Monday, November 16, 2009

Milton Friedman's Mischief

On the left is a scan of one of the graphs from Milton Friedman's book Money Mischief; on the right is a tweak of that scan.  [Regarding the tweak...]

For the figure on the left, I moved the "Figure 3" label to the bottom and reduced the size of the text below the "Figure 3". Otherwise this figure is not retouched.

In the figure on the right, I moved the label, reduced the text, and shifted the "money" line up so that the two lines start at the same level. That makes it easier to compare the trends. And I erased the Y-Axis labels because shifting the trend line makes those labels incorrect. (These tweaks were all done in Paint.)

The tweak shows that money increased more quickly than prices. Funny -- that's not what you might expect. If printing money causes inflation, the two lines should travel together. They don't.

Friedman himself points out the discrepancy. For Germany and Japan both, rose more rapidly than prices: Germany, 4.8 percent a year for money versus 2.7 percent for prices; in Japan, 7 percent for money versus 5.7 percent for prices. The rapid growth in output and in financial activities in both countries led to a greater demand for real money balances per unit of output (a decline in velocity). The same phenomenon had occurred in the United States at an earlier date....

"A decline in velocity." People increased their spending less than the quantity of money increased. People were "holding" more cash, or holding it longer. This, Milton Friedman explains, is the reason his graphs do not show the thing he claims they show -- that "money and prices clearly move together."

The Germany graph, the Japan graph, and the U.S. graph "at an earlier date" -- call it two and a half graphs.

It is worth pointing out that Friedman's U.S. graph at a later date is "extrapolated after 1975 by official data." He made it up. Money Mischief is copyright 1992 and 1994 by Milton Friedman. The data needed to create the graph without extrapolation would have been available by 1992. Nevertheless, the data after 1975 is "extrapolated." Friedman liked the trend he saw before 1975, and he just ran that trend out to 1990.

Two and a half of Friedman's five figures offered as evidence that money and prices move together, fail to show that money and prices move together.


"When a country starts on an inflationary episode, the initial effects seem good. The increased quantity of money enables whoever has access to it -- nowadays, primarily governments -- to spend more without anybody else having to spend less. Jobs become more plentiful, business is brisk, almost everybody is happy -- at first. Those are the good effects. But then the increased spending starts to raise prices...."

Friedman lays it out clearly. These days, when no one is happy with government, it might be better to drop the incendiary phrase "nowadays, primarily governments" and try to focus on the economics. And based on the initial effects Friedman describes, it might have been better to say "the initial effects are good" rather than "seem good." Especially since he says Those are the good effects.

But I don't quote Friedman here for his description of effects. (We can get that from Anna Schwartz.) I quote Friedman for his brief, clear explanation of the reason prices go up: the increased spending starts to raise prices. According to Friedman, it is the spending that causes prices to rise. Not the printing.

And again:

"The situation is wholly different when the increased demand has its origin in newly created money. The demand for most goods and services can then go up simultaneously. There is more total spending...."

Friedman says an increase in the quantity of money allows spending to increase; with this I do not quibble. But I rigidly adhere to Milton Friedman's view that it is spending, not money, that drives prices up.

And again:

"During the German hyperinflation after World War I, hand-to-hand money increased.... During the Hungarian hyperinflation after World War II, hand-to-hand money increased...."

"Hand-to-hand money." What's that? It's not a technical term. But it can only be "money changing hands." It can only be spending. Once again, Friedman points out it is not the existence of money that causes inflation, but the use of money. Not printing, but spending.

Oh, yes! We must watch out for the printing, because printing money allows and encourages the spending. But it is the spending, not the printing, that is the cause of inflation.

1 comment:

The Arthurian said...

RE: Doubting Milton Friedman

See: Seven Fallacies Concerning Milton Friedman’s ”The Role of Monetary Policy” (PDF, 21 pages) by Edward Nelson of the Federal Reserve Board.