Milton Friedman on Freedom: A New Book

Milton Friedman on Freedom is a delightful new book of Friedman’s best works mf-on-f-coveron freedom compiled and edited by Robert Leeson and Charles Palm.  It is a delight to have these writings in one lean volume, and the book also highlights a new and much larger online collection consisting of all of Friedman’s published and significant unpublished writings, The Collected Works of Milton Friedman compiled by Leeson and Palm, together with selected audio-visual and other unpublished materials from the papers of Milton Friedman in the Hoover Institution Archives.

Both the book and online collection are sorely needed now. People often channel Friedman to support their own views, even if they are contrary to his actual views!  So he deserves to be read in the original, and readers will find the book refreshing even if they are already familiar with Friedman.

Leeson and Palm arrange the essays chronologically, starting with one of Friedman’s first articles on freedom from the 1950s where he notes that liberalism in the classical sense “takes freedom of the individual—really, of the family—as its ultimate value.”

Friedman wrote often about the connection between economic freedom and other freedoms, and he believed that “economic freedom, in and of itself, is an extremely important part of total freedom.”  What we sometimes forget, however, is that he thought that the loss of total freedom caused by restrictions on economic freedom were as much a concern as the loss of economic prosperity caused by such restrictions.  His essays provide many examples that show how reductions in economic freedom through government subsidies or regulations stifle freedom of speech. He refers to President Ford’s WIN (Whip Inflation Now) program, about which, though “pretty silly,” no business leader spoke against.  The reason, Friedman argued, was a concern about such things as the “IRS getting ready to come and audit” or “the Department of Justice standing only too ready to launch an anti-trust suit.”

In particularly interesting essays in the book, Friedman contrasts his views with other champions of freedom. He argues for an empirical approach—in which one is tolerant of views one disagrees with and tests them with data—as a way to help resolve differences. He writes that there is a “utopian strand in libertarianism. You cannot simply describe the utopian solution, and leave it to somebody else how we get from here to there. That’s not only a practical problem. It’s a problem of the responsibilities that we have.”

Friedman warns that periods of freedom are very rare in the long span of history, especially in his essay “The Fragility of Freedom.” Friedman, along with his wife Rose, argues that there is a close connection over time between ideas and practical policy applications, but there is a long lag between the two: The “Rise of Laissez-Faire” from 1840 to 1930 followed the “Adam Smith Tide” that began in 1776. The “The Rise of the Welfare State” from 1930 to 1980, followed the “Fabian Tide” that began in 1885. The “Resurgence of Free Markets” starting in 1980 followed the “Hayek Tide.”  fraser-chart But, as I write in the introduction to the Leeson-Palm book, this most recent resurgence appears to have been cut short as policy has moved away from the principles of economic freedom in recent years as shown by this table of United States data in economic freedom from the Fraser Institute.

Perhaps the tide is now turning again. I hope so. But, in any case, this timely book tells us there is never a time for complacency.

Posted in Teaching Economics

Economic Policy Explains Growth Conundrum

“Growth Conundrum” sets the theme for the many fascinating articles in the latest issuecover-fd of the IMF’s quarterly magazine Finance and Development which includes an opening essay by Nicholas Crafts and a profile of Kristin Forbes. I was asked to write one of the articles summarizing my recent research on the recent slow growth in which I have been critical of the secular stagnation view. In this post I reprint that article, but also add references to articles and papers by me and others providing relevant background and support, which I could not put in the published article due to understandable space constraints.

The article is one part of a two-part “Point-Counterpoint: Secular Stagnation” in which Brad DeLong takes the other side. Brad has already responded to my article on his blog, but he apparently did not have the benefit of these references and he was completely off point in his counter point to the magazine’s point-counter point.

Here’s my article from F&D with the additional reference notes in italics:

Policy Is the Problem. Secular stagnation has been the subject of much debate ever since 2013, when Lawrence Summers proposed the hypothesis “that the economy as currently structured is not capable of achieving satisfactory growth and stable financial conditions simultaneously.” This quote and the one in the next paragraph is from Chapter 2: Low Equilibrium, Real Rates, Financial Crisis, and Secular Stagnation by Summers in the book Across the Great Divide
edited by Matin Baily and me, and is based on the October 2013 Brookings-Hoover conference where Larry first presented the idea. My chapter in the same conference volume includes an early critique of secular stagnation.

Speaking at a recent conference, Summers posited that for the past decade and a half, the economy had been constrained by a “substantial increase in the propensity to save and a substantial reduction in the propensity to spend and invest,” which were keeping equilibrium interest rates and economic growth low. See page 44, Chapter 2, of the Baily-Taylor volume from the same conference.

