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Mithun has kindly sent me the transcript of the Friedman interview I wrote about yesterday (see below). It makes Friedman’s position much clearer. His is a different conception from what I first thought he was proposing.

I thought he had concluded that the Fed couldn’t do its “job” because of structural constraints and so the free banking system would do a better job.

It seems, though, that he merely wanted to substitute the Fed with a money generating computer program (say, a money-producing robot).

I’m sure this is far better than having a Fed, but is this good enough? I’m not sure. The very definition of money changes over time, the demand for money changes (we need less real money over time to buy goods, or food, or electricity – as productivity increases). No doubt an expectation of deflation (which is possible in a free banking system backed by convertibility) might reduce investment, but it will also motivate productivity. Only a competitive free banking system can adjust money supply optimally in which all local information and factors are taken into account.

No central bank can deal with this, nor can a formula. While Friedman’s solution is not bad, I suggest that free banking, with appropriate regulation, will deliver the best solution. A key regulation, as I pointed out elsewhere, is that bank shareholders not be allowed the cover of limited liability, but be wholly and personally made liable for losses. That would ensure greater prudence than artificial imposition of convertibility or reserve requirements.

Relevant extracts:

Milton Friedman: If you really carried out the logic concerning the quantity of money, you deprive the Federal Reserve of anything to do. Suppose the Federal Reserve said it was going to increase the quantity of money by 4 percent a year, year after year, week after week, month after month. That would be a purely mechanical project. You could program a computer to do that. The central bank associates with banks. It regards itself as sort of a mentor of the banking system and, to the individual bank, it doesn’t believe it creates a quantity of money. I’ve always been in favor of abolishing the Federal Reserve and substituting a machine program that would keep the quantity of money going up at a steady rate. Russ Roberts: And over the last 20 years or so, they’ve approximated that. Milton Friedman: Come closer to approximating it. Absolutely. Russ Roberts: And I would argue, and I assume you would as well, that the relative stability of the U.S. economy over the last 20 years is a reflection of that steady growth in the money supply. Milton Friedman: I think there’s no doubt at all.

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