He thought the Fed failed in its role as lender of last resort during the Great Depression.

Lovers of Big Government and apologists for debt like Paul Krugman have tried to paint Milton Friedman as a contradiction. They say that Friedman’s insight that more Fed intervention might have mitigated the Great Depression is inconsistent with his view that the Depression would have been less severe without the Fed.


Krugman can typically be discounted because his partisanship diminishes his perceptiveness. It is, however, disappointing when National Review joins the fray and publishes opinion claiming that Friedman “would likely have supported a much more aggressive monetary response to our economic downturn.”

Professor Ivan Pongracic of Hillsdale College explains that Friedman’s insight was that the Fed’s inaction in the Great Depression was in the context of a banking system in which the central bank had monopolized the position of lender of last resort.

Pongracic writes:

Friedman and Schwartz claimed that the depression would not have been a Great Depression if there had been no Federal Reserve in the first place: “[I]f the pre-1914 banking system rather than the Federal Reserve System had been in existence in 1929, the money stock almost certainly would not have undergone a decline comparable to the one that occurred.”

That point was effectively elaborated by Milton and Rose Friedman in Free to Choose:

Had the Federal Reserve System never been established, and had a similar series of runs started, there is little doubt that the same measures would have been taken as in 1907 — a restriction of payments. That would have been more drastic than what actually occurred in the final months of 1930.

The existence of the Reserve System prevented the drastic therapeutic measure: directly, by reducing the concern of the stronger banks, who, mistakenly as it turned out, were confident that borrowing from the System offered them a reliable escape mechanism in case of difficulty; indirectly, by lulling the community as a whole, and the banking system in particular, into the belief that such drastic measures were no longer necessary now that the System was there to take care of such matters.<



Pongracic goes on to explain that Friedman’s insight that the Fed should have acted to avert deflation in the face of bank runs is a conclusion based on the scenario of a Federal Reserve System that has monopolized the function of “lender of last resort,” quoting from monetary economist Lawrence H. White:

Friedman and Schwartz’s view of the 1930s was that the Fed, having nationalized the roles of the clearinghouse associations [CHAs], particularly the lender-of-last-resort role, did less to mitigate the panic than the CHAs had done in earlier panics like 1907 and 1893. In that sense, the economy would have been better off if the Fed had not been created. This position is perfectly consistent with the position that, provided we take the Fed’s nationalization of the clearinghouse roles for granted, the Fed was guilty of not doing its job.


So, was Friedman an advocate for an aggressive Fed? I think it a mistake to label an economist famous for monetary restraint as an advocate for aggressive monetary policy. It is a stretch to try to make Friedman into some Krugman-like apologist for quantitative easing.

Donald Boudreaux of George Mason makes the point as well. Friedman, he writes, advocated Federal Reserve intervention given a Federal Reserve monopoly of lender of last resort:

Friedman understood that, without the Federal Reserve, private bank–clearinghouse associations — market institutions that were displaced by the Fed — would likely have prevented the money supply from collapsing and, hence, might well have kept the depression from becoming “great.” But Friedman also understood that the Fed, having substituted its own technocratic discretion for the market adjustments of clearinghouses, then had a responsibility to manage the money supply properly. It failed to do so. Friedman (and his co-author Anna Schwartz) properly criticized the Fed for this terrible failure.


It is a disservice to Milton Friedman’s memory, though, to assert that he would be a Krugman-like advocate for quantitative easing. Anna Schwartz in her lecture The Legacy of Milton Friedman writes that “Friedman’s position was that monetary restraint is necessary for inflation control.” Friedman advocated for a constant growth rate of a monetary aggregate. Hardly sounds like the monetary expansion of quantitative easing.

No one, myself or anyone at National Review, can claim to know exactly what Friedman would say about our current debacle. But if he were alive today and given the choice of adjectives to describe his monetary policy, “aggressive” or “restrained,” I can’t imagine he would not choose “restrained.”

— Rand Paul is a Republican U.S. senator from Kentucky.