Quotes of the day inspired by recent ECB and Fed actions

|Peter Boettke|

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.

 

 

 

Comments

[Nikolaj]

Dear professor Beottke,

it is strange that you classify Hayek as one of the greatest economists of the second half od the 20th century, having in mind that almost all his crucial economic works were written before the Second world war, and even before 1936. Those essential economic writings are collected in the volume "Prices and Production and Other works", published by the LvMI.

Had you said that Hayek was one of the greatest social or political philosophers of the second half of the 20th century that would have been much more correct. The only Hayek's strictly economic work published after 1945 I am aware of is "Denationalization of Money". But that slim volume on banking and monetary policy could have hardly earned him the honor of being one of the greatest economists of any period.

Of course, I can guess that the reason for your awkward dating of Hayek's economic work is that you actually do not like so much his books and articles written before 1937, the works his fellow-giant Friedman called "very bad" and inflicting a great deal of damage by advocating "liquidationism". It is very awkward that you failed to note in your post this rather simple point. Friedman and Hayek had diametrically opposed views on the role of monetary policy and that Hayek almost certainly would have severely criticized QE3, whereas Friedman, Bernanke's idol, would have supported it (as consistent with nominal GDP targeting). Your two temporally disjointed giants are actually worlds apart in monetary theory and policy. Who would have guessed that by reading your post?

[K Sralla]

"Your two temporally disjointed giants are actually worlds apart in monetary theory and policy"

And that was the point of the essay. Despite their differing views on money, they both agreed that central banking was a flawed institution that allowed a few bad, stupid, or ignorant yet well-intentioned people to do great harm. Do you disagree?

Your other point about Hayek's post 1950 contributions to economics is nonsense. Hayek enjoyed an enormous resurgence after his 1974 Nobel Prize, and was influential (as was Friedman) in the signficant change in policy direction in Britain and the U.S. after the late 1970's. Several other late 20th century Nobel winners in Public Choice and New Institutional economics drew heavily from the Hayek research program. Yes, he was a giant economist in the second half of the 20th Century.

[Harrison Searles]

Another disturbing trend in Europe has been just how political the central bank has become and how political (rather than economic) hopes are pinned onto it. The ECB's actions are neither to ensure full employment nor to ensure price stability, but to ensure the continuance of a political ideal. This type of statecraft will impoverish the Euro zone because now the ECB is pursuing a policy without regard for the prosperity of countries along the Euro's periphery. It sets a course of events that Hayek and Friedman would have feared by politicizing the money supply.

[Nikolaj]

K. Sralla, please give me a technical economic book or article that Hayek had written after 1945 (apart from "Denationalization of Money", which I mentioned). It is not enough to say that people liked Hayek after 1945 or 1974 in order to classify him as an economist of the second half of the 20th century. That would mean that his contributions came largely in the second half of the century. Au contraire, he abandoned economics entirely after "The Pure Theory of capital" (1941) and never really contributed anything worth mentioning after that. He received the Nobel Prize in 1974 for the work he had done in the 1930s, for his "pioneering contribution to the theory of economic fluctuations" as Nobel Committee said (for evil liquidationist ABCT), not for his post-World War II quasi-philosophical musing about "knowledge", "spontaneous order", "constitutions of liberty" and all the rest.

Apart from that, why then Friedman supported the Fed, and spent his entire life arguing about the "proper monetary policy" if the Fed was so awful and beyond redemption? As you probably know, Friedman criticized Fed not for existing, but for not being inflationary enough during the Great Depression, for failing to "stabilize" the declining money supply. His major fear was that the Fed bureaucrats would fail to inflate enough in the critical situations. He argued that the Japanese central bank was not printing enough during the 1990s and that this was the major reason for the "lost decade" Hence, he praised Alan Greenspan as a great genius and maestro who "got it right" during the 2000s (namely, during the house bubble).

[K Sralla]

No energy to argue over drivel.

[Jerry O'Driscoll]

@Nikolaj,

You need to get command of the facts before posting comments like these. You asked for one example of an economics work by Hayek after 1945, so here is one.

Hayek, "Three Elucidations of the Ricardo Effect," JPE 77 No. 2 (1969).

