The Palmetto Insider

The blog of the South Carolina Policy Council

What Milton Friedman Means Today

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Today would have been Nobel Laureate Milton Friedman’s 97th birthday. The modern economic voice for capitalism and freedom, Friedman died in 2006. On his birthday today, it is an appropriate time to remember Friedman’s lessons as well as his guidance against government intrusion in the marketplace.

In 2002, Ben Bernanke, current chairman of the Federal Reserve, credited Friedman with correctly identifying the Federal Reserve as the leading cause of the Great Depression. Bernanke was referring to research Friedman did almost 40 years prior, pointing to the Fed as a major culprit in causing – and worsening – the Great Depression of the 1930s.

Milton Friedman was the first economist to write a different version of the events of the 1930s, shifting blame away from the “fallacies of the free market.” His book – cowritten with Ana Schwartz – A Monetary History of the United States, outlines the view that the Federal Reserve policies after the stock crash of 1929 negatively impacted the nation’s economy.

From 1929-1933, there was a massive deflation of the money supply – to the tune of 30%. The Federal Reserve was created to have prevented such a catastrophic collapse. With such a high demand for money, Friedman argues the Fed should have increased money supply, which could have helped slow the Depression from the start.

In order to understand Friedman’s take on the Fed, it is important to understand banking in the United States before 1913. Created in 1913, the Fed was given the task of preventing bank panics. Prior to the Fed, it was the responsibility of commercial bank clearinghouses to halt massive bank failures. In 1907 there was a panic as stocks crashed and an ensuing run on banks. However, a restriction of payments resulted, and the crisis was relatively short-lived, as economic growth resumed the next year.

But with the 1929 crash, banks assumed the Federal Reserve was there to provide assistance. The actions of the Federal Reserve during the 1930s are sadly ironic. Rather than power being dispersed among multiple private organizations, all monetary distribution rested at the Fed. And when the Fed decided to sit on its hands in 1930 and let bank after bank fail, it contradicted prior signals, leading to massive instability in the market. This essentially exponentially worsened the situation, causing the recession of 1929 to become a Great Depression well into the 1930s.

We can learn a lot from the lessons that Friedman taught us about economic growth and government actions. In his book Capitalism and Freedom, Friedman wrote:

“The Great Depression in the United States, far from being a sign of the inherent instability of the private enterprise system, is a testament to how much harm can be done by mistakes on the part of a few men when they wield vast power over the monetary system of a country.”

One of the major reasons for the severity of today’s recession are the Fed’s actions that artificially stimulated the boom period. During the recession of 2001, the Federal Reserve continued to lower interest rates to encourage more investment – from around 6 percent in 2001 to nearly zero in 2004. This helped boost prices, which led to a massive bubble. 

When government entities begin to believe they can dictate economic directions, the path is set for more extreme downturns. South Carolina’s Legislature can learn from Friedman and end its ongoing effort to control the state economy. If we allow individual incentives and motivations to lead, recovery will come about at a faster pace.

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Written by Geoff Pallay

July 31, 2009 at 6:28 pm

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