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The Monetarist Mistake

Author(s): Bradford DeLong

The inadequate response to the Great Recession reflects policymakers' acceptance of Milton Friedman's analysis of the Great Depression. And yet the dominance of Friedman's monetarism has less to do with the evidence supporting it than with the fact that economics is all too often tainted by politics.

From Project Syndicate:

Ideas matter. That is the lesson of Hall of Mirrorsthe American economist Barry Eichengreen’s chronicle of the two biggest economic crises of the past 100 years: the twentieth century’s Great Depression and the ongoing Great Recession, from which we are still struggling ineffectually to recover.

 Eichengreen is my friend, teacher, and patron, and his book is to my mind the best explanation to date of why policymakers in Europe and the United States have reacted to the most dramatic economic collapse in almost four generations with half-hearted measures and half-finished interventions.

 

 According to Eichengreen, the Great Depression and the Great Recession are related. The inadequate response to our current troubles can be traced to the triumph of the monetarist disciples of Milton Friedman over their Keynesian and Minskyite peers in describing the history of the Great Depression.

 In A Monetary History of the United States, published in 1963, Friedman and Anna Jacobson Schwartz famously argued that the Great Depression was due solely and completely to the failure of the US Federal Reserve to expand the country’s monetary base and thereby keep the economy on a path of stable growth. Had there been no decline in the money stock, their argument goes, there would have been no Great Depression.

 This interpretation makes a certain kind of sense, but it relies on a critical assumption. Friedman and Schwartz’s prescription would have worked only if interest rates and what economists call the “velocity of money” – the rate at which money changes hands – were largely independent of one another.

What is more likely, however, is that the drop in interest rates resulting from the interventions needed to expand the country’s supply of money would have put a brake on the velocity of money, undermining the proposed cure. In that case, ending the Great Depression would have also required the fiscal expansion called for by John Maynard Keynes and the supportive credit-market policies prescribed by Hyman Minsky.

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