I read an excellent post by Lars Christensen this evening in which he points out a pamphlet that includes excerpts of essays by Milton Friedman and Charles Goodhart in order to help provide some insight into causes of the recent episode of monetary policy failure that crystalized the sub-prime crisis into the Great Recession. I thank Lars tremendously for including a link to the pamphlet in PDF form so I could read it.

While Lars points out a particular quote from the pamphlet as to why monetary policy has not taken a more active role in recovery from the Great Recession, due to lack of understanding of the power involved in expectations management, which I think is an excellent find, my attention was captivated by the Forward section of the pamphlet as possible cause, written by Phillip Booth, Professor of Insurance and Risk Management at St. John Cass Business School, City University in 2003.

The essay by Geoffrey Wood links the Goodhart and Friedman essays and puts the Friedman essays in their historical context. In doing so, Wood raises a very important issue. The fact that central banks do not always directly target money supply aggregates or directly control them, instead preferring to use intermediate instruments such as short-term interest rates, does not mean that excess monetary growth is not the cause of inflation. It is. Many commentators today stress that ‘increased competition’ or ‘lack of cost pressure’ are responsible for today’s benign inflation environment. They are not. If we do not wish to relive the experience of the 1970s we must continually remind ourselves of the causes and consequences of inflation and always seek better institutional mechanisms for delivering a stable price level. Such issues are fundamental to any basic training in economics, and this volume is a fine exposition of these issues.


And then there is the Summary (all of the bullets are from the pamphlet. I do not format them as quotes here because my theme displays bullets as unreadable when block-quoted – the emphasis is mine):

  • Except in the short term, unemployment cannot be reduced by creating inflation.
  • Even in the short term, unemployment can only be decreased by creating inflation if people are ‘surprised’ by the increase in the price level.
  • As soon as inflation becomes persistent, people will cease to be surprised by inflation (‘you cannot fool all of the people all of the time’), and any temporary decrease in unemployment will reverse.
  • The relationship between inflation and monetary growth is not a direct one. However, inflation is a monetary phenomenon and can only be controlled through prudent monetary policy.
  • Monetary policy should be directed towards the objective of achieving a stable price level; unemployment should be kept low by ensuring labour markets work effectively.
  • An anti-inflation policy will cause less economic damage if people expect the policy to be followed and if there is a ‘credible’ framework for delivering monetary policy.
  • Such a credible framework can be provided by an independent central bank with a well-defined objective.
  • The current institutional arrangement for the conduct of monetary policy in the United Kingdom provides such a framework.
  • It would not be appropriate to create an independent fiscal authority because such an authority would have to balance the achievement of multiple objectives – a problem that is best settled in the political arena.
  • While central banks do not generally target monetary growth directly when controlling inflation, it is nevertheless true that inflation is caused by excess monetary growth and can only be reduced by controlling monetary growth.


It’s not that there is anything wrong with any of these points if considered in a vacuum. The problem I see with these is that the message is lopsided without context. While these are likely good “rules of thumb” they do not take into account a situation such as the one excerpted in the very same pamphlet from Milton Friedman explaining the failure of monetary policy during the Great Depression regarding things believed to be true which turned out to be true under certain conditions but not others. If considering the works of Milton Freidman over the course of his career, the largest and most impressive take-away, at least in my point of view, is that there is a time and a place for everything – but the most important thing is to do the right thing at the right time because there are disastrous consequences on either side of the fulcrum between excess expansion of the base and excess contraction.

My view is that at least two points in the Forward are wrong by omission. Here it is.

The fact that central banks do not always directly target money supply aggregates or directly control them, instead preferring to use intermediate instruments such as short-term interest rates, does not mean that excess monetary growth is not the cause of inflation. It is.

On one hand I like that Mr. Booth appears to be stating here that interest rates are not particularly a controlling factor. But the thing that bothers me is the semantics, using the word “the” in “the cause of inflation.” It is one cause and has been a major cause in the past, but is not the only one (is Mr. Booth implying that we have too much demand for food?). In looking at this passage with glasses made in 2014, I feel a tad intellectually violated that “excess” in “excess monetary growth” isn’t given context in order to distinguish what is excess and what is not. This is important because reasonable growth in the base should be driven by something, doubtful as it is that controlling prices is the only reason because waiting for a decline means they’ve already encountered a disaster of some degree.