You are equally wrong about Friedman. He never supported discretionary monetary policy. Allan Meltzer went through all of Milton's Newsweek columns and he never deviated from his commitment to following a monetary rule. It is that commitment to a rule that links his position on moeny with Hayek's.

(It is news to me that Milton ever supported nominal GDP targetting.)

On Friedman and Bernanke, see also Jeff Hummel's article "Ben Bernanke versus Milton Friedman" in The Independent Review, Spring 2011.

[FC]

I have been considering the notion that the USA has become a mortgage-holders' republic through the actions of the Congress, executive, GSEs and Fed.

Given the lack of Congressional outrage over QE3, I can only conclude that the Democratic party has learned to love "trickle-down economics."

[Neel]

Too bad Milton Friedman did not use Hayek's argument on the dispersal of knowledge in this passage in Capitalism and Freedom and used it a year later in a different context (without mentioning Hayek).

[George Selgin]

I'm quite certain that Friedman never supported nominal GDP targeting, despite having at various times endorsed quite a few different types of monetary rules. I say this because I once did a paper on the history of the productivity norm, and in researching it searched systematically for various past proposals for what's now called nominal income targeting. I doubt I'd have overlooked one by MF in the course of that research.

[Daniel Kuehn]

Of course the key to your question, Peter, is what happens in the counterfactual. It's not enough to simply say that a central bank has these problems. Clearly it does. I am open to abolishing central banks in theory for all the reasons you state, I just have reservations about the case that it would actually work.

This line of argument here is the same that those opposed to the free market use. They provide a laundry list of the problems with the market and then conclude we ought to abandon it. It doesn't quite do it for me (either as an anti-market argument or as an anti-government institution argument).

The troubling thing for me is that:

1. We really don't know how the alternative will work.
2. The status quo seems to be working OK. The two premier liberal market economies on the planet seem to have done fine with central banks.
3. I worry about the robustness of the solution. Will it unravel into something worse?

These are honestly open questions and concerns for me - I am open to the idea of abolishing central banks, just not ready to embrace it.

[Daniel Kuehn]

#2 was a little cryptic... I meant UK and US - the two premier liberal market economies in their own golden ages, of course.

[Allan Walstad]

Daniel Kuehn: What was Peter's "question" to which you were responding?

Some of us would detect a bit of (presumably unintended) irony in your reference to "golden ages," of course, but why do things go sour? Perhaps at least in part due to political monetary manipulation and debasement? Do you really think the US has done perfectly well with a central bank, given the onset of the Great Depression less than two decades after the Fed was established, and now the positively insane descent into crude inflationism? It is precisely what we have now that appears to be unraveling into something far worse.

[Nikolaj]

Professor O Driscoll,

ok, we have now another article in addition to "Denationalization of Money". The question is: do you really defend the thesis that whatever Hayek wrote on economics after 1945 (actually after 1974, since I still was unable to locate anything in the period 1945-74) was more important that what he wrote before? That this article is more important than "Prices and Production"?

As for Friedman, it is rather awkward to say that Friedman's commitment to the monetary rule (read, a constant annual increase in the money supply) should "link" his position to Hayek's. It seems to me that this is the strongest possible difference between them: Friedman believed, as his mentor Irving Fischer did, that the only distortionary effect can come from CPI inflation, and that is the entire rationale for the monetary rule (to stabilize the "nominal income"). This is exactly the opposite of what Hayek believed - the general price level is irrelevant, the relative price effect are the only thing that counts. Actually, his thesis was that the prevalence of this kind of misguided Fischerite and Friedmanite "mechanical" and "literal" quantitative theory of money caused the Great Depression.

[K Sralla]

1. We really don't know how the alternative will work.

Which alternative?

2. The status quo seems to be working OK. The two premier liberal market economies on the planet seem to have done fine with central banks.

Really? A great depressionary deflation, war inflation, 1970's inflation, central bank enabled sovereign debt, a central bank fueled tech bubble and then a huge housing bubble. Do you really argue that it is working OK? Sure things have been improving long term, but it seems that under almost any sane metric, the track record of the Fed has been awful.

3. I worry about the robustness of the solution. Will it unravel into something worse?

Again, which alternative?

[Peter Boettke]

Nikolaij,

Let me be clear, I consider Hayek one of the greatest economists of all time. The works cited were written in the second half of the 20th century.

