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Abenomics As A Fulfillment Of Milton Friedman’S Policy Prescriptions

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Today would be Milton Friedman’s 101st birthday. What better way to celebrate his birthday than to recognize that Abenomics is largely a fulfillment of the policy prescriptions he outlined for Japan 13 years ago. Here is Friedman in 2000

[T]he Bank of Japan’s argument is, “Oh well, we’ve got the interest rate down to zero; what more can we do?” It’s very simple. They can buy long-term government securities, and they can keep buying them and providing high-powered money until the high powered money starts getting the economy in an expansion. What Japan needs is a more expansive domestic monetary policy.

In other words, Friedman was calling for large scale asset purchases (LSAPs) long before it was vogue and understood that for the purchases to help the economy there must be a sufficiently large and permanent expansion of the monetary base. On the latter point, Friedman knew that even though the monetary base and treasuries may be near perfect substitutes in a zero lower bound environment, they would not be in the future. And since investors make decisions on what they think will happen in the future, a monetary base injection that is expected to be permanent and greater than the demand for the it in the future is likely to affect spending today.

The importance of the public believing the monetary base expansion will be permanent can be illustrated by looking back to the early part of the Great Depression. As seen in the figures below, the monetary base grew rapidly between 1929 and early 1933 compared to previous growth. Yet during this time the money supply and nominal GDP continued to fall. The reason this monetary base growth did not stall the collapse of financial intermediation and aggregate spending is because it was still tied to the gold standard. Consequently, the public did net expect a large, permanent expansion of the monetary base. But that all changed with FDR in 1933. He created what Christy Romer calls a “monetary regime shift” both by signalling through articles, speeches, and movies a desire for a higher price level and by abandoning the gold standard which led to even more rapid monetary base expansion. This shift is apparent in the figures below. FDR’s actions caused the public to expect a permanent monetary base expansion that would raise future nominal income. A sharp recovery followed in 1933. 

It is too early to know for sure whether Abenomics is working, but the evidence so far suggest it is making a difference. Here is Ambrose Evans-Pritchard:

Abenomics is working,” says Klaus Baader, from Societe Generale. The economy has roared back to life with growth of 4pc over the past two quarters – the best in the G7 bloc this year. The Bank of Japan’s business index is the highest since 2007. Equities have jumped 70pc since November, an electric wealth shock.

“Escaping 15 years of deflation is no easy matter,” said Mr Abe this week, after winning control over both houses of parliament, yet it may at last be happening.

Prices have been rising for three months, and for six months in Tokyo. Department store sales rose 7.2pc in June from a year earlier, the strongest in 20 years.

I think Milton Friedman would be happy to see Abenomics if he were alive. Happy birthday Milton Friedman.

http://www.economonitor.com/blog/2013/08/abenomics-as-a-fulfillment-of-milton-friedmans-policy-prescriptions/?utm_source=feedly

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Friedman is a monetarist charlatan. His prescription for curing stagflation in the late 70s enjoyed enormous popularity on both sides of the Atlantic but proved impossible to implement successfully. The Federal Reserve failed to achieve its targets for money growth by wide margins, the relationship between money supply and inflation was far weaker than Friedman implied, and unemployment grew far more quickly than the monetarists said it would. Friedman's belief that monetary supply is exogenous - under the control of central banks - is a falsehood. Central banks subsequently abandoned money growth targeting and adopted the Taylor Rule, a rule based heuristic which worked a little better in practice but critically failed in 2008 because it too ignores the dynamics of private debt.

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Central banks subsequently abandoned money growth targeting and adopted the Taylor Rule, a rule based heuristic which worked a little better in practice but critically failed in 2008 because it too ignores the dynamics of private debt.

Was the Taylor Rule still in use anywhere close to 2008? Wouldn't interest rates have been much higher throughout the 2000s if the Taylor Rule had been used?

clip_image002_thumb.jpg

http://historysquared.com/2012/11/07/housing-bubbles-interest-rates-the-taylor-rule-and-central-bank-folly/

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Was the Taylor Rule still in use anywhere close to 2008? Wouldn't interest rates have been much higher throughout the 2000s if the Taylor Rule had been used?

clip_image002_thumb.jpg

http://historysquared.com/2012/11/07/housing-bubbles-interest-rates-the-taylor-rule-and-central-bank-folly/

Eichengreen puts Greenspan's decision to keep rates low in 2002 once the US economy appeared to have bottomed out after the tech stock bust as the moment the Fed conduct departed from its previous behaviour which Taylor had characterised with the Taylor rule. However, as the Taylor rule is ad hoc descriptive, not proctor hoc normative, nobody was ever "using" it, any more than if I observe Accrington Stanley playing badly away from home and then say that they have stopped using the CotB Away Rule when they get an away win.

The conclusion of the section on Taylor rules is a concise summation of the thesis at your link, as best I understand it:

This story of lax monetary policy fueling the mother of all credit booms has its critics, notably Federal Reserve officials past and present. They object that the Fed controls only short-term interest rates, not the long-term rates that matter for investment. But while long-term rates may be what matter for firms contemplating investment in factories, this is not equally the case of individuals deciding whether to buy a home.

Source: Exorbitant Privilege, Barry Eichengreen (OUP, 2012)

Edited by ChairmanOfTheBored

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