Few dispute that the economy has grown slowly in recent years, especially when the financial crisis is taken into account. But secular stagnation as an explanation for this phenomenon raises inconsistencies and doubts.

Low policy interest rates set by monetary authorities, such as the US Federal Reserve, before the financial crisis were associated with a boom characterized by rising inflation and declining unemployment—not by the slack economic conditions and high unemployment of secular stagnation. I summarized the facts in a January 2014 Wall Street Journal article The economic hokum of ‘secular stagnation‘ saying that “There were boom-like conditions, especially in residential investment, as demand for homes skyrocketed and housing price inflation jumped from around 7% per year from 2002-03 to near 14% in 2004-05 before busting in 2006-07. The unemployment rate got as low as 4.4%—well below the normal rate and not a sign of slack. Inflation was rising, not falling. During the years 2003-05, when the Fed’s interest rate was too low, the annual inflation rate for the GDP price index doubled to 3.4% from 1.7%.” The evidence runs contrary to the view that the equilibrium real interest rate—that is, the real rate of return required to keep the economy’s output equal to potential output—was low prior to the crisis. And the fact that central banks have chosen low policy rates since the crisis casts doubt on the notion that the equilibrium real interest rate just happened to be low. Here I refer to the empirical work in my 2016 Business Economics article with Volker Wieland Finding the Equilibrium Real Interest Rate in a Fog of Policy Deviations in which we explain how monetary policy decisions to chose low rates confound methods to determine the equilibrium rate  Indeed, in recent months, long-term interest rates have increased with expectations of normalization of monetary policy. The 10-year Treasury has increased from 1.2% to 2.4% since last July.

For a number of years going back to the financial crisis, I and others have seen a more plausible reason for the poor economic growth—namely, the recent shift in government economic policy. References to research by Lee Ohanian, John Cochrane, Steve Davis, me and others are found in my 2016 AER paper “Can We Restart the Recovery All Over Again.”   Consider the growth in productivity (output per hour worked), which along with employment growth is the driver of economic growth. Productivity growth is depressingly low now—actually negative for the past four quarters. But there is nothing secular about this. Indeed, there have been huge swings in productivity in the past: the slump of the 1970s, the rebound of the 1980s and 1990s, and the current decline.

These shifts are closely related to changes in economic policy—mainly supply-side or structural policies: in other words, those that raise the economy’s productive potential and its ability to produce. During the 1980s and 1990s, tax reform, regulatory reform, monetary reform, and budget reform proved successful at boosting productivity growth in the United States. In contrast, the stagnation of the 1970s and recent years is associated with a departure from tax reform principles, such as low marginal tax rates with a broad base, and with increased regulations, as well as with erratic fiscal and monetary policy. During the past 50 years, structural policy and economic performance have swung back and forth together in a marked policy-performance cycle.  Evidence for these swings in productivity growth and policy is presented in my 2016 AER paper as well as in the paper Slow Economic Growth as a Phase in a Policy Performance Cycle” published in the 2016 Journal of Policy Modeling.

To see the great potential for a change in policy now, consider the most recent swing in productivity growth: from 2011 to 2015 productivity grew only 0.4 percent a year compared with 3.0 percent from 1996 to 2005.

Why the recent slowdown? Growth accounting points to insufficient investment—amazingly, capital per worker declined at a 0.2 percent a year clip from 2011 to 2015 compared with a 1.2 percent a year increase from 1996 to 2005—and to a decline in the application of new ideas, or total factor productivity, which was only 0.6 percent during 2011–15 compared with 1.8 percent during 1996–2005.

To reverse this trend and reap the benefits of a large boost to growth, the United States needs another dose of structural reform—including regulatory, tax, budget, and monetary—to provide incentives to increase capital investment and bring new ideas into practice. These reforms are described in my 2012 book First Principles.  Such reforms would also help increase labor force participation and thus raise employment, further boosting economic growth.

While the view that policy is the problem stands up to the secular stagnation view, the ongoing debate suggests a need for more empirical work. The recent US election has raised the chances for tax, regulatory, monetary, and perhaps even budget reform, so there is hope for yet another convincing swing in the policy-performance cycle to add to the empirical database.  This will depend on whether the slew of reform proposals in the Congress and the Administration are passed and implemented, as discussed in this Q and A with John Cochrane and me. If they are, then we will have more empirical evidence with which to test the hypothesis that policy has been the problem.

