In Which Paul Krugman Notices How Very Few Students Milton Friedman Has…

Paul Krugman succumbs once again to shrill unholy madness: Ph’nglui mglw’nafh Friedman R’lyeh wgah’nagl fhtagn!! This time it is over the observation that, as I put it, John Maynard Keynes has lots of disciples–people who believe that the macroeconomy can easily destabilize itself or be easily destabilized by inept policy rules (that should keep Nick Rowe quiet)–and Friedrich von Hayek has lots of disciples–people who believe that recessions are the market’s judgment upon the feckless, and that it would be both impious and counterproductive to interfere with the market, blessed be its unholy name–but Milton Friedman’s halfway house has no occupants today. Well, Scott Sumner. And James Pethokoukis. But even Nick Rowe is more a Clower-Leijonhufvud kind of guy. And Friedman’s wingpersons, like Allan Meltzer and Anna Jacobsen Schwartz, became more and more Hayekian as the tide of Friedman’s influence began to ebb.

At the level of economists’ ideology it is clear what is going on: If significant macroeconomic failures exist that can only be remedied if the central bak via fancy footwork adjusts and readjusts outside financial asset stocks to make Say’s Law true in practice, then the argument that the market always does well has one big huge counterexample. Friedman finessed that question by presenting fancy footwork adjusting and readjusting outside financial asset stocks to make Say’s Law true in practice as a “neutral” monetary policy. And via fast and aggressive talking he could carry the day as long as he was around. But once he was no longer around to talk faster than his interlocutors could think, those whose principal allegiance was to market perfection came under enormous psychological pressure to find a way to get rid of the anomalous macroeconomic edge case, and so fell into Hayekism.

At the level of economists’ nationality it is equally clear what is going on: German (and French) economists grew up and lived in a world where somebody else–the benevolent Kindlebergian hegemon of the United States–took on the task of maintaining a stable level of aggregate demand in the North Atlantic as a whole. With the possibility of large hemisphere-wide demand shortfalls ruled out, it made intellectual, pragmatic, and policy sense to focus on the “structural”.

But at the level of economic technocracy? Eppur si muove: Keynesianism, broadly defined, helps understand the world. Ordoliberal Hayekianism does not. The technocrats of the eurozone have a lot of explaining to do–to themselves, to their political masters, and ultimately to the continent’s worth of people whom they have failed.

Paul Krugman: Milton Friedman, Irving Fisher, and Greece: “I continue to be amazed by how many people regard debt relief and devaluation…

…as wild-eyed radical ideas; of course, it matters most that so many influential people in Europe share this ignorance. Anyway, for the record (and for my own future reference) I thought it would be helpful to post what Milton Friedman and Irving Fisher had to say about the Greek disaster. OK, they weren’t writing specifically about Greece–Friedman was writing in 1950, Fisher in 1933. But their analyses ring truer than ever.

First, Friedman (why oh why isn’t there a full electronic copy of this essay online?):

If internal prices were as flexible as exchange rates, it would make little economic difference whether adjustments were brought about by changes in exchange rates or by equivalent changes in internal prices. But this condition is clearly not fulfilled. The exchange rate is potentially flexible in the absence of administrative action to freeze it. At least in the modern world, internal prices are highly inflexible. They’re more flexible upward and downward, but even on the upswing all prices are not equally flexible.

The inflexibility of prices, or different degrees of flexibility, means and distortion of adjustments in response to changes in external conditions. The adjustment takes the form primarily of price changes in some sectors, primarily of output changes in others.

Wage rates tend to be among the less flexible prices. In consequence, an incipient deficit that is countered by a policy of permitting or forcing prices to decline is likely to produce unemployment rather than, or in addition to, wage decreases. The consequent decline in real income reduces the domestic demand for foreign goods, and thus the demand for foreign currency with which to purchase these goods. In this way, it offsets the incipient deficit.

But this is clearly a highly inefficient method of adjusting to external changes. If the external changes are deep-seated and persistent, the unemployment produce a steady downward pressure on prices and wages, and the adjustment will not have been completed until the deflation has run its sorry course.

That tells you everything you need to know about why ‘internal devaluation’ has been such a costly strategy–and why the ECB’s failure to move aggressively early on to achieve and if possible surpass its 2 percent inflation target was a major contributing factor to this disaster.

Then Fisher on why austerity hasn’t even helped on the debt:

(32) And, vice versa, deflation caused by the that reacts on the debt. Each dollar of debt still unpaid becomes a bigger dollar, and if the over-indebtedness with which we started was great enough, the liquidation of debts cannot keep up with the fall of prices which it causes. In that case, the liquidation defeats itself. While it diminishes the number of dollars owed, it may not do so as fast as it increases the value of each dollar owed. Then, the very effort of individuals to lessen their burden of debts increases it, because of the mass effect of the stampede to liquidate in swelling each dollar owed. Then we have the great paradox which, I submit, is the chief secret of most, if not all, great depressions: The more the debtors pay, the more they owe. The more the economic boat tips, the more it tends to tip. It is not tending to write itself but is capsizing.

The basic story of the European periphery–not just Greece–is one of a poisonous interaction between Friedman and Fisher, which has produced incredible suffering while failing to reduce the debt/GDP ratio, which even in star pupils like Ireland and Spain is far higher than when austerity began; the only success has been in suffering long enough so that some growth has finally resumed, and they can call it vindication.

The bizarreness of the whole thing is how flaky, speculative ideas like expansionary austerity became orthodoxy, while applying the economics of Fisher and Friedman became heterodoxy bordering on Chavismo.

July 7, 2015

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