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Milton Friedman Says Boost Money Supply

By David Francis / February 7, 1992



JUST short of three decades ago, Milton Friedman and Anna Schwartz starred at a news conference in New York City publicizing their book, "A Monetary History of the United States, 1867-1960." The fat volume immediately stirred up a storm among economists.

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Further, since the book accused the Federal Reserve System of inadvertently causing the Great Depression and subsequent recessions, it prompted alarm at the central bank. A spokesman at the Federal Reserve Bank of New York quickly called in the press to refute the "monetarist" thesis of the two economists.

Today, the Friedman-Schwartz theory that the rate of growth in the nation's money supply is highly important to future trends in the business cycle and to inflation is orthodoxy among economists, as Dr. Friedman noted this week in a telephone interview.

However, the impact of that theory on actual monetary policy is "more difficult to measure," he adds.

The Fed does not consistently follow a monetarist prescription for monetary policy. With near certainty, that default prompts a rebuke from the peppery leader of the monetarist school of economics, now a Nobel laureate.

"I have criticized the Fed for at least three decades for using interest rates rather than the quantity of bank reserves as their operating basis," says Friedman from his California home.

Right now, he blames the current weakness in the economy on the Fed's failure to keep near the 4.5 percent mid-point of its own 2.5 percent to 6.5 percent target range for money growth, particularly in the last half of 1991. A broad measure of money, M2, grew at an annual rate of only 1.3 percent from the second quarter of 1991 until the final quarter of the year.

"The Fed has been unwittingly restrictive," says Dr. Schwartz, who still works for the National Bureau of Economic Research in New York - as she did 30 years ago.

The word "unwittingly" refers to a finding by Robert Laurent, senior economist at the Fed branch in Chicago, and Paul Kasriel of the Northern Trust Company, that the slow growth in money resulted from the unintended removal of billions of dollars from the economy last year when government agencies shut down a host of banks and savings-and-loan associations.

Friedman accepts the Laurent-Kasriel finding, but adds: "That's a reason - not an excuse for the Fed." The Fed, he notes, can boost money growth by adding enough money to bank reserves and ignoring whether this action results in a sharp further decline in interest rates. Though the Fed has reduced interest rates 15 times since the start of the recession in July 1990, that decline results from a drop in the demand for money as economic activity slowed. It does not automatically mean a stimulative monetary

policy has been followed, argues Friedman.

"Relatively low interest rates are not a sign that the Fed has been expanding too rapidly," he says.

Friedman applauds the recent efforts of the Fed to reduce the growth of the money supply to bring inflation down from around 5 percent to perhaps 1 percent. But this should be done "gradually" over four or five years, not all at once. The recovery that started last spring petered out when the Fed did not supply enough money to the economy, he says.

Key Fed officials met in Washington Tuesday and Wednesday to consider monetary policy. Friedman expects them to step on the monetary gas again if necessary to get the money supply growing more quickly. Speaking of the Laurent-Kasriel finding, he says: "They are not going to let that happen again." So he anticipates economic growth will step up its pace in about six months or so - the usual lag between a changed monetary policy and its impact on national output. "The recession is not going to degenerate i nto another Great Depression," he says.

Friedman holds that monetary policy imposes the business cycle on top of a "basic trend of economic growth." That trend is influenced by other government policies. Here he charges President Bush with "reverse Reaganomics." Under Mr. Bush, he notes, regulations, taxes, and domestic spending have all risen rapidly - elements "counterproductive" to more rapid growth.

As Friedman sees it, the US is a strong country with great economic potential if we can get the government of our back."