With all the ass-kissing of Milton Friedman's memory in the press after his death, I was waiting for a real economist to come out and tell the truth about what the psuedo-libertarian crap he peddled really mean, and the legitimacy of his arguments about the great depression. Thankfully, Krugman has come to the rescue.

It's hard to describe all the reasons I dislike Friedman and think that he represents a step backwards in the legitimizing of economics as an actual science. Part of it is that his disciples tend to be libertarians, and there are few people in the world who are more wrong about more things than libertarians. The other reasons include:

1. He blamed the Great Depression on a failure of the Federal reserve, rather than the poor regulation of the stock market, irresponsible lending practices, and other more obvious causes of economic collapse.
   
2. Despite his theories largely being disproven by their practical use, he's constantly held up as some kind of wizard who was never wrong by the libertarian types.
   
3. The "Economic Man" model is so flawed it's a joke, consumers do not act in a rational manner, and the "invisible hand" is attached to a retarded monkey.
   
4. He was all libertarian yet he lived in San Francisco - c'mon.

Now at least, Krugman's got my back

In interpreting the origins of the Depression, the distinction between the monetary base (currency plus bank reserves), which the Fed controls directly, and the money supply (currency plus bank deposits) is crucial. The monetary base went up during the early years of the Great Depression, rising from an average of $6.05 billion in 1929 to an average of $7.02 billion in 1933. But the money supply fell sharply, from $26.6 billion to $19.9 billion. This divergence mainly reflected the fallout from the wave of bank failures in 1930-1931: as the public lost faith in banks, people began holding their wealth in cash rather than bank deposits, and those banks that survived began keeping large quantities of cash on hand rather than lending it out, to avert the danger of a bank run. The result was much less lending, and hence much less spending, than there would have been if the public had continued to deposit cash into banks, and banks had continued to lend deposits out to businesses. And since a collapse of spending was the proximate cause of the Depression, the sudden desire of both individuals and banks to hold more cash undoubtedly made the slump worse.

Friedman and Schwartz claimed that the fall in the money supply turned what might have been an ordinary recession into a catastrophic depression, itself an arguable point. But even if we grant that point for the sake of argument, one has to ask whether the Federal Reserve, which after all did increase the monetary base, can be said to have caused the fall in the overall money supply. At least initially, Friedman and Schwartz didn't say that. What they said instead was that the Fed could have prevented the fall in the money supply, in particular by riding to the rescue of the failing banks during the crisis of 1930-1931. If the Fed had rushed to lend money to banks in trouble, the wave of bank failures might have been prevented, which in turn might have avoided both the public's decision to hold cash rather than bank deposits, and the preference of the surviving banks for stashing deposits in their vaults rather than lending the funds out. And this, in turn, might have staved off the worst of the Depression.

An analogy may be helpful here. Suppose that a flu epidemic breaks out, and later analysis suggests that appropriate action by the Centers for Disease Control could have contained the epidemic. It would be fair to blame government officials for failing to take appropriate action. But it would be quite a stretch to say that the government caused the epidemic, or to use the CDC's failure as a demonstration of the superiority of free markets over big government.

Yet many economists, and even more lay readers, have taken Friedman and Schwartz's account to mean that the Federal Reserve actually caused the Great Depression-that the Depression is in some sense a demonstration of the evils of an excessively interventionist government. And in later years, as I've said, Friedman's assertions grew cruder, as if to feed this misperception. In his 1967 presidential address he declared that "the US monetary authorities followed highly deflationary policies," and that the money supply fell "because the Federal Reserve System forced or permitted a sharp reduction in the monetary base, because it failed to exercise the responsibilities assigned to it"-an odd assertion given that the monetary base, as we've seen, actually rose as the money supply was falling. (Friedman may have been referring to a couple of episodes along the way in which the monetary base fell modestly for brief periods, but even so his statement was highly misleading at best.)

That takes care of the depression arguments at least, but how about the failure of Friedman's pet theory - monetarism?

First, when the United States and the United Kingdom tried to put monetarism into practice at the end of the 1970s, both experienced dismal results: in each country steady growth in the money supply failed to prevent severe recessions. The Federal Reserve officially adopted Friedman-type monetary targets in 1979, but effectively abandoned them in 1982 when the unemployment rate went into double digits. This abandonment was made official in 1984, and ever since then the Fed has engaged in precisely the sort of discretionary fine-tuning that Friedman decried. For example, the Fed responded to the 2001 recession by slashing interest rates and allowing the money supply to grow at rates that sometimes exceeded 10 percent per year. Once the Fed was satisfied that the recovery was solid, it reversed course, raising interest rates and allowing growth in the money supply to drop to zero.

It's been tried people, it didn't work. Krugman in his essay includes many other examples, including in Latin America (hence Chavez) and Japan (which highlights the success of Keynesian policy).

Finally, tear apart the "invisible hand" for me Krugman:

On a more narrowly focused topic, one of Friedman's key targets was what he considered the uselessness and counterproductive nature of most government regulation. In an obituary for his one-time collaborator George Stigler, Friedman singled out for praise Stigler's critique of electricity regulation, and his argument that regulators usually end up serving the interests of the regulated rather than those of the public. So how has deregulation worked out?

It started well, with the deregulation of trucking and airlines beginning in the late 1970s. In both cases deregulation, while it didn't make everyone happy, led to increased competition, generally lower prices, and higher efficiency. Deregulation of natural gas was also a success.

But the next big wave of deregulation, in the electricity sector, was a different story. Just as Japan's slump in the 1990s showed that Keynesian worries about the effectiveness of monetary policy were no myth, the California electricity crisis of 2000-2001-in which power companies and energy traders created an artificial shortage to drive up prices-reminded us of the reality that lay behind tales of the robber barons and their depredations. While other states didn't suffer as severely as California, across the nation electricity deregulation led to higher, not lower, prices, with huge windfall profits for power companies.

Those states that, for whatever reason, didn't get on the deregulation bandwagon in the 1990s now consider themselves lucky. And the luckiest of all are those cities that somehow didn't get the memo about the evils of government and the virtues of the private sector, and still have publicly owned power companies. All of this showed that the original rationale for electricity regulation-the observation that without regulation, power companies would have too much monopoly power-remains as valid as ever.

Should we conclude from this that deregulation is always a bad idea? No-it depends on the specifics. To conclude that deregulation is always and everywhere a bad idea would be to engage in the same kind of absolutist thinking that was, arguably, Milton Friedman's greatest flaw.

I love Krugman. Maybe he could lead the anti-Friedman counter revolution?

Labels: economics

Hey, anyone else think that people who make these rational actor economics arguments are totally full of shit?

This diary at Kos extensively documents the proof that they are. I'm glad someone got around to damning these arguments for me. I simply don't have the time. But every time I do see research on consumer behavior or economic decision making the exact opposite of what the economists claim seems to be true. The consumer tends to make exactly the opposite of the right decision when faced with a choice. Consumers rely on information from misleading advertisements, poorly-written and researched news articles, pretty labels, etc., to dissuade them from doing things like buying generics, purchasing efficient vehicles, or avoiding fraudulent or worthless products.

This, more than anything, is why I think the Milton Friedman/libertarian types are full of shit. Whenever their arguments are studied scientifically, they're proven wrong.

Labels: economics, kos, libertarians