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.