Milton Friedman didn't like too much money. But he also didn't like too little money. In chapter 2 of Money Mischief he wrote:
There is strong evidence that a monetary crisis involving a substantial decline in the quantity of money is a necessary and sufficient condition for a major depression.
Insufficient money can cause a depression. If the "monetary base" grows too slowly it can cause a major downturn. That happened twice in the past hundred years:
Graph #1: Growth Rate of the Monetary Base From mine of 10 Feb 2021 The downtrend before the Great Recession runs from 2001 to 2008. |
Graph #2: Federal Debt 1970-2023 and the 2001-2023 Exponential Trend From mine of 7 March 2024 The "below trend" data before the Great Recession runs from 2004 (or before) to 2008-09. |
Graph #3: The Quantity of Transaction money per Dollar's Worth of Output The low before the Great Recession runs from 2004 to 2009. |
Fiscal and monetary policy cooperated, creating a substantial decline in the
quantity of transaction money, from the record low of 2000-01 to a level
at which our economy could no longer function.
"... substantial decline in the quantity of money is a necessary and sufficient condition for a major depression."
The evidence is overwhelming.
As an afterthought, I quote from Robert Lucas's "Ptize Lecture" of 1995:
Evidence on trade-offs is also marshalled, though in a very different way, in Friedman and Schwartz’s (1963) monograph A Monetary History of the United States. These authors show that every major depression in the United States over the period 1867-1960 was associated with a large contraction in the money supply, and that every large contraction was associated with a depression. These observations are correlations of a sort, too, but they gain force from the size of the largest contractions. In a period like the post-World War II years in the United States, real output fluctuations are modest enough to be attributable, possibly, to real sources. There is no need to appeal to money shocks to account for these movements. But an event like the Great Depression of 1929-1933 is far beyond anything that can be attributed to shocks to tastes and technology. One needs some other possibilities. Monetary contractions are attractive as the key shocks in the 1929-1933 years, and in other severe depressions, because there do not seem to be any other candidates.
Sargent (1986) also examines large, sudden reductions in rates of money growth (though not reductions in the levels of money stocks). In his case, these are the monetary and fiscal reforms that ended four of the post-World War I European hyperinflations. These dramatic reductions in growth rates of the money supply dwarf anything in Friedman and Schwartz or in the post-war data used by McCandless and Weber. Yet as Sargent shows they were not associated with output reductions that were large by historical standards, or possibly by any depressions at all. Sargent goes on to demonstrate the likelihood that these reductions in money growth rates were well anticipated by the people they affected and, because of visible and suitable fiscal reforms, were expected by them to be sustained.
... The observation that money changes induce output changes in the same direction receives confirmation in some data sets, but is hard to see in others. Large scale reductions in money growth can be associated with large scale depressions or, if carried out in the form of a credible reform, with no depression at all.
I'm not one to leap to Milton Friedman's defense. But in this case I have to. Robert Lucas presents a version of Friedman and Schwartz's view that is a satisfying equivalent of the Friedman quote in the opening of this post. But then Lucas seems to turn around and challenge Friedman's view:
These observations are correlations of a sort, too, but they gain force from the size of the largest contractions.
Lucas could have said they are correlations and they gain from the size -- thus adding the two positives together -- but he chose to say they are correlations but they gain from the size, as if the size subtracts from the significance of the correlations.
And they are only correlations of a sort.
Then, rather than appreciating Friedman's willingness to evaluate the largest contractions, Lucas minimizes Friedman's effort:
[A]n event like the Great Depression of 1929-1933 is far beyond anything that can be attributed to shocks to tastes and technology. One needs some other possibilities.
Lucas even takes advantage of an opportunity to criticize Friedman for using large contractions that were not large enough to disprove Friedman's view:
Sargent (1986) [studied] dramatic reductions in growth rates of the money supply [that] dwarf anything in Friedman and Schwartz or in the post-war data used by McCandless and Weber. Yet as Sargent shows they were not associated with output reductions that were large by historical standards, or possibly by any depressions at all.
Lucas provides the weakest support for Friedman that I have ever seen:
Monetary contractions are attractive as the key shocks in the 1929-1933 years, and in other severe depressions, because there do not seem to be any other candidates.
That's not support. Lucas is trying to undermine Friedman's view. But for crying out loud, what Friedman said (at least in Money Mischief) was
There is strong evidence that a monetary crisis involving a substantial decline in the quantity of money is a necessary and sufficient condition for a major depression.
Friedman did not say a substantial decline in the Q-of-M guarantees that a depression will follow. Lucas was being ridiculous, saying what he said. Worse than ridiculous, and I'm being polite.
Lucas concludes his thought by suggesting that good policy can prevent the depression, as if this somehow proves Friedman wrong. But surely, if policy was that good, it would not have created the substantial decline of money in the first place! And dumb luck doesn't count as good policy. It counts as luck.
Given what Lucas said, I must emphasize the point that economic policy is all-important. Lucas himself seems to miss that point, preferring to emphasize that Friedman was wrong. As if any fool could make good policy.
It takes a special kind of fool to make good policy.