Posted in Regulatory Policy, Slow Recovery

Restoring Prosperity

During the past two days, economists from around the world gathered at the Hoover Institution to focus on the crucial problem of how to restore prosperity. They took stock of lessons from past experiences in the US and Europe, and considered possibilities with a new Administration in Washington. It was a follow up to a conference and book that Lee Ohanian and I organized 5 years ago with Ian Wright. This year Jesus Fernandez-Villaverde joined with Lee and me in the planning, adding important economic and political perspectives as well as views from Europe.

Needless to say, the need to restore prosperity is still with us, as illustrated by the chart on this cover of 2012 book (Government Policies and the Delayed Recovery) along side the updated version today—the employment-to-population ratio is still barely above the level at the end of the recession in 2009. We have go a long way to go.two-covers

A huge amount of useful new facts and ideas were put forth at the conference so a book is again planned. The conference was also notable for topics that did not come up. No one suggested secular stagnation, as introduced by Larry Summers in a 2013 Hoover-Brookings conference, as a factor in the recent slow growth. Nor did anyone suggest demand-side fiscal stimulus packages as a means of restoring prosperity. Rather, people focused on structural or supply-side economic policy as reasons for the low growth and how to implement such policies.

Slides presented at the conference will soon be available on the conference web page, and there are some really amazing charts to look at. In meantime here are some of the highlights from my perspective.

George Shultz led off—as in the previous conference—with a note of optimism and words of encouragement reviewing how changes in policy—tax reform, monetary reform—led to greatly improved economic performance in the 1980s and could do so again.

Kevin Murphy then examined the key role for education and training in raising productivity growth. He showed that returns to education have increased, but that supply has not responded leaving a great deal of growth potential on the table with special harm to those at the bottom.  Rick Hanushek reported on the amazing economic growth gains that could come from simply weeding out the lowest 5% of teachers based on teaching effectiveness. Flavio Cunha examined underlying causes for poor educational performance delving into very early childhood experiences, where researchers can now monitor, for example, how many words children actually hear at home. There is no question that the US is not exceptional in K-12 education.

Bob Hall usefully decomposed empirically the recent slow growth of earnings per “member of the population,” showing that a decline in productivity growth and a drop in the share of labor in total income are the primary culprits.  John Haltiwanger examined the marked decline in young firms (5 years and less) as a share of US output, and examined how that decline in dynamism might be related to the decline in productivity; he found a suggestive association for some, but not all, industries.  Ed Prescott noted how technological change has created a wedge between output and real GDP citing examples of Bill Nordhaus’ work on “The Economics of New Goods.” However, Bob Hall and others noted that recent work by David Byrne, John Fernald and Marshall Reinsdorf shows that such developments are not new and do not explain changes in trends over time.

A full session concentrated on the role of government economic reforms in restoring prosperity.  Harald Uhlig focused on the role government in health care examining the recent ups and downs in the price of pharmaceutical firm stocks in response to statements coming from Washington. restoring-prosperty-conference-s-slides-taylorI assessed whether the US is having a much needed turning point in economic policy by applying the ideas in my book First Principles.  This chart shows the potential gain in productivity growth if reforms such as regulatory reform and tax reform are implemented; in my view the response to such supply side reforms can be large.  Steve Davis then discussed recent trends in regulation, intervention and policy uncertainty, provided new data and making new reform proposal to contain the costs. He provided a chart—which I replicate below—which shows some correlation between the swings in policy uncertainty and historical swings in productivity growth from my chart.

A good part of the conference was about the slow growth in Europe. regulatory-complexity-and-policy-uncertainty-davisMuch of this fascinating discussion focused on how poor policy has pulled down growth. Fortunately, the discussion will be broadcast by Russ Roberts on his famous Econtalk Podcast and includes Nicholas Crafts, Luis Garicano, and Luigi Zingales—so watch for that.  Joel Mokyr talked about his new book: A Culture of Growth, and examined whether the development of a “market for ideas,” which he argues led to the Industrial Revolution, has lessons for the future.  Jesus Fernandez-Villaverde spoke at lunch on European lessons for the US.  To paraphrase the key lesson, coming from joint work with Lee Ohanian, is: “If the US does not get its policy act together it will surely follow Europe to stagnation.”  He reminded everyone how unemployment rates in Europe used be less than in the US, and they are now of course much greater.  He was not optimistic about reforms in Europe given the demographic situation in there.

Joel Peterson, Chair of JetBlue and a leader in venture capital funding, gave the dinner talk explaining how government policy actually affects business formation and growth with many examples from his own experience. He thereby provided a much needed connection—and I would say confirmation—between the empirical/theoretical work of the economists and what actually goes on in individual firms.  Some of Joel’s examples came from his fascinating new book, The Ten Laws of Trust.