On Hayek's works, I'd say as a matter of fact after WWII, not only do you have his works in political and social philosophy, but also the entire "Abuse of Reason" project --- e.g., The Counter-Revolution, but also such very important essays as those contained in Studies (1967) and New Studies (1979). And, you need to see the various economic articles he wrote ... e.g., Competition as a Discovery Procedure.

But I am very much someone who follows Hayek's contributions from the 1920s to the 1980s.

[Bob Subrick]

The full Nobel citation states Hayek and Myrdal won "for their pioneering work in the theory of money and economic fluctuations and for their penetrating analysis of the interdependence of economic, social and institutional phenomena." He did not win solely for his monetary theory.

[Jerry O'Driscoll]

@Nikolij,

Yes, we have another and as Pete suggests, there are others.

As Neel notes, Friedman's argument for rules parallels Hayek's. That was my earlier point.

You have not read Friedman carefully. He wanted a rule for stability and predictability. That is apparent in the appropriately named Program for Monetary Stability (1960). Stability of the inflation rate was more important than a particular rate. And he reocognized that growth was compatible with deflation.

[Nikolaj]

professor O'Driscoll,

the other works cited are from social and political philosophy, not technical economics.

As for the notion that Friedman never advocated discretionary policy and even less the NGDP targeting, as you claimed in one of your previous comments, here is the quotation I had in mind when I initially asserted that the he did favor the NGDP targeting. It is from 1998:

"The Bank of Japan can buy government bonds on the open market, paying for them with either currency or deposits at the Bank of Japan, what economists call high-powered money. Most of the proceeds will end up in commercial banks, adding to their reserves and enabling them to expand their liabilities by loans and open market purchases. But whether they do so or not, the money supply will increase.

There is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so. Higher monetary growth will have the same effect as always. After a year or so, the economy will expand more rapidly; output will grow, and after another delay, inflation will increase moderately…"

Seems like NGDP targeting to me.

As for "stability" of the inflation rate in Friedman's framework, I did not deny that at all; the adaptive expectations of the people would neutralize any anticipated inflation rate. That's not a problem. The thing that I denied is your claim that Hayek and Friedman had similar concerns in mind when they talked about "monetary stability". Hayek meant the absence of artificial credit creation that upsets the inter-temporal and inter-sectoral asset prices, Friedman - the particular statistical behavior of some arbitrary chosen, centrally planned macro-economic aggregates.

[Steve Horwitz]

"The Non-sequitur of the Dependence Effect" - SEJ early 60s.

“Full Employment, Planning, and Inflation,” “Unions, Inflation, and Profits,” and “Inflation Resulting from the Downward Inflexibility of Wages,” all date from the 1950s.

"Competition as a Discovery Procedure" is from the 1960s.

Basically, Nikolaj, you are wrong on the facts, just admit it.

[Daniel Kuehn]

Allan -
No, of course I don't think things have gone "perfectly well". Why would you think I would? Do you think things would go "perfectly well" under free banking? This is exactly the line of argument I was pointing out was bad in my comment. Yes there are liabilities associated with different approaches that I think we're all generally aware of (Hayek and Friedman, and many others have pointed them out - it's not exactly a deep dark secret what the problems with central banking are!). Pointing out the problems is not sufficient for making the case for an alternative.

K Sralla -
re: Really? A great depressionary deflation, war inflation, 1970's inflation, central bank enabled sovereign debt, a central bank fueled tech bubble and then a huge housing bubble. Do you really argue that it is working OK? Sure things have been improving long term, but it seems that under almost any sane metric, the track record of the Fed has been awful.

Depression is partly on the Fed, it's true. Would free banking have done better? I have not been convinced of that. War inflation is probably demand-pull, right, and that demand was quite necessary IMO! 70s was another learning experience associated with expectations augmentation. Again you seem to be making the same weird argument that Allan is. Yes there are imperfections. So? That's not a complete argument. I'm not sure we agree on the causes of the IT bubble and the housing crisis.

I am primarily referring to the long-term growth of market democracies with central banks.

When you find a market democracy with a free banking system with that sort of robustness and growth performance, you let me know. I would be very interested in hearing about it.

A free banking episode that did well for a period of time and then wasn't robust enough to maintain itself isn't very appealing. Plus I'm not even sure the causality is in the right direction on that. I have no trouble believing that in good times free banking can manage things reasonably well. My concern is how it weathers a collapse in asset values and other shocks.

