time delay is itself highly variable. The lags on monetary policy are three in all:
- The lag between the need for action and the recognition of this need (the recognition lag)
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The lag between recognition and the taking of action (the legislation lag)
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the lag between action and its effects (the implementation lag)
These delays mean that is it difficult to ascertain whether the effects of monetary policy changes in the recent past have finished taking effect. Secondly, it is difficult to ascertain when proposed changes in monetary policy will take effect. Thirdly, feedbacks must be assessed. The magnitude of the monetary adjustment necessary to deal with the problem at hand is thus never obvious. It is common for a central bank to act incrementally. The central bank makes small adjustments to monetary conditions over time as more information is available on the state of the economy and forecasts are updated.
The existence of lags may mean that by the time policy has its full effect, the problem with which it was meant to deal may have disappeared.
Milton Friedman (1959) tested the Fed’s success at leaning “against the wind” by checking whether the rate of money growth has truly been lower during expansions and higher during contractions. He admits that this method of grading he Fed’s performance is open to criticism, but he decided to go ahead and see what turns up. Friedman found that Fed has – for the periods surveyed – been unsuccessful.
By this criterion, for eight peacetime reference cycles from March 1919 to April 1958. Actual policy was in the ‘right’ direction in 155 months, in the ‘wrong’ direction in 226 months; so actual policy was ‘better’ than the [constant 4% rate of money growth] rule in 41% of the months.
Nor is the objection that the inter-war period biased his study is good since Friedman found that:
For the period after World War II alone, the results were only slightly more favourable to actual policy according to this criterion: policy was in the ‘right’ direction in 71 months, in the ‘wrong’ direct in 79 months, so actual policy was better than the rule in 47% of the months.
One of the best ways to parry a metaphor is with another metaphor. 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 counters:
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, are mighty and 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.
Keynesian policies do not necessarily follow even if the Keynesian theory of the business cycle were conclusively proved. It must also be demonstrated that the government has the ability and willingness of the government to act as the theory prescribes. Friedman’s critique does not depend on the quantity theory of money.
New Keynesian macroeconomics as the triumph of monetarism
25 Jul 2014 Leave a comment
in macroeconomics, Milton Friedman, monetarism, monetary economics Tags: Brad Delong, Milton Friedman, monetarism, New Keynesian macroeconomics
In The triumph of monetarism, Brad De Long wrote in the Journal of Economic Perspectives—Volume 14, Number 1—Winter 2000—Pages 83–94 that today’s new Keynesian" macroeconomists would include in any list of their key ideas and premises the five following propositions that:
- The key to understanding real fluctuations in employment and output is to understand the process by which business cycle-frequency shocks to nominal income and spending are divided into changes in real spending and changes in the price level.
- Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.
- Business cycle fluctuations in production are best analysed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some sustainable potential output level).
- The right way to analyse macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyse each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.
- Any sound approach to stabilization policy must recognize the limits of stabilization policy—the long lags and low multipliers associated with fiscal policy; the long and variable lags and uncertain magnitude of the effects of monetary policy.
De Long then went on to argue that the above research programme is the macroeconomic research programme of Milton Friedman in the mid-20th century.
The failures of progressive politics
12 Jul 2014 Leave a comment
in Milton Friedman, politics Tags: Alex Millmow, failure of progressive politics, Friedman in Australia, Joan Robinson, Milton Friedman
Limiting ourselves to democratically elected governments, and there are many of these even in the under-developed countries, progressive ideas seem to fail, and fail again at the ballot box right around the globe as you concede the strong right-wing bias of many governments across the globe.
There was one left-wing federal government in Australia in the last 60 years. That was for three years between 1972 and 1975, and it lost in a landslide. the Whitlam government got in buy a few seats in 1972by beating tired and smelly government that had held office for 23 years
This inability of progressive politics get anywhere is important because every set of ideas needs effective critics to keep it on its toes and stop it from slouching into error and special interest capture.
The Right needs a vibrant Left to keep the Right fit, trim and down to its fighting weight so as to be able to thrash the Left once again at the next election. That is the function of left-wing governments: mind the shop while the right-wing parties are fed and rested and rejuvenated.
Prior to the 1990s, all it took to see progressive ideas off the political and economic stage in a country was a visit or two by Milton Friedman, if some are to be believed. I do not believe that political transformations are as easy as this.
However, some still want to maintain the rage over, for example, Friedman’s April 1975 trip to Australia for 18 days leading to a paradigm shift to neo-liberalism and Hayden’s supposedly monetarist budget shortly after if Alex Millmow is to be believed. Apparently, the spirited, witty Joan Robinson’s visit the same month and her own Monday conference program did not do the trick as an anti-biotic and vaccine.
Progressives will have no role in future political transformations because if you scratch a progressive you will find a left wing populist.
A left-wing populist is too busy telling you who to fear and who to blame to put up policies that are actually robust enough to work and to have worked in the past in a society where people are not perfect in their motivations, they do not have perfect knowledge in a changing world, and there is no offsetting behaviour and unintended consequences when these policies are put in practice.
Utopia, you are standing in it! 
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