Friedman’s Fancy

Milton Friedman (1912-2006): Economists shouldn’t make jokes (Friedman Foundation, CC01.0)

Helicopter money sounds wonderful. The state builds a printing press and hires a helicopter; the printing press prints notes and the helicopter drops them randomly on the population at large; people pick them up, spend them in the shops and — in the immortal words of the Keynesian textbooks — thereby “boost aggregate demand”. Everyone lives happily ever after.

The idea is attributed to Milton Friedman, who mentioned helicopter money in a recondite 1968 academic paper on “The optimum quantity of money”. In current discussions about monetary policy Friedman’s authorship is often noted and then used to endorse a proposal for outright money-printing. However, any sensible reader of the 1968 article can see — or ought to be able to see — that Friedman was joking. In order to discuss the article’s important concern (that is, the optimum quantity of money), Friedman assumed an economy quite different from that found in the real world of today. In his “hypothetical simple economy”, the population, capital stock and technology are given, and — crucially — “lending and borrowing is prohibited and the prohibition is effectively enforced”. If it cannot have lending and borrowing, Friedman’s hypothetical economy cannot have a commercial banking system or a central bank. The tendency of contemporary advocates of helicopter money to call on the central bank to organise the printing of the notes and their drop on the citizenry is therefore absurd.

Friedman posited his simplified economy precisely because the 1968 paper was theoretical; it was a large-scale thought experiment to stimulate the imagination. He did not want to become bogged down in the institutional complexities of modern monetary policy-making. The 1968 paper appeared as the title essay in a 1969 collection which included other contributions that were far more practical. For example, its 1963 article (co-authored with Anna Schwartz) on “Money and business cycles” was concerned with the American economy from 1867 to 1960, particularly with the instabilities that might arise from accidents in the commercial banking system and blunders committed by the central bank. 

The 1963 article offered “a tentative sketch” of how changes in monetary policy might be transmitted through the economy. It analysed “an unexpected rise . . . in the rate of change in the money stock” attributable, in the situation to be analysed, “from an increased rate of open-market purchases [of securities] by the central bank”. The sellers of the securities might be either commercial banks or non-banks, but both would “seek to readjust their portfolios”. The 1867-1960 evidence persuaded Friedman and Schwartz that “sizeable changes in the rate of change in the money stock are a necessary and sufficient condition for sizeable changes in the rate of change in money income”.

So, when Friedman returned from his 1968 fantasy economy to the real world of lending and borrowing, and of commercial banks and a central bank (the world of his 1963 article, as well as of dozens of others), not once did he recommend the helicopter drop. Media prattle about helicopter money and the constant referencing to Friedman are just a lot of silliness. Friedman was entirely conventional, thinking in terms of purchases of securities by the central bank as the archetypical monetary policy action.

Last month the Bank of England announced a package of monetary policy measures to avert a supposed Brexit-related recession. Most observers accepted that, because the Bank’s policy rate was already down to 0.5 per cent, the further reduction to 0.25 per cent could hardly make much difference to the economy. The interesting part of the announcement was that the Bank intends to expand its “quantitative easing” programme. It plans to purchase £60 billion more gilt-edged securities and, in a new departure, £10 billion of corporate bonds. QE matters because it increases the quantity of money. What would Milton Friedman make of the Bank’s operation?

We need to check whether money growth has been too slow, too fast or about right in the recent past. The last set of money numbers showed that in the year to June the UK’s quantity of money (labelled M4x in the data) went up by 5.8 per cent, the highest figure since 2008. Further, money growth has accelerated in the last few months. On this basis, the extra £70 billion of asset purchases — which will add over 3 per cent to the quantity of money — is unnecessary. The case for such a large stimulus depends heavily on the forecasts of a Brexit recession, and the forecasts may be wrong. Friedman’s signature prescription was not helicopter money, but stable growth of the quantity of money. Money growth of 4 or 5 per cent a year is about right for the UK in the long run; an annual rate of money growth in the high single digits would be excessive and take risks with inflation.

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