“Slouching" Semi-Erratum: Milton Friedman’s Monetary Framework: First Edition p. 401

A good catch by Mark Skousen!

The passage is:

Dig into Friedman’s thesis that the Great Depression was a failure of government and not of market, and things become interesting. For how could you tell whether interest rates were too high, too low, or just right? According to Friedman, too-high interest rates would lead to high unemployment. Too-low interest rates would lead to high inflation. Just-right interest rates—those that corresponded to a “neutral” monetary policy—would keep the macroeconomy balanced and the economy smoothly growing. Thus theory became tautology…

Mark Skousen writes:

I'm dumbfounded by your claim that Milton Friedman wanted to "stabilize interest rates" (pp. 401-402).  Actually Friedman wanted to target the growth of the stock of money, not the price of money.  He wanted the Fed (central banks) to increase the money supply at a stable rate equal to the long-term economic growth rate, and to let interest rates find their own equilibrium.”

He is correct: the implication that Milton Friedman sought to stabilize interest rates is wrong. He sought a neutral monetary policy—in which interest rates, and much else, would be stable. What I was trying to get at was that when Friedman talks about focusing on the monetary base plus checking deposits—M2—as a quantity to be stabilized, this M2 is not a control variable but rather an intermediate target. It is a leading indicator of nominal spending, and valuable and important only to the extent that it is a reliable leading indicator. M2 is, in Friedman's schema, an immense help as a thing to watch in crafting a neutral monetary policy. Whenever Goodhart's Law arrived and roosted, and the correlation between M2 and future nominal spending broke down. Friedman threw away the M2 target and focused on the nominal spending path as an ex post indicator of whether monetary policy had been properly neutral. But too much of that a argument was left on the cutting room floor in the final compression of the ms. And so it makes the points only to someone, like me, who already understands what I am trying to say.

For a while in his career, Friedman relied on historical correlations for his claim that a “neutral” monetary policy could be made automatic. But as Charles Goodhart had warned him, the historical correlations broke down as soon as central banks started to try to rely on them as control mechanisms. See C. A. E. Goodhart, “Problems of Monetary Management: The UK Experience,” in Monetary Theory and Practice: The UK Experience, London: Palgrave Macmillan, 1984, 91–121. Friedman then took refuge in a “‘neutral’ is whatever works” position. See Timothy B. Lee, “Milton Friedman Would Be Pushing for Easy Money Today,” Forbes, June 1, 2012, <http://www.forbes.com/sites/timothylee/2012/06/01/milton-friedman-would-be-pushing-for-easy-money-today/?sh=76b918545b16>.