Milton Friedman embarrassed some of his sound money followers by advocating indexed contracts

TO BE NOTED: From the FT:

"Inflation can act as a safety valve

By Samuel Brittan

Published: May 28 2009 19:57 | Last updated: May 28 2009 19:57

Are we faced with inflation or deflation? It seems to depend on which analyst you read and on which day of the week. Complaints about a new inflation due to, say, government money creation or budget deficits come hot on the heels of moans that deflation is still a menace. Looking at actual numbers adds to the confusion. On the UK official consumer price index, year-on-year inflation was still 2.3 per cent this April, slightly above the government’s 2 per cent target. On the traditional and more comprehensive retail prices index, it was -1.2 per cent.

Can we just say, then, that as there are both inflationary and deflationary fears, policy is on the right lines and we are enjoying rough price stability? Unfortunately we cannot. For great uncertainty about the direction and size of price movements is itself a danger to economic stability.

Not enough attention has been paid to the fact that after their recent plunge, oil and commodity prices are creeping up again. It was the effect of rising prices in these areas in generating inflation that accounts for the slowness of some central banks to shift last year from restrictive to expansionary policies. A renewed upsurge in primary product prices would make life more difficult for central banks’ monetary strategy. But this is not the most important danger. The real worry is that shortages of energy and basic commodities may be imposing real speed limits on world growth well before anything like full employment is regained.

Let us go back to the problem of uncertain overall price movements. There is a long history of indexation proposals for living with inflation. Milton Friedman embarrassed some of his sound money followers by advocating indexed contracts. In the UK the income tax starting points have been indexed to inflation since the 1970s, although the government has the option of suspending indexation when revenue needs are pressing. Social security benefits have long been indexed to inflation, earnings or some hybrid of the two.

There was a long battle during the Thatcher period in the 1980s over whether the government should issue indexed gilts. A long-time governor of the Bank of England, Gordon Richardson, was fiercely opposed as he regarded it as a moral surrender to inflation. But one of his successors, Eddie George, was happy to see the government push them through and was worried mainly that they were not as popular as they should have been. Some 30 per cent of the UK national debt is now in indexed bonds, as is 10 per cent of US debt.

My own view was that refusal to index out of a moralistic disapproval of inflation was akin to refusing to stop knocking one’s head against a brick wall in the hope that the wall would go away. The main snag about indexation lay in the indexation of wages. There are circumstances in which real wages need to rise less quickly than usual or even to fall. This is difficult enough to accomplish when pay talks centre informally on the “cost of living”. It will be far more so if it comes to renegotiating a formally indexed pay agreement.

The indexation discussion has been revived by an American economist, Robert Shiller, with the aid of Lawrence Kay, who has adapted the argument to British conditions. (“The Case for a Basket”, Policy Exchange). One novelty is that the case is now presented as a way of dealing with deflationary as well as inflationary threats. If you buy a widget on an indexed basis you do not have the embarrassment of asking the seller for a reduction because prices in general have fallen. This happens automatically. A second and more important innovation is that he suggests a new unit of account, which he calls the basket, defined to retain its value whatever national inflation indices do. He believes that the failure to supply such a unit is one reason why indexation has not caught on. “It is far easier for most people to say ‘I will lend you 500 baskets at 3 per cent interest’ than to say ‘I will lend you £500 at an interest rate equal to 3 per cent plus the percentage change each month of the CPI’.”

Prof Shiller’s main modern example of such a basket is Chile’s Unidad de Fomento. But the separation of the unit of account from money used as means of exchange goes back a long time. From the time of Charlemagne, trade and contracts in Europe were based on imaginary or ghost monies that were ultimately based on the silver denarius, which no longer circulated or was even seen.

If a unit of account different from the coin of a realm is to be introduced, it would be better to find a more appealing name than “basket”. I cannot imagine anyone being thrilled to be told by his employer that he had been awarded a pay increase of 0.2 baskets.

But the real snag about indexation remains the problem of wages. As Keynes, Prof Shiller himself and many others have observed, workers accept more readily a real wage cut arising from a rise in the general level of prices than an actual reduction in what they are paid. Prof Shiller tries hard to find a unit in which workers could accept with good grace a reduction in real pay; but I do not think he succeeds. In some circumstances a little bit of old-fashioned inflation is the best safety valve available.

Write to samuel.brittan@ft.com
More columns at www.ft.com/samuelbrittan"

We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like

TO BE NOTED: From the FT:

"Green shoots and dud forecasts

By Samuel Brittan

Published: May 14 2009 22:13 | Last updated: May 14 2009 22:13

We have been told by that usual bringer of bad tidings, George Soros, that the “economic freefall” has stopped. The normally cautious president of the European Central Bank, Jean-Claude Trichet, has identified a slowing down of the rate of decrease in gross domestic product and, in some cases, “already a picking up”. The Organisation for Economic Co-operation and Development composite leading indicator shows at least a slight uptick. The admittedly highly erratic Easter UK retail sales figures show an actual increase and surveyors report more property inquiries. Financial commentators talk of “green shoots” and one of them has even suggested that the recession came to an end in April. So – Bank of England dissenting – everything is all right and we can get back to normal life.

