What would Milton Friedman have said about QE……”3”?

I am genuinely interested in what he would have said, but not about quantitative easing per se, because he was obviously pro quantitative easing if there were issues about insufficient growth in the monetary base.

In a Wall Street Journal article of August 19, 2003 he said:

A convenient way to explain the Fed’s problem is with a truism called the quantity equation of money: the quantity of money (M) times the velocity of circulation (V) equals the price level (P) times output (y), MV=Py.

The Fed does not control directly any of the variables in this equation. For all practical purposes, the Fed controls one thing and one thing only: the volume of its own obligations — that is, high-powered money or the base. (The Fed controls the amount of high-powered money through open-market operations: when it buys The Fed’s Thermostat securities, it adds to the base; when it sells securities, it subtracts from the base.

What I do believe is that he was not particularly in favour of yanking policy too far in either direction.  In another article for the Wall Street Journal in 1997, Reviving Japan, Milton Friedman made the following comments:

..at the Louvre conference in February 1987… Japan, as its part of the deal, bought dollars, in the process creating yen. The resulting acceleration in monetary growth led to higher inflation and, initially, to higher real growth. The most notable result was the “bubble economy,” an explosion in the prices of land, stocks, and other assets; the Nikkei stock index more than doubled in three years.

The Bank of Japan reacted belatedly in 1990, reducing monetary growth from 13 percent to less than 3 percent in the first year of the new policy and to negative rates in the second–too much of a good thing. Tight money was spectacularly effective; the stock market, and also nominal income growth, plunged. Low inflation turned into actual deflation by 1994.

The surest road to a healthy economic recovery is to increase the rate of monetary growth, to shift from tight money to easier money, to a rate of monetary growth closer to that which prevailed in the golden 1980sbut without again overdoing it. That would make much-needed financial and economic reforms far easier to achieve.

The question is therefore, how much quantitative easing is too much and how much is too little?

As the following chart comparing the Japanese and US monetary base shows, Japan did appear to have allowed the monetary base to decline during the 1990s compared to the US trajectory, but the US response to its own monetary problems is of a totally different order of magnitude.  This is where we are today without any further QE.  What on earth will the future look like?


In fact the growth rate of the US monetary base had been in decline up to 2007:


But velocity had been expanding up till the crisis:


The problem is that the Federal Reserve and its academic cheerleaders are only focussing on a narrow monetary aggregate and an equilibrium assumption that economic activity is directly related to growth in the monetary base.  Hence the current crisis in their minds might be considered solely a monetary phenomenon and not relationships that are well out of equilibrium.   We appear to be pushing much too far on the monetary string, when in fact there is already enough money supply in the economy to get things moving if lack of monetary growth was the only problem.   We need a real catalyst to get things moving and not what is by now an excessive monetary catalyst.  

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