Conferences like this are useful if they help bring ideas into practice. Let’s hope that when we have the next conference on economic growth and prosperity–say in another 5 years–that many of the ideas from this conference will have been applied in practice and that we might be able to title the conference “Prosperity Restored.”

Posted in Regulatory Policy, Slow Recovery

Benefits of Comparing Policy with Reference Rules

In a recent VOX article, Henrike Michaelis and Volker Wieland write favorably about the approach taken by Fed Chair Janet Yellen in a recent speech where she compares recent Fed policy actions with several monetary policy rules—including the Taylor rule—much as would be required by recent legislation in the U.S. Congress. They argue that these kinds of “comparisons of Fed policy to simple reference rules show how such legislation would serve to bolster the Federal Reserve’s independence…. By referring to such legislation and appropriate reference rules, the Fed would be able to better stand up to … [political] pressure and more effectively communicate its reasons to the public.”  The article also refers to this statement by economists supporting the legislation.

As an illustration of the kind of constructive criticism that would likely be the healthy outcome of such comparisons, Michaelis and Wieland also take issue with one aspect of the Fed Chair’s comparison. They show that the comparison is incomplete, and thereby potentially misleading, because it uses only part of recent research by Holston, Laubach, and Williams (HLW).  The comparison applies the shift in the equilibrium interest rate r* from HLW, but not the associated shift in potential GDP that is an integral part of that study.  Janet Yellen shows that if you insert the HLW r* estimates into a Taylor rule, you get a lower policy interest rate than if you assume a 2 percent real rate as in the original version of that rule. However, Michaelis and Wieland show that plugging in the associated real output gap estimated with the HLW methodology, along with the HLW r*, moves the implied rate in the opposite direction.

Posted in Monetary Policy

Monetary Policy Strategy Statements Should Have a Strategy

At its meeting this week the Fed decided not to post changes in its “Longer-Run Goals and Monetary Policy Strategy” as might have been expected as part of its annual organizational meeting actions as it did last year at this time. The January 2016 statement is still on the Fed’s web page.  Maybe they will make changes at the next meeting, and, in particular, add some words about the Fed’s strategy for the policy instruments.  Despite the use of the phrase “Monetary Policy Strategy” in the title, a strategy for the policy instruments does not now appear in the statement. If you read the statement you will find nice clear sentences about goals, but little in the way of a strategy for the policy instruments to achieve the goals. As former Fed Staff member Andy Levin explains in a chapter in a recent book “the FOMC’s Statement on Longer Run Goals and Policy Strategy is almost exclusively aimed at clarifying its longer-run goals…what’s still missing—and what’s desired by the general public as well as academic economists, market investors, and members of Congress—is for the FOMC to explain its policy strategy more clearly.”

In a Wall Street Journal op-ed this week former Fed Governor Kevin Warsh made the very sensible suggestion that the Fed “announce a practicable long-term strategy” and add it to the “document—purporting to state the Fed’s strategy…”  In a paper published in the Swedish Riksbank Economic Review I also urged that consideration be given to including the strategy to achieve the existing goals, giving details about the strategy for the policy instruments.  In a blog post on Janet Yellen’s West Coast speeches I suggested a possible way forward.

The Fed is not the only central bank that could be clearer about its strategy. The European Central Bank also has a statement about monetary policy, which it simply calls “Strategy”. It has a good explanation about goals including a “quantitative definition of price stability”, but it too says little about a strategy for the instruments of policy other than reference to its “two-pillar approach” which provides for some cross-checking with the monetary aggregates. The time is ripe for change at a number of central banks. As ECB President Mario Draghi said in a speech last summer in Portugal: “…we would all clearly benefit from enhanced understanding among central banks on the relative paths of monetary policy. That comes down, above all, to improving communication over our reaction functions and policy frameworks.” If there is a first mover problem, the Fed would be a natural first mover.

Posted in Monetary Policy

Good Progress on Describing and Comparing Monetary Strategies

Janet Yellen visited San Francisco and Stanford last week. She gave two interesting talks about monetary policy, which together, in my view, break new ground, and are worthy of more discussion.

At the Commonwealth Club in San Francisco she briefly described the Fed’s monetary strategy for the policy instruments.  At the Stanford Institute for Economic Policy Research she compared the Fed’s recent monetary policy with the Taylor rule and closely related monetary policy rules.

