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Milton Friedman and Restraint

August 12, 2013 in Politics & Elections

Lovers of Big Government and apologists for debt like Paul Krugman have tried to paint Milton Friedman as a contradiction. They say that Friedman’s insight that more Fed intervention might have mitigated the Great Depression is inconsistent with his view that the Depression would have been less severe without the Fed.
Krugman can typically be discounted because his partisanship diminishes his perceptiveness. It is, however, disappointing when National Review joins the fray and publishes opinion claiming that Friedman ‘would likely have supported a much more aggressive monetary response to our economic downturn.’
Professor Ivan Pongracic of Hillsdale College explains that Friedman’s insight was that the Fed’s inaction in the Great Depression was in the context of a banking system in which the central bank had monopolized the position of lender of last resort.
Pongracic writes:

Friedman and Schwartz claimed that the depression would not have been a Great Depression if there had been no Federal Reserve in the first place: ‘[I]f the pre-1914 banking system rather than the Federal Reserve System had been in existence in 1929, the money stock almost certainly would not have undergone a decline comparable to the one that occurred.’

That point was effectively elaborated by Milton and Rose Friedman in Free to Choose:

Had the Federal Reserve System never been established, and had a similar series of runs started, there is little doubt that the same measures would have been taken as in 1907 – a restriction of payments. That would have been more drastic than what actually occurred in the final months of 1930.

The existence of the Reserve System prevented the drastic therapeutic measure: directly, by reducing the concern of the stronger banks, who, mistakenly as it turned out, were confident that borrowing from the System offered them a reliable escape mechanism in case of difficulty; indirectly, by lulling the community as a whole, and the banking system in particular, into the belief that such drastic measures were no longer necessary now that the System was there to take care of such matters.<

Pongracic goes on to explain that Friedman's insight that the Fed should have acted to avert deflation in the face of bank runs is a conclusion based on the scenario of a Federal Reserve System that has monopolized the function …read more


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