Friday, June 24, 2011

Milton Friedman on ABCT

Milton Friedman, the developer of the macroeconomic theory of monetarism, and himself a supporter of free market economics, was interviewed in Barron’s in 1998 (August 24), and gave his opinion of ABCT. Friedman’s comments are available on Mises.org:
“... I think the Austrian business-cycle theory has done the world a great deal of harm. If you go back to the 1930s, which is a key point, here you had the Austrians sitting in London, Hayek and Lionel Robbins, and saying you just have to let the bottom drop out of the world. You’ve just got to let it cure itself. You can’t do anything about it. You will only make it worse. You have Rothbard saying it was a great mistake not to let the whole banking system collapse. I think by encouraging that kind of do-nothing policy both in Britain and the United States, they did harm.”

Jeff Scott, “Business Cycles,” September 6, 1998.
While I don’t think much of Friedman’s monetarism, here he is quite correct.

In 1929, America faced a collapsing asset bubble. While the limited interventions of Hoover did very little to counteract the slump that followed, Hoover at least did not engage in large cuts to government spending (or at least did not try to balance the budget until fiscal year 1933). An “Austrian” policy of dismantling government and complete privatisation (anarcho-capitalism) or savage government spending cuts and abolition of the central bank (in some types of Misesian Classical liberalism) would have collapsed the US economy to an even greater extent than its contraction from 1929–1933.

To see how much harm deflationary austerity did, one only has to turn to what happened in Weimar Germany:
“Economic breakdown [sc. in Germany during the Great Depression] led to political upheaval which in turn destroyed the international status quo. Germany was the most striking example of this complex interaction. Without the depression Hitler would not have gained power. Mass unemployment reinforced all the resentments against Versailles and the Weimar democracy that had been smouldering since 1919. Overnight the National Socialists were transformed into a major party; their representation in the Reichstag rose from 12 deputies in 1928 to 107 in 1930. The deflationary policies of the Weimar leaders sealed the fate of the Republic” (Adamthwaite 1977: 34).
It is interesting that Friedrich von Hayek, to his credit, actually changed his mind on the effects of US deflation in 1929–1933, at least later in life:
“There is no doubt, and in this I agree with Milton Friedman, that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation! So, once again, a badly programmed monetary policy prolonged the depression” (Pizano 2009: 13).
In Hayek’s view, a secondary deflation had negative effects on the US economy after 1929 and his mea culpa is worth quoting:
“Although I do not regard deflation as the original cause of a decline in business activity, such a reaction has unquestionably the tendency to induce a process of deflation – to cause what more than 40 years ago I called a ‘secondary deflation’ – the effect of which may be worse, and in the 1930s certainly was worse, than what the original cause of the reaction made necessary, and which has no steering function to perform. I must confess that forty years ago I argued differently. I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way” (Hayek 1978: 206).
BIBLIOGRAPHY

Adamthwaite, A. P. 1977. The Making of the Second World War, Allen & Unwin, London and Boston.

Hayek, F. A. 1978. New Studies in Philosophy, Politics, Economics and the History of Ideas, Routledge & Kegan Paul, London.

Pizano, D. 2009. Conversations with Great Economists, Jorge Pinto Books Inc., New York.

6 comments:

  1. Bob Roddis said...

    Since Churchill is a bĂȘte noire of the Austrians and his imposition upon Britain of a “gold standard” after World War I at an exchange rate that was far too high was a statist act, you can’t very well blame Rothbardians or "the free market" for that, can you?

    http://www.lewrockwell.com/raico/churchill-full.html

    Lord Keynes said...

    I am not "blaming" Rothbardians for the imposition on Britain of a “gold exchange standard” at too high a rate.


    http://tinyurl.com/67cfm7s

    Hayek: I have since altered my opinion – not about the theoretical explanation of the events, but about the practical possibility of removing the obstacles to the functioning of the system in a particular way.

    Lesson for the day: Messes caused by statist economic policies will generally cause misery in the short run no matter what action is taken.

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  2. "Messes caused by statist economic policies will generally cause misery in the short run no matter what action is taken."

    I disagree. Proper action by states can fix economic crises and avert disaster.

    Hayek at least had the honesty to admit that his "do nothing" stupidity in the 1930s was wrong.

    He could also have admitted that the large numbers of economists in the 1930s who ignored his "do nothing" ideas, and treated his policy "advice" with the utter contempt it deserved, were right too.

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  3. I read Hayek as saying that "do nothing" is still theoretically the right thing to do but cannot be practically instituted upon an economically illiterate mob. Further, if you don’t satiate the howling mob with stolen goodies in the short run, the Nazis might take over Germany and Austria (hmmm, and they did).

    The fact that "do nothing" (to the extent such a thing has ever existed) worked fairly well in the 1920 depression and the "let’s do everything crazy we've never done before" in the 1929 downturn caused a 15 year depression suggests that there is no empirical evidence whatsoever to support Keynesian policies of money dilution and government debt. Of course, there is no theoretical basis for Keynesian policies at all and you cannot analyze facts without a theory.

    Finally, Friedman’s critique is in the typical anti-Austrian format of focusing solely upon policies prescriptions proposed to cure statist-induced problems and taken completely out of context without any understanding of the problems of ignorant acting man, economic calculation and the pricing process.

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  4. "The fact that "do nothing" (to the extent such a thing has ever existed) worked fairly well in the 1920 depression "

    That is totally false:

    http://socialdemocracy21stcentury.blogspot.com/2010/10/us-recession-of-19201921-some.html

    (1) 1920-1921 as NOT a depression: it was mild to moderate recession, with positive supply shocks;

    (2) there was no large collapsing asset bubble in 1920/1921, of the type that burst in 1929, which was funded by excessive private-sector debt;

    (3) Because of (2) the economy was not gripped by the death agony of debt deflation;

    (4) There was no financial crisis, as in 1929-1933;

    (5) The Fed lowered rate and had a role in ending this recession.

    It is the height of stupidity to claim that a recession that was ended partly by Federal reserve intervention through interest rate lowering was just the result of the "free market". It wasn't.

    And there is yet another absurd contradiction here. You claim that the recession of 1920-1921 ended, and a recovery occurred: but the Fed lowered interest rates. Didn't this just cause an Austrian trade cycle and unsustainble boom, distorting capital structure??

    In other words, by your own economic theory, it was no "recovery" at all: just another Austrian business cycle!!

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  5. "let’s do everything crazy we've never done before" in the 1929 downturn caused a 15 year depression

    Rubbish. The US economic contraction we call the Great Depression lasted from 1929-1933: it wasn't a 15 year depression.

    From 1933 a recovery began and in America many - though not all - of Roosevelt's policies caused signifivant growth and lowering of unemployment until he went for austerity in 1936: then a another severe recession resulted.

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  6. 1. Please explain what is fundamentally different between mis-priced wages and consumer prices and mis-priced assets purchased with debt?

    2. Why must the government intervene to support those wrong prices regardless of the scenario and why doesn't that unnecessarily continue the misery?

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