TOPICS: Milton Friedman’s monetary mantle

In the early postwar era, the cause of the Great Depression of the 1930s was something of a mystery. By 1932, 1 of every 4 Americans was jobless. Then, in 1963 economists Milton Friedman and Anna Schwartz charged that it was the Fed who dunnit.

In a statistics-heavy tome, A Monetary History of the United States, 1867-1960, the two scholars fingered the Federal Reserve System. The central bank had shrunk the nation’s money stock by one-third between 1929 and 1933. There wasn’t enough money left to maintain reasonable prosperity. Professor Friedman, who died on November 16, is regarded as one of the most influential economists of the 20th century. The Nobel Prize winner revived recognition of the role of the nation’s money supply in economic growth and inflation.

“His influence has been profound,” says Schwartz of the National Bureau of Economic Research (NBER). But it took more than a decade and “Milton’s tireless insistence on the importance of the money supply” to persuade the economics fraternity that the quantity of money mattered, she adds. Reporting for the Monitor in New York, I attended the press conference on the publication of the Friedman-Schwartz book. The conference had been called by then-NBER president Arthur Burns, later Nixon’s Fed chairman. Fed economists in New York tried to shoot down the book’s conclusions. They were influenced by famed British economist John Maynard Keynes, who saw interest rates and fiscal policy as more important than money in controlling inflation and the business cycle.

Over time it became clear that money was an excellent predictor of the business cycle and inflation. Research by such economists as Beryl Sprinkel, then chief economist for Harris Trust & Savings Bank in Chicago and Allan Meltzer of Carnegie Mellon University, Pittsburgh found a close correlation between changes in the money supply and, after a delay, the nation’s output of goods and services. By the late 1970s, Friedmanites and Keynesians were engaged in a hot debate. A commercial firm capitalised on this debate by selling taped discussions of topical issues. Friedman would speak one week and Paul Samuelson, also a Nobel Prize-winning economist, the next. The blossoming of money substitutes (money-market funds, credit cards, junk bonds, and many others), plus the globalisation of the economy and the reduction of commercial banking’s share in the nation’s financial system have made it harder to measure money and reduced the Fed’s influence on the economy.

Samuelson advocates an “eclectic” approach to monetary policy. Meltzer says the money supply can’t be used today to predict quarterly changes in the nation’s gross domestic product. But the money supply remains important in determining future inflation and output. The European Central Bank, the Bank of England, and Sweden’s Central Bank pay much more attention to money than the Fed does, Meltzer says. — The Christian Science Monitor