The Tribune

YOUR SAY By RALPH J MASSEY A DRAFT of the following was delivered at a Milton Friedman commemoration at the Nassau Institute on January 27. Dr Milton Friedman's teaching career began at the University of Chicago in 1947 and ended in 1977 when he began a more public career as a Fellow at the Hoover Institution. As a child of the Great Depression and as a Doctoral Candidate at Chicago in the mid-1950s, I was greatly impressed by his work on the role that money played in causing the severity of that depression. One of his "first principles" was: "Inflation is always and everywhere a monetary phenomenon." He began work on the subject in the late 1940s when he accepted a National Bureau of Economic Research invitation to participate in an inquiry into the role of money in the business cycle. * That research led to the publication in 1963 of A Monetary History of the United States. Harry G Johnson, an economist and associate, described it in the Economic Journal as "a monumental scholarly achievement". * Milton also examined inflation in China, the UK, Germany, Japan, Brazil, Chile and Israel where he found with statistical certainty that accelerated monetary growth leads to subsequent accelerated price inflation. Writing in 1991 in a book titled Money Mischief, he restated that principle plus four additional "truths": 1. Today, governments determine the quantity of money in circulation because they all have paper currencies that are no longer tied directly or indirectly to gold or silver...they are not exchangeable into gold or silver at a stated price. 2. The only cure for inflation in the market prices of goods and services is a slower growth in the quantity of money in circulation. 3. The first great problem in dealing with consumer price inflation is that it takes time for an accelerating money supply to show up in the cost-of-living; and it produces initially the illusion that accelerated monetary growth is solving real problems; 4. The second problem is that it also takes time (measured in years, not months) for inflation to be cured; and this produces unpleasant side effects. In this book in 1991, he expressed concern that the US had embarked on a policy of increasing monetary growth. His "monetarism" was and is the polar opposite to the prevailing Keynesian economic policies of the times. He focused on the importance of monetary stability and, particularly, a commitment to a fixed target for monetary growth that slightly exceeds the annual growth in the production of goods and services. When I was at Chicago, he recommended a target of three per cent per year when Gross Domestic Product was growing at two per cent per year. His expressed concerns in 1991 were justified by subsequent events. * In 2003, both M2 and M3, two measures of the quantity of money in circulation, grew at five per cent per year. * In 2006, M3, the broader more inclusive measure of money, started growing at 8 per cent per year as the housing bubble approached its zenith; and also the Federal Reserve stopped publishing the M3 data. * In 2008, a non-government source estimated M3 growth at 17 per cent per year; * In 2009, the Fed reported an M2 growth at 17 per cent per year and, in 2011, 21 per cent. These events create a serious dilemma - the juxtaposition of Milton Friedman's disciplined control of the money supply and the actual dizzying heights of M2. This, plus the political impasse, can bring to mind an alarmist vision of "Germany between the Wars" or even today's hyper-inflation in Zimbabwe. I must point out that no Government has literally followed the Friedman prescription for monetary stability even though his critics publicly agree on the basics. For instance, Ben Bernanke in 1997 stated that "Most economists agree that monetary policy can effect real output and employment only in the short run". However, monetary systems differ, but only in the choice of monetary targets, the administrative latitude in management to those targets and the degree of public disclosure. * Germany and Sweden for decades have followed a policy of targeting the rate of inflation. In the case of Germany "money growth targets are...consistent with an annual inflation target, given projections of the growth of potential output...This inflation target, in turn, has been brought steadily down over time and has remained at 2 per cent since 1986, the level that the Bundesbank deems consistent with its price stability target. * New Zealand, another example, links by law "the tenure of the governor of the Reserve Bank to his achieving the inflation target...[it] comes closest to providing an explicit 'incentive contract'." Under Alan Greenspan from 1987 to 2006, the Fed was managed in virtually complete secrecy using an increase in money supply and bailouts to solve each and every crisis. And Ben Bernanke before the 2008 recession exhibited poor judgement. For instance, "the derivatives" explosion, extreme leverage of regulated and shadow banks and excesses of mortgage lending were all flagrant abuses that both Mr Bernanke and Mr Greenspan could have said "no" to. But they did not. As a result, a complex and unstable system veered dangerously out of control. And he clearly misjudged the quality of the risk management systems operating within the banking and financial sector. The problem is that the Fed is politically driven as in its statement supporting the President's re-election spending plans. The Fed would "maintain a highly accommodative stance for monetary policy" that includes a Fed funds rate at 0 to 1/4 per cent "at least through late 2014, and it expects "a subdued outlook for inflation over the medium term". The broader problem is politics - the fatal flaw in republican democracies is that candidates win primarily via a popular vote. Nothing wrong with that, except that constituents do not stomach the consequences of loose lending very well and a solution to "bite the bullet". In this case, the potential nasty consequence of loose money and its remedy have not been discussed.