Friedman versus Keynes forever (I)

By Luis Arroyo, in Madrid | There is a roaring debate on the Net about Friedman and his book ‘Free to Choose’, published 30 years ago: Crochrane comes to its defense against De Long; Krugman stands for De Long; Noah clarifies… It is purely American scholastic squabble, being a Friedman-versus-Keynes struggle in the end.

I believe Krugman hates Friedman. He hates him so much that he does not even quote him in his papers about deflation and Japan’s liquidity trap in the 90s. However, both Friedman and Krugman pointed out the same theory: Japan’s Central Bank should encourage inflation in order to end up with deflation forces. It seems that back then Krugman didn’t believe in the power of expansive fiscal policy: contrary to the IMF –for which monetary policy had lost its force,– Krugman advised against it. These were his very own words in 1998:

“If this stylized analysis bears any resemblance to the real problem facing Japan, the policy implications are radical. Structural reforms that raise the long-run growth rate (or relax non-price credit constraints) might alleviate the problem; so might deficit financed government spending. But the simplest way out of the slump is to give the economy the inflationary expectations it needs. This means that the central bank must make a credible commitment to engage in what would in other contexts be regarded as irresponsible monetary policy –that is, convince the private sector that it will not reverse its current monetary expansion when prices begin to rise!”

But this debate is about something else: if Friedman was right or wrong in his economic freedom crusade. I think he was. He essentially did the right thing and since 1980 America has experienced 30 glorious years stained at the end by a bubble that screwed us all. A bubble that not even Friedman saw coming…

Both sides fundamentally exaggerate their positions: US economy was not that bad before 1980 (it actually was in the last 70s), nor wasn’t that awful in the beginning of this century. Nevertheless, rivals seem to be keen on tarnishing his opponent’s ruling period. If Friedman’s theories prevailed from 1980 onwards, keynesians say, he is the one to blame –he was wrong about everything bad that happened afterwards, but not the good things.

Friedman would have not suggested to free CDOs nor that toxic assets would spread around the world, but using those arguments to judge a 30-year-period is like clouding all the positive aspects of the economy from the mid-80s until the bubble in 2006.

Besides, Friedman never criticized fiercely the 50s, that looked very similar to the 90s, in terms of productiviy. Not even Roosevelt’s policy, which permitted the US to leave the big depression behind, raising prices to the level they were before the crisis. FDR, by the way, used fiscal policy as a bait to reassert that he would rise the prices as much as needed. Moreover, in monetary aspects, Friedman stands for Keynes. Like Minsky, he believes he was a great monetary economist. His article called ‘John Maynard Keynes’ praises him –except for his fiscal policy and his interventionist reflexes. Cochrane and Noah are for me the best balanced.

Luis Arroyo is a former Bank of Spain economist. He writes for www.consensodelmercado.com.