This is a question about the Chicago School of Economics. What was Milton Friedman's criticism of the Austrain business cycle theory, and why was it wrong? If there's another thread or an article answering this, I'd greatly appreciate it if it was posted. I know he's a supporter of the Fed, but to be honest, I haven't read much of his work, only enough to know that he sharply disagreed with the Austrians on the cause of economic downturns.
Thanks again.
Friedman's basic argument was that the Austrian theory of cycles "simply doesn't correspond to the facts." In other words, the Austrian theory of cycles, though logically consistent, partially contradicts the monetarist explanation and is therefore untenable (how convenient). Now, the facts that he refers to are (a) the rate of bank failures skyrocketed and the total supply of money contracted dramatically, leading to general price deflation, and (b) the 1920s saw only a moderate rate of general price inflation. Additionally, some think that Friedman's critique of the Keynesian framework also applies to the Austrian theory of cycles, namely the fact that inflation, in the long run, actually increases interest rates rather than reducing them.
The problem is that Milton Friedman did not entirely understand the ABCT. In fact, the Monetarist explanation fully agrees with what Hayek referred to as "secondary phenomena." In other words, the Monetarists, like the Keynesians, focus on the effects of depression rather than the causes of depression. Additionally, he has a very primitive understanding of inflation, namely as a general and uniform rate of price inflation amongst final consumer goods and services (this dogma still dominates much of the mainstream today).
And finally, the fact that monetary expansion eventually increases interest rates is entirely consistent with the Austrian theory of cycles.
"If we wish to preserve a free society, it is essential that we recognize that the desirability of a particular object is not sufficient justification for the use of coercion."
It seems that he doesn't understand what money is at all. And he seems like another one of those 'spending' fetishists.
See:
http://www.youtube.com/watch?v=O7pnjzCuSv8
If I recall, the Austrians are wrong because they aren't friedmanites.
I know he's a supporter of the Fed, but to be honest, I haven't read much of his work, only enough to know that he sharply disagreed with the Austrians on the cause of economic downturns.
Milton Friedman was never a supporter of the Fed. He favored it's abolishment. I can't even begin to count the number of times Austrians have repeated this false claim.
He favoured its replacement with a computer applying fixed rules. if we would be allowed to call the computer 'the fed' then...
Where there is no property there is no justice; a proposition as certain as any demonstration in Euclid
Fools! not to see that what they madly desire would be a calamity to them as no hands but their own could bring
Sure, he advocated that as a second best option. He stated many times that the Great Depression would have never happened if the Fed didn't exist and said that the system in place before the Fed was created would have avoided what happened. Milton Friedman also advocated school vouchers even though he ultimately would have liked to see a completely private school system - does that mean he didn't support privatizing schools?
justinx0r,
Again, I haven't read much of his work, so I'm sorry for misrepresenting his ideas. However, I do know for a fact that he supports fiat currency with free-floating exchange rates. I guess this is the part where him not understanding monetary theory comes into play; nowhere in his theory of free-floating exchange rates from what I've read does he address the government printing money and how this affects the purchasing power of the monetary unit.
This is somewhat off-topic, but I've been watching "Free to Choose" and in the episode covering the Great Depression (I think its called "The Anatomy of a Crisis") he blames the financial crash on the Fed not merging the Bank of America with other large national banks, so I don't think he's as anti-Fed as monetarists and paleo-conservatives seem to think he is.
Esuric,
Thanks for the answer. Though I'm not very versed in Austrian business cycle theory (I'm currently reading Man, Economy, and State and I'm at around the 800 page mark, for those of you keeping track at home), I think I was able to digest your explanation of why Friedman was wrong on economic downturns. I do have one other question though. When you refer to the fact that monetary expansion eventually increases interest rates, are you talking about the period of the business cycle when consumers panic and withdraw all of their savings to buy goods and services now in expectation of higher prices, reducing the bank's reserves and forcing them to increase interest rate loans, or am I misunderstanding you?
Milton Friedman "Abolish the Fed"
http://www.youtube.com/watch?v=JL3FT0O4kYg
It is true that Friedman supported the existence of the fed at one point. It is also true however that later in his life he reconsidered his views and eventually decided it should be abolished.
Did he ever write about that fleshing it out? One wonders how later period Friedman would answer the question of 'should the USGov maintain a national fiat money' ?
In making the case for a monetary rule, Friedman advocated a paper-money standard rather than the gold standard, arguing that this would save on the resource costs of digging the metal out of the ground just to store it away in bank vaults. But in the years after he received the Nobel Prize he had second thoughts about his monetary rule and the gold standard. In a series of articles in the 1980s Friedman stated that Public Choice theory had convinced him it will never be in the long-run interest of governments or their monetary authorities to follow the type of rule he proposed, since the temptation to abuse the printing press for political reasons would always be too strong. He therefore concluded that, given the actual history of Federal Reserve policy in the twentieth century, remaining on the gold standard would have been far less costly for America than the Fed-created inflations and recessions.
http://www.thefreemanonline.org/featured/milton-friedman-1912-2006/#
Good find Bardock, thanks for presenting this. Its only a shame that these 1980's articles aren't referenced
I just came across this today. I'm searching for the article out of curiosity, and I'll let you know if I come across anything.
I do have one other question though. When you refer to the fact that monetary expansion eventually increases interest rates, are you talking about the period of the business cycle when consumers panic and withdraw all of their savings to buy goods and services now in expectation of higher prices, reducing the bank's reserves and forcing them to increase interest rate loans, or am I misunderstanding you?
What you're talking about is specific phenomenon that will elevate interest rates but it occurs only when the affects of monetary expansion become obvious (relatively high rates of general price inflation). Banks also charge higher rates of interest in order to protect themselves from inflation.
But what I'm talking about is the fact that interest rates will rise right before the bust because the rate of monetary expansion, for whatever reason, is not high enough to keep market interest rates suppressed below the natural rate. This is because inflation suffers from diminishing returns and monetary expansion must continuously rise in order to sustain the malformed capital structure and perpetuate the malinvestments. Once this occurs (an insufficient rate of inflation), prices, including (especially) the interest rate, will adjust to reflect true consumer preferences; they will rise towards the natural rate (the monetarists also believe in a natural rate of interest but they don't believe that it diverges from the market rate of interest for any significant period of time).
Once the recession is underway, there will be an higher demand for money (velocity will fall), and this will cause market interest rates to rise above the natural rate of interest.