The genius that was Milton Friedman

Going back over old posts, I found one from 6 years ago that covered Milton Friedman. That was in Portuguese, and here I have more.

This is taken from the Q&A following Friedman´s Keynote Address at a Bank of Canada Conference in 2000. Here´s Friedman, on the hot topics of today: The Euro, Inflation Targeting operated primarily through interest rates, and Japan

Michael Bordo: Do you think the recent introduction of the euro will lead to the formation of other common-currency areas?

Milton Friedman: That’s an extremely interesting question. I think that the euro is one of the few really new things we’ve had in the world in recent years. Never in history, to my knowledge, has there been a similar case in which you have a single central bank controlling politically independent countries.

The gold standard was one in which individual countries adhered to a particular commodity—gold—and they were always free to break or to leave it, or to change the rate. Under the euro, that possibility is not there. For a country to break, it really has to break. It has to introduce a brand new currency of its own.

I think the euro is in its honeymoon phase. I hope it succeeds, but I have very low expectations for it. I think that differences are going to accumulate among the various countries and that non-synchronous shocks are going to affect them.

Right now, Ireland is a very different state; it needs a very different monetary policy from that of Spain or Italy. On purely theoretical grounds, it’s hard to believe that it’s going to be a stable system for a long time. On the other hand, new things happen and new developments arise.

The one additional factor that has come out that leads me to raise a question about this is the evidence that a single currency—currency unification— tends to very sharply increase the trade among the various political units. If international trade goes up enough, it may reduce some of the harm that comes from the inability of individual countries to adjust to asynchronous shocks. But that’s just a potential scenario.

You know, the various countries in the euro are not a natural currency trading group. They are not a currency area. There is very little mobility of people among the countries. They have extensive controls and regulations and rules, and so they need some kind of an adjustment mechanism to adjust to asynchronous shocks—and the floating exchange rate gave them one. They have no mechanism now. If we look back at recent history, they’ve tried in the past to have rigid exchange rates, and each time it has broken down. 1992, 1993, you had the crises. Before that, Europe had the snake, and then it broke down into something else. So the verdict isn’t in on the euro. It’s only a year old. Give it time to develop its troubles.

(Note: and the troubles developed)

Malcolm Knight: Countries with a flexible exchange rate need a nominal target for monetary policy to anchor expectations. Do you feel that inflation targeting provides a useful nominal target?

Milton Friedman: As I mentioned earlier, I think it’s a good thing to have a nominal target, to say that you’re not going to try to fine-tune, and to indicate what you aren’t going to do.

The problem I have is this: the current mechanism for all of the central banks who are inflation targeting is a short-term interest rate—as in the United States—in all of the central banks.

We know from the past that interest rates can be a very deceptive indicator of the state of affairs. A low interest rate may be a sign of an expansive monetary policy or of an earlier restrictive policy. And similarly, a high rate may be a sign of restriction, of trying to hold things down; or it may be a sign of past inflation.

The 1970s offer the classical illustration in which there were high interest rates that were reflecting the Fisher effect of inflation expectations. So I’m a little leery of operating primarily, or almost primarily, via interest rates. But, I think that having a given inflation target is a good objective. The question is, how long will you be able to keep it?

David Laidler: Many commentators are claiming that, in Japan, with short interest rates essentially at zero, monetary policy is as expansionary as it can get, but has had no stimulative effect on the economy. Do you have a view on this issue?

Milton Friedman: Yes, indeed. As far as Japan is concerned, the situation is very clear. And it’s a good example. I’m glad you brought it up, because it shows how unreliable interest rates can be as an indicator of appropriate monetary policy.

The Japanese bank has supposedly had, until very recently, a zero interest rate policy. Yet that zero interest rate policy was evidence of an extremely tight monetary policy. Essentially, you had deflation. The real interest rate was positive; it was not negative. What you needed in Japan was more liquidity.