I disagree with just about everything in George Will’s pro-tight-money column except its spirit. He wants the Federal Reserve to provide a context of monetary stability within which economic actors can make and coordinate their plans — and suggests, rightly in my view, that the Fed should never set any goals more ambitious than that. He thinks that the Fed should be constrained by rules, which would serve the goals of predictability and stability.
It’s in applying those principles that he goes astray:
Uncertainty is exacerbated by the Fed’s exercise of its vast discretion, including QE1, QE2 and, perhaps soon, QE3 (or QE5, including two “twists” also aimed at lowering borrowing costs). Bernanke, who promises more “policy accommodation” to support the economic recovery, is inadvertently vindicating Milton Friedman’s belief that “the stock of money [should] be increased at a fixed rate year-in and year-out without any variation in the rate of increase to meet cyclical needs.”
Friedman adopted that view at one point in his career — admittedly, the most influential point — because he thought that the velocity of money (the rate at which it changes hands, or the inverse of the demand for money balances) was fairly stable. If velocity is stable, then stabilizing the growth of the money supply stabilizes nominal spending. (The money supply × velocity = nominal spending = the price level × economic output. Or, M*V = P*Y.) Stabilizing nominal spending is the best way for a central bank to stabilize an economy, because most labor and debt contracts are negotiated in nominal terms. By stabilizing the growth of M*V or P*Y, the bank is providing the most important form of stability it can, and letting market actors make their arrangements against that backdrop.
The trouble with this Friedman idea is that velocity isn’t stable. It fell off a cliff during the financial crisis, for example. To serve the end Friedman had in mind, then, the money supply has to grow, not steadily, but in a way that balances movements in velocity. Or, to put it another way, the supply of money has to respond to changes in the demand for money balances. (Note, incidentally, that even under a constant money-growth rule the Fed should have been more expansionary during the last few years — at least as long as we’re measuring the money supply in the most appropriate way for the task.) If markets expect that to happen, then velocity will be less volatile in the first place.
Will argues that monetary expansion will lower interest rates and punish savers. He sees the low interest rates we already have as a sign that the Fed has run an expansive policy. Friedman, however, cautioned against that sort of inference. Low interest rates, he said, can be a sign of a monetary policy that is too tight. By depressing an economy, tight money can lower returns on investment. In that case, looser money might be needed to help savers. He specifically recommended that the central bank make large-scale asset purchases on one occasion when he made that diagnosis.
Will has the right impulses and the right guru, in other words; he just needs to reverse all of his conclusions.
— Ramesh Ponnuru is a senior editor ofNational Review.