I think Mr. Booth, though hardly alone, has taken the purpose of the concept of price stability for granted as if that is the reason for monetary policy (and I use the word “the” in the same context as Mr. Booth used it in the description of the cause of inflation). Unexpected monetary inflation is bad because of the short-run effects on the quality of life. Unexpected monetary deflation is bad because of the short-run impact to the quality of life. The overall point is that nominal instability – not price instability (different!)– impacts the short-run quality of life in no small way.

I’m not certain of the purpose in the inclusion of the long-run non-effect of monetary policy on unemployment in the Summary because it is a truism of the long-run neutrality of money. If we’re to wholesale the assumption that monetary policy is ineffective in solving unemployment without being given the proper context, then it makes as much sense to assume that there is no purpose for a central bank. The short-run is where monetary policy has purpose or it has no purpose at all.

And there’s a certain irony in presenting truisms on the neutrality of money in order to define monetary prudence as hawkishness. The only way bad policy produces the illusion of long duration effects is if the bad policy persists regardless of which way it swings. The only way to “relive the inflation of the 1970s” is under a regime of persistent volatility in excess monetary growth from targeting the wrong variable, or no variable at all, or the target not being credible. The only way to relive the Great Depression is persistent tight money from persistently targeting the wrong variable, or no variable at all, or the target not being credible. There is zero root-cause difference – it has to be wrong and persistent. And I am pretty sure that core PCE has been below target by nearly 50% for years. Persistent wrong variable. Persistent public debate among policymakers about the right variable, i.e., the size of the Fed’s balance sheet, market disruption, bubbles, etc… Persistent vagueness regarding the stated target: We’re targeting 2% inflation, but you get to guess which inflation measure we care about today. We are lucky the Great Recession wasn’t worse than it has been.

[Update – clarification]

The basic issue at hand that the idea omitted in the Forward is that inflation and price stability aren’t core problems reflected in quality of life issues in and of themselves. A central bank could target five or even ten percent core inflation and provided that it manages expectations appropriately economic activity and quality of life would be stable in the monetary context. So the question related to public welfare is not about inflation or even deflation for that matter, with the notion of price stability being but the currently accepted theoretical option in providing economic stability that derives from nominal stability. I’d caution that accepted practice hasn’t always been the ideal option; and it is likely as true today as it was in the 1970s as I recall the cause of the misery episodes of the 1970s was not the practice of excess monetary growth, but excess monetary growth that occurred in unexpected fits and starts as the monetary authorities targeted the unemployment rate claiming they had no control over inflation that occurred during the starts. One could argue that in the context of supply side issues occurring at the time, the lack of understanding of how monetary policy should be conducted during supply shocks also played a role in monetary mismanagement that would go down in infamy, though a misnomer, as the Great Inflation. It is quite a misunderstanding indeed as Mr. Booth continued to beat the dead inflation horse in 2003.

Then, I have an objection to the semantics again in the bullet points. “As soon as inflation becomes persistent, people will cease to be surprised by inflation (‘you cannot fool all of the people all of the time’), and any temporary decrease in unemployment will reverse.” My objection isn’t on technical grounds as the statement, though narrowly framed, is hypothetically correct. The parenthetical displays unsubstantiated ideological bias, is demagogic and irresponsible, and amounts to behavior unbecoming of an academic much less one receiving public funds. The framing of the foundational information included in the consolidation of ideas from great thinkers in the field of macroeconomics in this way does violence to their reputations. It has no place in this pamphlet and the men whose ideas it leverages in order to covey propaganda deserve far more respect.

It’s not that I am in the practice of defending monetary authorities. No, they have plenty of serious flaws that do not culminate in service to the public good. But tom foolery is not one of them. Even more to the point, however, it speaks volumes toward dissenting viewpoints such as mine, almost as if to say, “If you think that creating inflation to solve unemployment problems is a good idea, you must be either a complete idiot or complicit in a great deception that does violence to the public good,” while I suppose that beating the dead horse of 1970s inflation long after it has been remedied and propagandizing theoretical macro is an occupation with good intentions that regardless of details will always serve the public good. It is well beyond me how attempts at co-opting dissent in such a way on the basis of evidence that must be very narrowly framed or it falls apart logically is not severely sanctioned by the profession.

And this is sort of a long-winded approach to asking some simple questions about why something like this pamphlet was circulated containing as many holes in practicality as swiss cheese. This is the cause of the mess, past and present; not only lack of critical thinking but also translating that lack into educational material that it becomes pervasive over time.