I have some time this week to do more studying in macro and I found a topic of interest, the Friedman rule that came from the Optimum Quantity of Money, 1969. If I understand it correctly, I’ve a new found sympathy for the sentiment David Glassner has expressed toward Freidman, with my admiration of Friedman possibly displaced. That is unless Friedman has been misunderstood in the assumption that the dynamics of deflation is entirely monetary. I do not have the book the Optimum Quantity of Money at my immediate disposal and I can only guess at the implied context. By the way, I found the Friedman rule referenced in a paper co-authored in 1998 by formerly hawkish member of the FOMC, Narayana Kocherlakota, and I was entirely surprised by the find.

Here’s what it says on the Wiki page for the Friedman rule (notations omitted):

The Friedman rule is a monetary policy rule proposed by Milton Friedman. Essentially, Friedman advocated setting the nominal interest rate at zero. According to the logic of the Friedman rule, the opportunity cost of holding money faced by private agents should equal the social cost of creating additional fiat money. It is assumed that the marginal cost of creating additional money is zero (or approximated by zero). Therefore, nominal rates of interest should be zero. In practice, this means that the central bank should seek a rate of deflation equal to the real interest rate on government bonds and other safe assets, to make the nominal interest rate zero.
The result of this policy is that those who hold money don’t suffer any loss in the value of that money due to inflation. The rule is motivated by long-run efficiency considerations.

The Friedman rule has been shown to be the welfare maximizing monetary policy in many economic models of money. It has been shown to be optimal in monetary economies with monopolistic competition (Ireland, 1996) and, under certain circumstances, in a variety of monetary economies where the government levies other distorting taxes. However, there do exist several notable cases where deviation from the Friedman Rule becomes optimal. These include economies with decreasing returns to scale; economies with imperfect competition where the government does not either fully tax monopoly profits or set the tax equal to the labor income tax; economies with tax evasion; economies with sticky prices; and economies with downward nominal wage rigidity.

If I read the exceptions correctly, there are only a few types of economies where the Freidman rule is optimal in maximizing welfare. And the US economy is an exception – imperfect competition, sticky prices, and downward nominal wage rigidity (I have no comment on the other exceptions listed).

I don’t have much trouble understanding the sentiment that the purchasing power of a dollar should remain intact if held over long periods of time. But I do have trouble wrapping my brain around why that is particularly important and how, even with well-behaved monetary policy, preserving the purchasing power of a dollar could be accomplished with supply side events distorting the price level and without other tradeoffs that come with sticky prices that could be represented as opportunity costs in a real sense. Perhaps I am conflating two different ideas, 1) how we would get from where we were pre-Great Recession to a Friedman rule world (and what we get from doing that) and, 2) what would the optimal policy be in a do-over or as in technology we would call a “greenfield.”

I disagree that the Friedman rule is welfare optimizing, at least in my view of welfare in any category. There might be some exceptions to this point of view, though I haven’t put a large degree of thought toward it in order to delineate them. Certainty enough though, there is currently a raging debate about whether we as a society should accommodate a seeming desire to hold the medium of exchange as an investment. The proponents, whom I believe to be a vocal minority, want to, in essence, stuff mattresses with certainty. While it would be reassuring in an era of fear and doubt to be able to make at least one investment that theoretically will not lose, I have doubts about the propriety of government assurance of any investment; and I have deep reservations about whether that government-guaranteed investment should be the medium of exchange. It changes economic life as we know it in no small way by affecting exchange. My guess is that the general public doesn’t agree with the proposition either given the loud and persistent protestations regarding the impact on economic performance from making moves in that direction with monetary policy. We are partially toward a Friedman rule world from where we were, and media reporting from nearly every outlet contains main headlines that are still about the recovery, whether it is self-sustaining, and lackluster growth after all of the time that has passed since the 2008 crash. I suspect that nearly every night there are dreams about the way things used to be occurring in the majority of households.

How much of this is attributable to Friedman, I cannot say. But, in admission of error, I probably owe TravisV an apology because the seeming obsession with inflation and central bankers bent on targeting deflation probably has some origin in Friedman’s scholarship; though it is more likely this rule rather than credit theory that has contributed to the current situation.

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