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Thursday May 7, 2009 - 14:49:17 GMT
Larry Greenberg -

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Keynes or Friedman: A Never-Ending Debate

John Maynard Keynes was the most famous economist during the first half of the twentieth century.  His counterpart in the second half of that century was Milton Friedman.  Each of these men was extraordinarily brilliant, prolific in their writings, influential in public policy-making, and a philosophical mentor to broad swatches of future economists and interpreters of their work.  The polarization of U.S. politics between conservative and liberal is mirrored in the disciples of these two giants of economic thought.  By coincidence, Monday’s Op-Ed page in the New York Times offers a sample from each camp. 

Professor Allan Meltzer of Carnegie Mellon (age 81), a long-time critic of Fed policy as chairman of the Shadow Open Market Committee, warned that ultra-easy monetary policy, compromised central bank independence, and massive Federal deficit spending serve up a recipe for accelerating and unacceptably high future inflation.  He argued, “no country facing enormous budget deficits, rapid growth in the money supply and the prospect of a sustained currency devaluation has ever experienced deflation” and cited one of Friedman’s most remembered assertions: “inflation was always and everywhere a monetary phenomenon.”

Princeton Professor and New York Times columnist Paul Krugman (age 56), winner of the 2006 Nobel prize in economics, wrote about insidious falling real wages that puts the U.S. economy at risk to experience the kind of cycle of deflation and stagnation that Japan has been unable to escape since the early 1990’s.  To illustrate his point, Krugman invokes Keynes’ General Theory of Employment, Interest and Money (1935): “The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period.”

There is little intersection in these two positions.  Keynes’ ideas in the midst of the Great Depression were truly revolutionary, and Friedman’s counter-revolution in the inflationary 1970’s pretty much repudiated everything about Keynesian economics.  The first decade of the 21st century finds the two ideologies still battling for the hearts and minds of policymaking politicians.  With nearly opposite forecasts and policy prescriptions, Meltzer and Krugman cannot both be correct here.  What they share in common is the role of modern-day Cassandra and torch-bearers in a very old debate that has split the practitioners of macroeconomics.  The failure to settle an issue as basic as this is a reason why business cycle forecasters often struggle to gain the confidence of investors and businessmen.

I find Krugman’s warning more compelling.  The inflationary problem that former Chairman Volcker inherited in the autumn of 1979 took a very long time to germinate in a global and U.S. environment very different from the one that exists now.  The table below compares U.S. consumer price inflation on a percent per annum basis (% p.a.) in the four successive five-year periods prior to September 1979 to the sequence of five-year periods leading up to March 2009.  The more recent sequence underscores the stability of inflation over the past 15 years, while progressive deterioration festered in the earlier period.  Meltzer leaves the impression of a shorter path down the primrose path.  The Fed is right to prioritize the dangers of not doing enough to reinvigorate growth above the threat of sowing seeds of inflation.  The former is a much more immediate threat.

CPI, % p.a. 9/59-9/64 9/64-9/69 9/69-9/74 9/74-9/79
  1.2% 3.6% 6.4% 8.0%
  3/89-3/94 3/94-3/99 3/99-3/04 3/04-3/09
  3.8% 2.3% 2.6% 2.6%


A second reason why I am inclined to defer to the concern raised by Krugman is that other parts of the Friedman legacy have not held up well this decade.  Friedmanomics espouses deregulation and market fundamentalism.  In banking, that ideology allowed a gross over-allocation of resources into this sector and the repetition of leveraged risk-taking on a scale that produced a catastrophic global economic accident.  The mistakes of the 1920’s should have been consigned to the never-again bin.

Copyright 2009 Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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