The first from F. A. Hayek, The Constitution of Liberty (1960, 338-339)
"The increased dependence of the individual upon government which inflation produces and the demand for move government action to which this leads may for the socialist be an argument in its favor. Those who wish to preserve freedom should recognize, however, that inflation is probably the most important single factor in that vicious circle wherein one kind of government action makes more and more government control necessary. For this reason, all those who wish to stop the drift toward increasing government control should concentrate their efforts on monetary policy. There is perhaps nothing more disheartening than the fact the there are still so many intelligent and informed people who in most other respects will defend freedom and yet are induced by the immediate benefits of an expansionist policy to support what, in the long run, must destroy the foundations of a free society."
Hayek argues earlier in that same chapter that "the chief source of the existing inflationary bias is the general belief that deflation, the opposite of inflation, is so much more to be feared that, in order to keep on the safe side, a persistent error in the direction of inflation is preferable." The determination to avoid deflation, Hayek continues, results in cumulative inflation. And, from a long-run point of view, it is rather doubtful that "deflation is really more harmful than inflation." In fact, he concludes, "there is a sense in which inflation is infinitely more dangerous and needs to be more carefully guarded against." (1960, 330).
The next sample is from Milton Friedman, Capitalism and Freedom (1962, 75-76)
"... a primary excuse for the expansion of governmental activity at the federal level has been the supposed necessity for government spending to eliminate unemployment. ... This view has been thoroughly discredited by theoretical analysis and even more by actual experience, including the emergence of wholly new lines for private investment not dreamed of by the secular stagnationists. Yet it has left its heritage. The idea may be accepted by none, but the government programs undertaken in its name, like some of those intended to prime the pump, are still with us and indeed account for ever-growing government expenditures. ... The chief harm done by the balance-wheel theory is therefore not that it has failed to offset recessions, which it has, and not that it has introduced an inflationary bias into governmental policy, which it has done too, but that it has continuously fostered an expansion in the range of governmental activities at the federal level ..."
At the recent Mont Pelerin meetings on the first day of sessions, Sam Peltzman, Allan Meltzer and myself all gave papers which were in their own unique way takes on these points raised by Hayek and Friedman about monetary and fiscal policy, and in particular how the fiscal imbalance impacts monetary policy choices. In our separate ways, we all addressed the question not just of the scale of government, but the scope of government. And again in our own ways we relied on public choice analysis to highlight the problems of reversing an unsustainable policy situation we find ourselves currently wrestling with in the EZ and US.
Before concluding, however, I would like to highlight one other passage from Friedman's Capitalism and Freedom which the actions by the ECB and the Fed raise. Even if we assume away all public choice considerations for the sake of argument, we should be worried about the sort of authority bestowed upon these insitutions and the actors in charge of their operation. As Friedman points out:
"The Great Depression in the United States, far from being a sign of the inherent instability of the private enterprise system is a testament to how much harm can be done by mistakes on the part of a few men when they wield vast power over the monetary system of a country.
It may be that these mistakes were excusable on the basis of knowledge available to men at the time -- though I happen to think not. But that is really beside the point. Any system which gives so much power and so much discretion to a few men that mistakes -- excusable or not -- can have such far reaching effects is a bad system. It is a bad system to believers in freedom just because it gives a few men such power without any effective check by the body politic -- this is the key political argument against an 'independent' central bank. But it is a bad system even to those who set security higher than freedom. Mistakes, excusable or not, cannot be avoided in a system which disperses responsibility yet gives a few men great power, and which thereby makes important policy actions highly dependent on accidents of personality. This is the key technical argument against an 'independent' bank. To paraphrase Clemenceau, money is much too serious a matter to be left to the Central Bankers." (1962, 50-51, emphasis added)
I added the emphasis because I want to argue that this robustness critique of the Fed is independent of what your monetary theory. The sincere mistakes emerge over disagreements of monetary theory, but the problem isn't lack of, or consensus about, monetary theory and policy. The problem is the institutional arrangement in the EZ and the US is a bad system which magnifies the consequences of mistakes and bad decisions (whatever their source). Such institutional arrangements must be rethought.
I, for one, think our current political discourse -- even by those generally in the free market camp -- reveals that economists have forgotten these words of wisdom and robust political economy analysis that two of the greatest economists of the second half of the 20th century -- Hayek and Friedman -- had to offer in these classic texts of theirs on the issuses of monetary and fiscal policy that are so relevant for our times.