Milton Friedman, the noted economist, has made a career of dumping on the Federal Reserve Board. It almost never does anything right, in the Friedman view--and over a long stretch, going way back to the Big Depression, there is plenty of blemish on the Fed record.
Professor Friedman, a Nobel award winner, gets a lot of attention not only because he is one of the nation's most distinguished economists, but also because he is one of the most articulate. And as the founder of the monetarist school of economics, he has had a profound effect on the thinking of economists and governments all over the world.
The Reagan administration adopted his basic belief that a slow, stable growth in the money supply is the correct--and only--strategy necessary to control inflation. If it grows too fast, inflation is the result. If it doesn't grow enough, the economy doesn't grow enough. If the growth is erratic, then financial markets are erratic.
Friedman is said to be the president's favorite economist, telling him it's okay to slash taxes as the best way to reduce the size of government--even a 25 percent maximum rate would work. It's a mutual admiration society: on "Meet the Press" last week, Friedman labeled Reaganomics "a great triumph."
But the truth is that Reaganomics has led the nation to the brink of economic disaster, and the monetarist approach blueprinted by Friedman, endorsed by Reagan and carried out by the Fed has acted not just to squeeze out inflation in the economy, but also to crunch real growth to the point of creating a recession.
So Friedman has to find an excuse for failure of the monetary policy, and his excuse is that the Fed hasn't been doing what it was supposed to do. The Fed's overall money growth targets are okay, but he complains that one week the money policy is too tight, and the next week it is too easy. By pursuing such a "roller-coaster" or "yo-yo" approach, he argues, the Fed has eroded the confidence of the business community in the Reagan program, and thus should take the blame for economic instability and high interest rates.
Even when confronted with evidence that he may have overstated the case--or, God forbid, may actually be wrong--he won't admit it. Federal Reserve Chairman Paul Volcker, for example, testified before the Senate Banking Committee that there is no "obvious link" between the growth rate of monetary aggregates and "our current economic problems."
If there were, Volcker asks, how come that countries whose economic performance we tend to admire--like Japan, Switzerland and West Germany--have so much wider swings in their rates of monetary growth?
Volcker supplied committee Chairman Jake Garn (R-Utah) with figures for the narrowly defined money supply growth last year that showed a range between minus and plus of 138 points for Japan, 60 for West Germany, 56 for Switzerland, and only 29.5 points for the United States. The only better record among industrial powers--if stability is some kind of virtue--was Italy (which, incidentally, had one of the highest inflation rates!).
On "Meet the Press," Friedman brushed these statistics aside as "wholly meaningless." He told a questioner that Germany, Switzerland and Japan can get away with wide fluctuations, because "over a period of years, they have demonstrated the credibility of their long-run patterns. You can have the wildest fluctuations in a short run, provided everybody is confident that over the longer run you will attain your target.
"The Federal Reserve has not, in fact, achieved its targets over the longer run. It has no credibility, and the real harm which these fluctuations is doing is that it destroys the credibility of the Fed's targets."
But the record shows that the Fed has pretty much done what Reagan demanded of it. True, in 1980, it slightly overshot the target range for M1, the narrowly defined money supply that Friedman now focuses on. And in 1981, it considerably undershot it. However, looking at M2, a much broader measure of the money supply, the Fed was just about on the mark last year.
Interestingly enough, after having said a year ago that M2 was the be-all and end-all of money measurement, Friedman has reverted to M1 as his guide, although many other experts think that the vast innovation that has taken place in financial markets makes M1 much less meaningful.
For example, there was a huge bulge in M1 in January that agitated Friedman and other monetarists. But as Boston Federal Reserve Bank President Frank Morris pointed out recently at a conference in Atlanta, most of the bulge occurred in interest-paying checking accounts. This was probably "a defensive buildup of precautionary balances . . . that in earlier times would have been largely reflected in an increase in savings accounts."
In other words, people edgy about the economy may have decided at that time to hold extra money in "NOW"-type checking accounts, which are federally insured, rather than in higher yielding money market funds, at least temporarily. The bulge, as Morris says, didn't mean that an inflationary surge was under way, or that the Fed had lost control, or had to rush to change its policy.
" . . . it seems to me that the monetary aggregates, particularly M1, have been rendered obsolete by innovation and the computerization of the financial system," Morris said.
The Fed's recent scorecard has certainly not been perfect, but on the whole, considering the difficulties of combatting an inflationary White House fiscal policy, it's not bad. Even if it were physically possible to hold the supply of money rock steady in the exact middle of a target range (which many respected monetary analysts doubt), there is no reason to believe that there is a predictable relationship between a stable money supply and the economy.
Gyrations in interest rates are not due to short-term money supply fluctuations, but, as Henry Kaufman says, to monetarism itself. It's the monetarist fixation with the money supply that "creates interest rate volatility."
But given the monetarist mania created by Friedman and his followers, and which has swept up the Fed itself (and large segments of the press), the panicky money markets have gotten "hooked" on the weekly M1 growth figures published every Friday. Any big bulge--regardless of the reason--sends interest rates soaring.
If there is a ray of hope, it is that the slavish devotion to monetarism is finally being questioned. Ferment for a change is reflected not only in the Morris speech, but also in an earlier one by New York Federal Reserve Bank President Anthony Solomon, and in testimony by Kaufman.
What's needed is not a new set of technical measures (as demanded by Friedman) to make money growth patterns even more rigid, but a complete breakaway from monetarism so that the nation once again can follow a sensible monetary policy that doesn't focus exclusively on interest rates or the money supply.
In today's computerized era, with a whole new range of money market and other financial instruments that can constantly shift in their composition, no one knows how to define money, much less control it--not even Milton Friedman. It's time to move monetarism out of the Fed to a quiet historical study corner in the Smithsonian.