Wednesday, August 07, 2013

My problems with "My Milton Friedman Problem"

David Glasner
argues that Milton Friedman was too a closet Keynesian.  He generally criticizes Friedman but, to be sure, makes some concessions to Friedman's many admirers (from both sincere belief and the aim for Ballance I'm sure).

He basically says that Friedman used an IS-LM model augmented with the Fisher effect and a critique of the hypothesis that there could be a liquidity trap.  The critique is based on the Pigou effect (see post above).  Also Friedman attempted to develop a theory of the determination of the price level.  In this post Graeber correctly notes that he is describing things in Friedman's work which aren't in Hicks's paper on Keynes and the classics.  All but the Pigou effect are in the General Theory  (Keynes admitted that he hadn't gotten anywhere useful in his efforts to understand the price level, would that Friedman had been so modest as hey got to the exact same place).

I comment

I'd be very interested to know if anyone can find anything written by Friedman about unemployment and inflation which isn't there in Samuelson Solow (1960).  In contrast, Samuelson and Solow (1960) note that cyclical unemployment can become structural.  Friedman ignored this possibility in 1968.  It was quite a hot topic in 1985 when OJ Blanchard and Samuelson's nephew dusted off the concept and named it "hysteresis".


Solow and Samuelson (in the famous paper 1960 in the AEA papers and procedings) argued that there can't be a liquidity trap due to the Pigou effect.  Like Keynes, they argued that depressions  couldn't last forever.

The Friedman Samuelson Solow Pigou effect argument against the liquidity trap depends entirely on the undefended and indefensible assumption that the marginal propensity to consume out of wealth is higher for nominal creditors than for nominal debtors.  This silly idea is possible if one first simplifies by assuming there are two agents -- the public sector and the private sector.

Also the Pigou effect depends on assuming Ricardian non equivalence.  Friedman asserted both that Pigou's argument against the liquidity trap is obviously correct and also that "to spend is to tax." I am sure that he was smart enough to notice the contradiction.  I think he chose not to mention it because of intellectual dishonesty.

3 comments:

marcel said...

The Friedman Samuelson Solow Pigou effect argument against the liquidity trap depends entirely on the undefended and indefensible assumption that the marginal propensity to consume out of wealth is higher for nominal creditors than for nominal debtors.

As a logical matter, I don't think this is quite right. With sufficient deflation, the value of the privately held monetary base will rise so much that no matter what the relative MPCs out of wealth are, aggregate consumption will rise.

I cannot find the citation or the exact quote at the moment, but IIRC, Pigou responded along these lines to Kalecki after the latter pointed out that most of the money stock was low-powered money and would net out, as you say. Pigou also noted that long before this degree of deflation happened, revolution or some other rupture would certainly intervene making the ex ante monetary base worthless. That is, he recognized it to be purely a logical exercise with not connection to real life.

Robert said...

Marcel I was not talking about low powered money. I was talking about private sector nomainal debt that is household and corporate nominal debt.

For one example, almost all corporations are nominal debtors. A huge decline in the price level would make them all insolvent. What would happen ? We know because of the casees of Argentina and Indoenesia where they were dollar debtors.

There was no way forward for the market system. If property rights were respected, then the public employees would take over control of the economy. The fact that they were bankruptcy court judges doesn't make that capitalism. Then years and years later maybe the means of production could return to private control. Alternatively contracts could be rewritten by state fiat. There was no way to combine respect for property rights and private control of the means of production.

These examples show that the market system can not survive a massive drop in the price level (due to debt deflation). Note I have not mentioned low powered money.

Also note what happened when house prices declined by about 30 40%. Samuelson Solow and Friedman have to argue that a many fold decline (in an economy then full of 30 year fixed interest rate mortgages) would not create problems.

Federal reserve notes are not the only nominal assets. 3 Nobel laureates assumed that they were.

Max said...

"Also the Pigou effect depends on assuming Ricardian non equivalence. Friedman asserted both that Pigou's argument against the liquidity trap is obviously correct and also that "to spend is to tax." I am sure that he was smart enough to notice the contradiction."

No contradiction, given Friedman's beliefs about money. In his paradigm, money is net wealth, i.e. not a liability of the issuer. (I think this is nuts, but it's what Friedman believed).