The Corner

Re: What Would Milton Friedman Say?

My friend Todd Zywicki, a professor of law at George Mason and a frequent blogger on the Volokh Conspiracy, wonders whether I haven’t sold Milton Friedman short. 

In my column for Forbes this week, I write that Milton would have known we were in trouble the moment the housing bubble burst.  Todd argues that Milton would have seen the trouble a lot sooner:

I would argue that the price bubble in the housing market was [itself] a monetary phenomenon.  The Fed pushed down short-term interest rates post-9/11 to prevent recession.  This caused a big gap between short-term and long-term interest rates.  This did two things.  First it brought in speculators who borrowed at the artificially short-term rate with a plan to flip the house/condo quickly.  Second, it allowed many regular borrowers to qualify for larger principal amounts on homes by taking out ARMs or hybrids at the lower short-term rates.  When the Fed then started raising short-term rates this caused an upward ratchet on the ARM rate and raised monthly payment obligations.

So I’d say that Milton would’ve seen that coming too.

That may very well be so.  But it’s worth noting that Milton went on record in favor of Fed’s efforts in increase liquidity after 9/11–and, for that matter, before 9/11 as well.  (He was reluctantly in favor, but in favor all the same.)  Look at this exchange from my Uncommon Knowledge interview with Milton on Sept. 25, 2001, just two weeks after the terrorist attack:

Milton Friedman:    …let me show you what the dilemma that Alan Greenspan and the Fed were in because this is not the typical circumstance. You’re at the Fed, you’re Mr. Greenspan, what are you looking back at? You’re looking back at the fact that the 1990’s in the United States was an incredible period of rapid expansion, both in the economy and especially in the stock market. What prior example do you think of? The 1920’s…

Peter Robinson:    That’s what I think of.

Milton Friedman:    …almost identically the same rate of inflation of the twenties, well lack of inflation, low inflation in the twenties but enormous increase in the–in the market, a great bull market. The economy very much in a good shape. And the twenties, like the nineties, were brought about by technological innovation and change. In the twenties, it was the adaptation to the electricity and to the automobile. In the nineties, we all know that it was the computer, the Internet and so on. What other example do you think of? The 1980’s in Japan. Identical pattern. Rapid economic growth as a result of technological improvement and change, a bull market, ‘29 and ‘89, what do you observe afterwards?

Peter Robinson:    Bad events.

Milton Friedman:    Bad, bad, bad. ‘29, a catastrophe. In–in ‘89 in Japan, stagnation for a ten-year period. All right, now you’re Mr. Greenspan looking back at those episodes, what are you going to say to yourself? You’re going to say, if I have to take a chance, I’d rather take a chance on a little inflation than on producing–re–on–on reproducing those episodes.


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