TCS Daily

Kuttner v. Friedman; Hamlet Without the Prince

By Arnold Kling - January 6, 2006 12:00 AM

"A signature Friedman debating technique is to disclaim knowledge when conversation moves into an area where the facts are at odds with his theories."
-- Robert Kuttner, The American Prospect

If you want to read the debate between Robert Kuttner and Milton Friedman yourself in order to decide who won, feel free. Not taking any chances, Kuttner wrote his own evaluation, quoted above.

The subject of this article is Kuttner's column about the debate, rather than the debate itself -- Kuttner the fight judge, not Kuttner the boxer. I was particularly struck by Kuttner's statement above. Evidently, the concept of genuine humility is so foreign to Kuttner that he regards an expression of humility as a debating tactic. In a sense, that is why Kuttner belongs on the left. Contemporary liberalism without hubris is Hamlet without the Prince.


Kuttner reports round one as follows:

"after the stock market collapse of 2000-2001, Greenspan led the Fed to cut interest rates 12 times in a year, reducing the short-term interest rate effectively to zero.

"Greenspan opened the monetary floodgates...In short, despite Friedman's obsession with money supply, it took a very loose monetary policy by the Fed coupled with major interventions in the banking system plus a very stimulative budget (helped along by the willingness of foreign central banks to continue lending America money) to keep the post-crash economy from sinking into deflation and deep recession. Whatever Greenspan did, he neither put the money supply on automatic pilot nor passively targeted price stability."

Both Friedman and Kuttner believe that monetary policy after the stock market crash was constructive. The difference between the two is that Friedman argues that the Fed kept the money supply growing, while Kuttner argues that the Fed intervened to keep the money supply growing. Furthermore, he contends, because the Fed intervened, that proves that left-leaning economists, who favor government intervention, are correct.

What is the difference between keeping the money supply growing and intervening to keep the money supply growing? There is no such difference in monetary economics. In the money market, there is a relationship between the interest rate controlled by the Fed, called the Fed Funds rate, and the money supply. If a financial shock threatens to reduce money growth and the Fed wants to offset the shock, then it has to reduce the interest rate. If it refuses to "intervene" in this way, the money supply will fall below target. It could be said that Friedman has always favored "intervention" to maintain stable money growth; however, by Keynesian standards, this is a passive, noninterventionist policy rule.

Ironically, in the debate, Friedman did admit to a departure from one of the tenets of monetarism, which is that the velocity of money can be viewed as roughly constant. Instead, he suggests that the velocity of money drops when there is a stock market crash, and that it is wise to offset this drop in velocity with faster money growth. Kuttner might have done better to press Friedman on this point.

Currency Markets

Friedman, a longtime proponent of flexible exchange rates, argues that the Federal Reserve should leave foreign currency markets alone. Kuttner writes,

"If, for example, the U.S. currency tumbled in world financial markets, the Fed would be torn between a policy of tight money to stem the dollar's fall and loose money to keep the domestic economy out of severe recession."

Here, Kuttner is confused. If a recession were to coincide with a decline in the dollar, the causal factor would be the recession. However, that is not what Kuttner has in mind. What he appears to be contemplating is a thought-experiment in which speculators autonomously drive down the value of the dollar.

Conventional macroeconomics says that such an autonomous, speculative decline in the value of the dollar would not cause a recession. On the contrary, it would increase exports and reduce imports, and thus would be expansionary/inflationary. There is absolutely no reason to loosen the money supply under such a scenario.

On the larger point, about whether the government should allow market forces to determine the value of the dollar, economists are nearly unanimous in their support of Friedman. (The only exceptions are economists who prefer a gold standard.) Friedman believes that speculators may be mistaken, but it is difficult for governments to intervene effectively in currency markets. The overwhelming weight of empirical evidence is on his side. I do not know of any important American economist arguing for currency intervention today. (Many economists would argue for policies to influence America's savings rate, which in turn would affect the dollar. See The Balance of Saving.)