If you view these two talks together, I think they resemble what would be required under the Requirements for Policy Rules of the Federal Open Market Committee, Section 2 of the Fed Oversight Reform and Modernization (FORM) Act which has passed the House of Representatives. That legislation requires that the Fed (1) “describe the strategy or rule of the Federal Open Market Committee for the systematic quantitative adjustment” of its policy instruments and (2) compare its strategy or rule with a reference rule. More detail here.

Let me explain why the two talks represent progress in both directions. In the San Francisco talk, Janet Yellen summarized the Fed’s strategy for the policy instruments, saying that

“When the economy is weak and unemployment is on the rise, we encourage spending and investing by pushing short-term interest rates lower. As you may know, the interest rate that we target is the federal funds rate, the rate banks charge each other for overnight loans…. Similarly, when the economy is threatening to push inflation too high down the road, we increase interest rates to keep the economy on a sustainable path and lean against its tendency to boom and then bust.” She then described “price stability” as a level of inflation of “2 percent a year,” the maximum level of employment that can be sustained in the longer run as an unemployment rate of around 4-3/4 percent, and a “longer-run neutral rate” of the federal funds as a rate of “3 percent.”

One could certainly add more detail, but the statement includes the signs of the responses by the policy instruments, though not the magnitudes; it mentions key factors driving the responses; and it gives numerical values for three key parameters.  It could be usefully added, as is, to the Fed’s Statement on Longer-Run Goals and Monetary Policy Strategy, which, despite its name, now has no strategy for the instruments, only goals.

Next consider the Stanford talk which was loaded with charts and references to the Taylor rule and other policy rules. The purpose was to compare actual Fed policy with the Taylor rule, which she states, “embodies key principles of good monetary policy,” and then explain any differences. People found that useful, and it was good to see clarification of how the FOMC uses such policy rules in a constructive manner. That’s the kind of comparison that is required in the legislation that passed the House.  My question to her at the talk (see here) was meant to explore the possibility that such a presentation could satisfy the legislation, but in her answer she still expressed opposition to the legislation. Nevertheless, I think further discussion of the issue would be useful. There are more similarities than differences between the type of presentation given by Janet Yellen in California last week and the type of presentation required by the FORM Act, suggesting that a compromise might be feasible.

To be sure, the description of the policy strategy and the comparison of policy with the reference rule took place in two different talks.  If presented in the same talk the analogy with the requirement under the legislation would be easier to make. Janet Yellen frequently uses footnotes for algebraic descriptions in her talks. If she added another footnote, an algebraic way to summarize the words used in San Francisco might be:

r = p + ay + b(p – 2) + 1

with a > 0 and b > 0, where r is the federal funds rate, p is the rate of inflation, and y = 2.3(4.75-u) where u is the unemployment rate. (The 2.3 comes from Janet Yellen, Remarks, April 11, 2012)

In contrast the reference rule (Taylor rule) is:

r = p + .5y + .5(p – 2) + 2

So the comparison is pretty obvious.

In listening to Janet Yellen’s talk I was reminded that I invited Alan Greenspan to give a talk to the same research group at Stanford 20 years ago in 1997 when I was the director. He came, and he chose as the topic, Rules vs. Discretionary Monetary Policy. He discussed the Taylor rule, about which he listed “a number of attractive features” and commented on the usefulness of monetary policy rules in general. The experience with monetary policy, both when it is rules-based and when it is not rules-based, in the United States and other countries during the past 20 years provides much useful information about how to improve monetary policy going forward. Talks such as Janet Yellen’s and further discussion about them will further this important goal.

Posted in Monetary Policy

The Room Where It Happens

I enjoy the nexus between the world of ideas and the world of action, probably because I have gone back and forth between those two worlds several times as described here. There is nothing more rewarding then developing ideas and then having the opportunity to bring them into action. The song “The Room Where It Happens” in the musical Hamilton is a wonderful rendition of this nexus where Alexander Hamilton gets his debt ideas into action.

When asked by the Wall Street Journal and Bloomberg News about by favorite books for 2016, I chose books that fell into this nexus.  For the Wall Street Journal list, I chose The Man Who Knew, Sebastian Mallaby’s excellent biography of Alan Greenspan, and War by Other Means by Robert Blackwill and Jennifer Harris. Here are the reasons that I gave and that the Journal published:

wsj_booksoftheyear-12-10-16-cropped

For Bloomberg News I chose The Euro and the Battle of Ideas by Markus Brunnermeier, Harold James and Jean-Pierre Landau (I also wrote a longer review here) and The Curse of Cash by Ken Rogoff.  Again here are the reasons as published by Bloomberg News:

bloomberg-books-2016-1

bloomberg-books-2016-2

Posted in Teaching Economics