You have to realize that we aren't being pugnacious or stubborn when we ask for this sort of thing. We have long spans of experience with strong long-term growth and durable market democracy under central banks. An argument to abandon them rather than improve them needs to be a lot more convincing than telling us what we already know: that they aren't perfect.

[Nikolaj]

Steve, I accept prof. Boettke's clarification about Hayek. It was not contrary to my initial thesis. He did not mean that Hayek's contributions after 1945 were more significant that those before 1945.

It is good, nevertheless, that you found free time to set the record straight, even if the dispute by now became moot. It's good to know that you consider everything I write so important.:)

However, I am not still convinced that a couple of short essays dealing mostly with the relationship between the unions, inflation and unemployment compare with Hayek's work in the 1920s and 1930s. Not even close. You could also add his chapter on inflation from the "Constitution of Liberty", but that's besides the point. My main claim was that after 1945 there is nothing "worth mentioning" that Hayek published in technical economics and that he is essentially an economist of the first half of the 20th century. In that regard I am still right. He himself conceded many times that he had largely withdrawn from economic debates after 1941, in order not to prejudice the people with his unfashionable economic views about his larger philosophical theories that he held more important at the time.

[George Selgin]

"A free banking episode that did well for a period of time and then wasn't robust enough to maintain itself isn't very appealing. Plus I'm not even sure the causality is in the right direction on that. I have no trouble believing that in good times free banking can manage things reasonably well. My concern is how it weathers a collapse in asset values and other shocks."

Daniel, what episode are you referring to? And are you equating the mere fact that free banking was not allowed to continue to its lack of "robustness"? Neither the Scottish nor the Canadian FB episode--to pick on the most famous and pertinent ones--ended because of any economic storm it either caused or was incapable of weathering. Bot ended because of politics and despite their superior record. In the Scottish case the end came as a result of the thoughtless extension of Peel's Act to Scotland; in Canada's it came because of populist pressure for inflation, informed by the schemes of Major Douglas, which the chartered banks were not prepared to accommodate.

To compare such instances of the "non-survival" of free banking to, say, the collapse of the gold exchange standard, or of Bretton-Woods, or (if recent developments are any indication) of the Euro, is to commit a category mistake of the grossest sort--rather like saying that a hit and run victim died a "natural" death because he wasn't strong enough to stand up to a speeding vehicle!

[Keith Henry]

@K Sralla & Daniel Kuehn

How do we sort out the signal from the noise?

The 1900's were a time of exceptional growth and prosperity for most of the world. Do we attribute these gains (or a substantial portion) primarily to central banking? Or is it that central banking was fortunate enough to be the "method in practice" during this remarkable time? Such as a fortunate CEO or President?

Likewise, it is probably not appropriate to cherry pick all the 'negative' events that have happened and put them squarely on the shoulders of the FED / Central Bankers. I think the system is far to complex for such a simple culprit.

At 100 years old the FED is still in it's infancy (and evolving), and at ~300-400 central banking is also a relatively new endeavor. We simply don't know how it will perform over the next 100 years. It's an experiment in progress. I'd argue that our data sample is simply not large enough to make a confident prediction of the future on the merits or long term feasibility/success of the FED. Most certainly not when the rules keep changing.

Now, in general, I favor more decentralized systems. Concentration of power tends to blind those who are enabled to make decisions through hubris and/or ignorance. When we are free from the recourse of our actions, we tend to be less thoughtful with our decisions. After all, incentives matter.

[Allan Walstad]

Daniel, here's part of what you posted, to which I was responding:

"2. The status quo seems to be working OK. The two premier liberal market economies on the planet seem to have done fine with central banks."

That's why I asked if you really thought the US had done perfectly well with a central bank. It sure sounded to me like that's what you were saying. Furthermore, the burden of demonstration properly falls on those who would impose, or continue to impose, government intervention rather than permitting people to trade freely. England was becoming the preeminent economic power when Adam Smith wrote against mercantilism, but his criticisms did not fall on deaf ears. When we can rather clearly delineate how central banks distort market information and cause bubbles and busts, it should be taken seriously that the sort of interventionism pursued by central banks ought to be abandoned.