Robert E. Hall and Thomas J. Sargent: Short-Run and Long-Run Effects of Milton Friedman’s Presidential Address

Should-Read: WTF?! Real economic outcomes are not invariant to the monetary policy rule. A gold standard, a silver standard, adoption or non-adoption of Bagehot’s Rule, a constant stock of high-powered money rule, a constant broad money stock rule, a k% growth rate rule, a k% growth rate rule with base drift, a k% growth rate rule with catchup after unexpected shortfalls, inflation targeting, price level targeting, inflation targeting switching to price level targeting with catchup at the ZLB—to claim that “real outcomes are invariant to the monetary policy rule, not just to the trend in inflation” is to ignore most of monetary economics. Why are these people writing this?: Robert E. Hall and Thomas J. Sargent Short-Run and Long-Run Effects of Milton Friedman’s Presidential Address: “The immediate effect of Friedman’s 1968 AEA presidential address on the economics profession was the introduction of an adaptive term in the Phillips curve…

…that shifted the curve, as Friedman proposed, based on expected inflation. Initial formulations suggested that the shift was less than point-for-point, but later thinking, based on the emerging idea of rational expectations, together with the experience of the 1970s, came to agree with Friedman that the shift was by the full amount. The profession also recognized that Friedman’s point was deeper—real outcomes are invariant to the monetary policy rule, not just to the trend in inflation. The presidential address made an important contribution to the conduct of monetary policy around the world. It ushered in low and stable inflation rates in all advanced countries, and in many less advanced ones…

Much, much better would have been to simply parrot John Maynard Keynes (1924): Tract on Monetary Reform: “Inflation and Deflation… inflicted great injuries…

…Each as an effect in altering the distribution of wealth, Inflation in this respect being the worse…. Each has also an effect in overstimulating or retarding the production of wealth though here Deflation is the ore injurious…. How have the price changes of the past nine years affected the productivity of the community… and… the conflicting interests and mutual relations of its component classes? The answer to these questions will serve to establish the gravity of the evils….

If the depreciation of money is a source of gain to the business man [nominal debtor], it is also the occasion of opprobrium…. No man of spirit will consent to remain poor if he believes his betters to have gained their goods by lucky gambling. To convert the business man into the profiteer is to strike a blow at capitalism, because it destroys the psychological equilibrium which permits the perpetuance of unequal rewards…. If the fall in the value of money discourages investment, it also discredits enterprise….

Inflation redistributes wealth…. Its most striking consequence is its injustice to those who in good faith have committed their savings to titles to money rather than to things…. Injustice on such a scale has further consequences…. Inflation has… destroyed the atmosphere of confidence which is a condition of the willingness to save….

We see, therefore, that rising prices and falling prices each have their characteristic disadvantage. The Inflation which causes the former means Injustice to individuals and to classes, particularly to investors; and is therefore unfavourable to saving. The Deflation which causes falling prices means Impoverishment to labour and to enterprise by leading entrepreneurs to restrict production, in their endeavour to avoid loss to themselves; and is therefore disastrous to employment.

The counterparts are, of course, also true,—namely that Deflation means Injustice to borrowers, and that Inflation leads to the over-stimulation of industrial activity. But these results are not so marked as those emphasized above, because borrowers are in a better position to protect themselves from the worst effects of Deflation than lenders are to protect themselves from those of Inflation, and because labour is in a better position to protect itself from over-exertion in good times than from under-employment in bad times.

Thus Inflation is unjust and Deflation is inexpedient. Of the two perhaps Deflation is, if we rule out exaggerated inflations such as that of German, the worse; because it is worse, in an impoverished world, to provoke unemployment than to disappoint the rentier. But it is not necessary that weigh one evil against the other. It is easier to agree that both are evils to be shunned.

Individualistic Capitalism of to-day, precisely because it entrusts saving to the individual investor and production to the individual employer, presumes a stable measuring-rod of value, and cannot be efficient—perhaps cannot survive—without one.

For these grave causes we must free ourselves from the deep distrust which exists against allowing the regulation of the standard of value to be the subject of deliberate decision. We can no longer afford to leave it in the category of which the distinguishing characteristics are possessed in different degrees by the weather, the birth-rate, and the Constitution,—matters which are settled by natural causes, or are the resultant of the separate action of many individuals acting independently, or require a Revolution to change them…