The Natural Rate of Unemployment

Kuttner writes,

"Another favorite Friedman idea was a "natural rate of unemployment" -- the rate of joblessness that would keep prices roughly stable, supposedly around 6 percent. If governments or central bankers tried to reduce unemployment below this ostensibly natural rate, inflation would result, because workers in tight labor markets could bargain for wage increases in excess of their actual productivity.

"However, the rate of unemployment that is consistent with stable prices turns out not to be a constant or knowable number, hence not a reliable target for monetary policy."

Kuttner has apparently missed the point of the concept of a natural rate of unemployment, which is that the unemployment rate should not be a "target for monetary policy." What Friedman means by the term natural unemployment rate is the rate toward which the economy will gravitate without any attempt at activist management by government. It is because the economy will settle on this natural rate that the Fed should not intervene to manipulate unemployment. If you are not intervening to manipulate the unemployment rate, then the accuracy of your measure of the natural rate of unemployment is irrelevant. Uncertainty about the level of the natural rate is a problem only for the opponents of Friedman, who are interventionists.

Health Care and Schools

On health care and schools, Kuttner writes,

"When pressed, he [Friedman] concedes that government ought to provide 'catastrophic' health insurance for people who can't afford to buy it, but as a humanitarian act of charity and not as an act of economic efficiency.

"...Friedman makes similar arguments about schooling. In his ideal world, government would cease providing, or even financing, schools entirely. 'My ideal school system,' he told me, 'would be one in which parents are responsible for supporting [the education of] their children, as they are responsible for feeding and clothing them.' He added, 'If government has any role at all, it is solely on a humanitarian basis, for those cases of indigent families who simply cannot afford to school their child.'"

Kuttner does not address these views. Perhaps he believes that they are self-evidently wrong. For those of us who are more inclined to think that Friedman's views are self-evidently right, I wish that Kuttner had provided more argument. For example, I would concede that there are parents who do not seem to have the motivation and the means to ensure that their children are educated. So far, however, judging by the performance of schools attended by such children, the government is unable to solve the problem. However, if Kuttner has ideas for overcoming dysfunctional parents, I am ready to listen.

Uncomfortable Facts

The quote that I used at the beginning of this essay, in which Kuttner accuses Friedman of pleading ignorance to uncomfortable facts, is followed immediately by:

"For example, self-regulation obviously failed investors in the multiple insider-trading, self-dealing, and stock promotion scandals of the late 1990s that in turn led to the stock-market bubble. Insiders ripped off investors by cooking corporate books, misallocating trillions of dollars of investment capital."

This is the first I have heard of the hypothesis that scandals caused the stock bubble. I have found many economists who think of it the other way around -- scandals seem to be a feature of the final phase of a stock bubble. Their explanations for the bubble tend to focus on investors' expectations -- for the economy, the profitability of Internet stocks, and the behavior of other investors. Many economists draw a comparison with the railroad boom 150 years earlier.

This is also the first time I have heard that corporate accounting scandals resulted in "misallocating trillions of dollars of investment capital." According the U.S. National Income Accounts, total nonresidential fixed investment in the U.S. barely tops $1 trillion per year. Kuttner is saying that more than 100 percent of one year's purchases of plant and equipment went down the toilet. If such an enormous misallocation had occurred, then productivity would have declined sharply. That is hardly the case.

In Kuttner's view, these are the "facts" of which Milton Friedman disclaimed knowledge. Was the Nobel Laureate being evasive, or overly polite?

Genuine humility is a feature of libertarian conservatism, which may be the fundamental reason that it differs from neoconservatism. If you think you have all of the answers, then it is difficult to resist passing No Child Left Behind Laws and other expressions of government hubris. Libertarian conservatives believe that we do not know enough to justify imposing our will on others through government. Supporters of activist government believe they know more than we do. I fear that they know less.

