Milton Friedman was, as Paul Krugman said, “the great popularizer of free-market doctrine.” A citizen with a basic knowledge of economic thought would think that a free-market activist would be in favor of the Classical laissez-faire approach, and would allow the market to self-correct back towards a market clearing equilibrium. The unprecedented bond buying program devised by Bernanke’s Federal Reserve in the wake of the worst U.S. economic crisis since the Great Depression seems to be at odds with the free market philosophy. Additionally, one could argue that the flooding of the open market with a booming stock of money, shown below, is in opposition with Friedman’s sentiment that variations in the money supply can have large effects on the real economy, particularly rampant inflation, which led to Friedman’s k-percent rule.
While the Monetarist sentiment may seem to be at odds with the degree of actions by the Federal Reserve during the Financial Crisis, Friedman commented on the idea of quantitative easing (QE) when he was alive in a post for the Wall Street Journal. In it, he blames the era of deflation that Japan faced in the late 1900’s on “a decade on inept monetary policy by the Bank of Japan.” Before the idea of quantitative easing was being used by three central banks across the globe, Friedman offered up an answer in response to questions of where a Central Bank should go when they’re essentially at the zero lower bound – “The Bank of Japan can buy government bonds on the open market… Most of the proceeds will end up in commercial banks, adding to their reserves and enabling to expand their liabilities.”
Friedman pretty much called the plays for the Federal Reserve 10 years before the Financial Crisis occurred. The Federal Reserve proceeded to purchase trillions of dollars of debt from late 2008 to late 2014, and excess reserves skyrocketed.
Since Friedman is on the record vying for quantitative easing, the question to be asked is if he would agree with the degree of QE that took place and if he believed that it stimulated the economy. There is a divergence in Friedman’s expectations of the effectiveness of the program. He seems to be in favor of a large degree of purchases, as he says that “there is no limit to the extent to which the Bank of Japan can increase the money supply if it wishes to do so” – a level of commitment to the program reminiscent of Mario Draghi’s “whatever it takes” speech in regards to European QE to keep the euro intact. But Friedman was under the impression that QE, which would drive the money supply, would in turn cause the economy to expand rapidly in about a year and that soon inflation would follow after a short delay. One can safely conjecture that Friedman would predict a return to pre-recession levels of consistently above 2% for GDP growth by early-mid 2010 and 2% inflation by the end of 2012.
When we look at these post-recession metrics, we don’t find that Friedman’s predictions came as true as he would’ve hoped to see. Real GDP, shown below, bounced back following the financial crisis but there has been a long recovery which has seen persistently stagnant annual GDP growth that has hovered closer to 2% than in the pre-recession economy.
Inflation has been even gloomier than Friedman may have expected, as core PCE, the preferred metric used by the Federal Reserve to judge inflation, has persistently stayed below 2% since 2009 and has consistently been lower than the period of 2004 – 2008 leading up to the recession.
Friedman goes on in the WSJ article to compare the inability of the Bank of Japan to stimulate the economy through monetary policy to the Federal Reserve’s inaction in the wake of the Great Depression, where the Fed allowed the “quantity of money to decline by one-third from 1929 to 1933.” While I believe it’s safe to say that Milton Friedman would have been in favor of quantitative easing, I don’t believe his expectations for the program to stimulate the economy were necessarily realistic. Given his own “whatever it takes” stance he seems to take in the article, Friedman may have lobbied for an even more drastic growth in the money supply and may have pushed for a greater degree or longer duration for the Fed’s bond buying program. But given the already drastic steps taken by the Fed and the inability of the program to return the economy to pre-recession levels, I don’t believe that additional action taken by the Fed would have necessarily been met with an equivalent boost to the economy as the program likely faced diminishing returns. The absence of the counter factual restricts us from definitively saying that QE didn’t work, or that additional rounds of QE would or would not have brought about more economic growth, but there appears to be evidence that the program was not as effective at stimulating the economy as Friedman thought possible.