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Krugman on Friedman: An Austrian Approach


Paul Krugman, in a most recent post, argues “Backward moves the macroeconomic debate” with “the result that our economic discourse is significantly more primitive now that it was 70 years ago.” Per Krugman, this backward movement is apparent in the use by some opponents of active demand management policy, such as Amity Shlaes, and of the “supposed legacy of Milton Friedman.”

He further argues, “The truth, although nobody on the right will ever admit it, is that Friedman was basically a Keynesian — or, if you like, a Hicksian.” While those on the “right” might never admit it, those familiar with the work of Roger W. Garrison would not be surprised that in a key important way, Friedman’s similarity with Keynes, or more correctly Keynesians such as Krugman, are more important than his apparent empirically based disagreements, the level of aggregation chosen for macroeconomic modeling. As early as 1992, Garrison in “Is Milton Friedman a Keynesian?” addresses the question gives and answer to Friedman’s own conclusion (Friedman on J M Keynes , p. 6), “He isn’t, but he is.” Garrison explains in more detail, “This ISLM framework, more broadly called income-expenditure analysis, has in many quarters—but not in Austrian ones—come to be thought of as the analytical apparatus common to all macroeconomic theories. Appropriate assumptions about the stability of investment and money demand, interest elasticities, and price and wage rigidities allow for the derivations of either Keynesian or Monetarist conclusions.”

A major theme of Cochran and Glahe, The Hayek-Keynes Debate: Lessons for Current Business Cycle Research, was that Hayek and the Austrians with their underlying capital theory and market process analysis provided a potentially more useful macroeconomics when compared to the analysis of Friedman, monetarist/classical; old or new, and or Keynesians; old and new. Garrison’s Time and Money, best known for its restatement of the Mises-Hayek Austrian business cycle theory into a capital-structure based macroeconomics which contrasts a saving supported sustainable growth to policy induced unsustainable growth provides strong support for this argument. Garrison is often at his best when he compares and contrasts different approaches to addressing macroeconomic conditions (see chapter 12, “Taxonomy and Perspective”).

More recently Garrison adeptly applies his Friedman/Austrian contrast in the context of the current crisis in a recent Independent Review essay “Alchemy Leveraged: The Federal Reserve and Modern Finance” (see especially pp 442-450). Here he concluded, Time and again Dowd and Hutchinson point to downwardly distorted interest rates and long-term investments as key to our understanding of loose money’s perverse effects. This emphasis, of course, is the Austrian element. Friedman downplays allocation effects of the rate of interest and casts the interest rate as only a minor determinant of the demand for money. Dowd and Hutchinson see the Greenspan Fed’s loose-money policies as an essential element in the story of housing-led boom and subsequent financial crisis. On the occasion of Greenspan’s retirement from the Federal Reserve, Friedman penned a piece for the Wall Street Journal with the title “He Has Set a Standard” (2006). The fact that Greenspan’s reign had seen only mild inflation was evidently enough for Friedman to credit him for doing the right thing, despite the absence of a viable monetary rule.”

Building on Garrison, I recently commented in a similar context (“A Crisis of Authority: Pierre Lemieux’s Somebody in Charge: A Solution to Recessions?” The Independent Review, 596-97),

Without the Fed, the impact of the distortions in the housing market would still have been significant, but they would also have been much more limited. The fact that the “Greenspan Fed adopted a loose monetary stance in the wake of the dot.com bust and well into the century’s first decade was a game changer. The accommodation freed the housing sector from having to draw investment funds from other sectors. It fueled an economywide boom—the housing bubble leveraged by practitioners of Modern Finance being the most dramatic aspect of it.” And he concludes, “[T][he fact that the bubble was doubly artificial provided a strong hint about the difficulties inherent in the subsequent recovery” (2012, 449).

Lemieux is correct that the “authorities in charge messed up in more than one way” (p. 131), but he understates the role of a key player. The Fed messed up in a big way, generating back-to-back cycles driven by monetary excesses that “turbo-charged” misdirections of economic activity. The Fed’s actions and expanding power since the onset of the crisis are even more alarming. To criticize the Fed and the Treasury’s response to the financial crisis, John Taylor has coined the term mondustrial policy, which describes “not a monetary framework,” but “an intervention framework financed by money creation” (qtd. in Hilsenrath 2009). Hummel argues that the policy responses to the crisis “resulted in another Fed failure” and have “also resulted in a dramatic transformation of the Fed’s role in the economy. [Ben] Bernanke has so expanded the Fed’s discretionary actions beyond controlling the money stock that it has become a gigantic, financial central planner” (2011, 485–86).

Krugman is partially correct that the debate is more primitive today, but more primitive than 80, the apex of Hayek’s influence as a monetary theorist, not 70 years ago which was the beginning of Keynesian ascendency. The debate is primarily more primitive because while the insights of Hayek and Mises at least appear in some discusions, capital theory is still too much neglected. The debate moved backward, not by the insertion of an unfortunate and perhaps uninformed appeal to authority of Friedman, but to the return of textbook Keynesianism to the policy front.

For some interesting commentary from a non-Austrian persepctive see Uneasy Money, “Was Milton Friedman a Closet Keynesian” at http://uneasymoney.com/2012/03/16/was-milton-friedman-a-closet-keynesian/.

John P. Cochran (1949-2015) was emeritus dean of the Business School and emeritus professor of economics at Metropolitan State University of Denver and coauthor with Fred R. Glahe of The Hayek-Keynes Debate: Lessons for Current Business Cycle Research. He was also a senior fellow of the Mises Institute and served on the editorial board of the Quarterly Journal of Austrian Economics.

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