Arnold Kling is author of Learning Economics.


Blind hatred
Our Blind hatred of the "left" has led you to right another waster of disk space Arny. Your one dimensional view of the world means you have little to contribute. Sure you may be right some times (like everyone is) but it's your inability to except you might be wrong about something is what turns most people off. Your more interested in trying to score a point then finding a solution.

Role of Government
“Libertarian conservatives believe that we do not know enough to justify imposing our will on others through government.”

Many individual and government policies/actions are made/taken based on less than optimal information. The lack Perfect (or even sufficient) information does not obviate the necessity for decision and action. Based on imperfect evidence, citizens must decide the role of their government. When individuals or consumers purchase a product or service, they use an evaluation process to find the “best” choice. The role of government should work similarly…citizens should assign to government those responsibilities (and only those) for which government has demonstrated unique competencies and can provide the “best” solution. The Common Defense and law & order are readily defendable as government competencies. Beyond these, all other government “intervention” is not clearly supported by the preponderance of the evidence and should be continually challenged. And as far as monetary policy goes, the FED’s historical record is hardly without blemish and the premise that monetary control can be used to beneficially manage an economy is at best marginally established.

In the end, citizens will suffer the consequences when either they or their government makes mistakes. Absent clear evidence of value-added capability from government action, the responsibility for action (education, health care, retirement …) should reside with the citizen…as the Constitution requires.

Government should also manage traditionally common property
To your short list ‘The Common Defense and law & order are readily defendable as government competencies.’ I would add government should manage traditionally common property like local roads waterway ground water and air as long there is no practical way to privatize them.

The only blind hatred I am feeling right now, is comming from wwgeek1.

Regardless, sometimes there are no solutions. Pointing this out is an effective policy position.

Kuttner v. Friedman
I've been reading Kuttner for years. I've never gotten the impression that he was interested in economics. Every argument of his I've read is utterly dependent on a politically convenient assumption that he never thinks is worth validating. If you don't share his assumptions -- whatever they are -- you'll see through his argument. You'd think he'd want to talk you into sharing his assumptions.

I trust a Kuttner analysis of a debate with Friedman as much as I'd trust a punk's review of the fight he'd just had with a heavyweight champion.

Let's not forget all the economists who assured us that Reaganomics couldn't possibly work. They wrote at length how it couldn't work, and at every slight downturn (in any statistic) they'd tell us that the benefits of Reaganomics were coming to their inevitable end. When Reaganomics turned out to be an unquestionable success, these "economists" tried to argue that recovery happened naturally, or that Volker tightening the loan rate had been sufficient. You don't have to be an economist to know that's ludicrous.

Founders Agree
"The role of government should work similarly…citizens should assign to government those responsibilities (and only those) for which government has demonstrated unique competencies and can provide the “best” solution. "

This is why the Constitution is supposed to be a limit to federal power and nearly unlimited power to the states. That way bad policies won't sink the entire ship and good policies could be adopted in to the fedeal level.
Since Lincoln and on through Roosevelt (FDR) the trend has been to nationalize instead of federalize.
Maybe we can start steering back to the federal plan.

I think they are both wrong.
There is no way known for a small group of individuals to manage the supply of money in an economy. What happens is that the money supply folks increase it and hope that the corresponding rise in prices doesn't happen too fast and require too big of an adjustment. This process steals wealth from investors and gives it to debtors the biggest of which is the government who happens to be the manager of the money supply.

The Internet Bubble example in the article shows the folly of central banking. From Kuttner, the Fed sprang into saving the world mode and flooded the economy with money. The other savior, congress, spent more (based on the cheap credit from the Fed.) and that added to the saving of the world from accounting fraud. This whole argument overlooks the fact that accounting fraud happened after the investments were made but that is a separate issue. The corresponding expansion in money and credit made some other bubbles in commodities and realestate that are now popping.

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