Except that it isn’t. It is perhaps unfair to cite the continuing horrifying rise in unemployment in so many countries. For that is admittedly a lagging indicator. A better reason for being suspicious is that so much of the new optimism is associated with a very recent recovery in equities. These lost up to half their value in the key US and UK markets, but have come less than a third of the way back since early March. Paul Samuelson once said that the stock market had predicted eight of the last five recessions. The same might be said of recoveries.

There is also a little matter of arithmetic. UK GDP is estimated to have fallen at an annualised rate of 7.4 per cent in the first quarter of 2009. So it is as well that the rate of decline is itself declining. A more specific factor is that a drop in stocks much amplifies any recession. As the Bank of England inflation bulletin explains: “De-stocking only reduces GDP growth if the fall in stock levels is larger than the fall in the previous period.” When this no longer happens the recession looks less draconian; but it does not mean that it is over.

In fact, I have never shared the gloom-and-doom, end-of-capitalism attitude to the credit crunch. Injecting public funds into failing banks was not the best way to bolster demand and credit, especially as governments have relied upon these very same bankers to advise them. Critics on the left and right agree on this matter and are largely right. Nevertheless, governments and central banks have probably injected enough cash into the world economy to prevent the worst from occurring. Sound money commentators fret about the difficulties of withdrawing the stimuli in time. They should equally worry about the danger of withdrawing them too soon. One reason why US unemployment remained so high in the New Deal period is that a premature monetary tightening and attempt to balance the budget aggravated a new recession in 1937.

There has been much discussion about whether the present recession will be V-shaped, which is what national authorities would like; W-shaped, in which a modest recovery would be followed by a further downturn; or L-shaped, in which output stops falling but we crawl along at the bottom without getting back to normal trend growth. Having exhausted suitable letters of the alphabet, commentators talk of bath-shaped and hook-shaped recessions as well.

The truth is that we do not know. To me the most dispiriting aspect of current discussion is the way in which both governments and their critics still cling to national income forecasts, known in the trade as “NIF”. The value of such forecasts is not to be judged by their average record over several years, but by whether they signal problems and opportunities in advance of turning points. Here their record is abysmal. At the beginning of 2007 both national and international mainstream forecasters looked ahead to a golden period of good growth with low inflation, oblivious to the credit crunch that was to hit us later the same year. This should have been the coup de grâce, but it was not. There is no solution in putting wide ranges of error on the predictions – what one economist called “giving them wings”. New Bank of England charts show a range of between minus 2 per cent and plus 6 per cent for output growth in 2011 and 2012, which is honest but useless.

I recently heard a well-known forecaster say that the only valid question is which forecasters to go by and what methods they should use. Not so. New mathematical theories of chaos and complexity provide insights into why forecasting is so problematic but do not provide alternatives. We just have to accept that the future cannot be foreseen in the way many governments and businessmen would like.

Let me end with a simple illustration. The weather in summer in north-west Europe is known to be highly variable. Somebody going away for a fortnight in that part of the world would find it helpful to have a day-by-day prognosis of temperature, rainfall, sunshine, wind conditions and so on. But apart from the first day or two it cannot really be done. Rather then rely on long-term weather bureau predictions, it is safer to take an umbrella or raincoat and a warm pullover as well as sunglasses and a sunshade, even at the cost of slightly heavier luggage. Now apply this homely little story to economic policy.

More columns at www.ft.com/brittan
www.samuelbrittan.co.uk"

I found this early essay much more helpful than his better-known later proposal for a constant growth of the money supply

TO BE FILED: From the FT:

‘A framework for economic stability’

By Samuel Brittan

Published: December 4 2008 20:21 | Last updated: December 4 2008 20:21

The reduction to 2 per cent and 2.5 per cent of the Bank of England’s and European Central Bank’s respective official interest rates may be historically unprecedented, but it is the least the two central banks could have got away with. Their measured step-by-step approach falls below the level of events and makes me wish that the US Federal Reserve were in charge of policy on the European side of the Atlantic as well.

The Bank’s continued reluctance to resort to extreme measures makes it all the more unfortunate that the November 24 pre-Budget report turned out, at best, a damp squib and, at worst, counterproductive. Little of the discussion was on the fiscal stimulus but rather on the subsequent tax increases required “to pay for it”. If an old-school economist had deliberately tried to arrange a demonstration against fiscal policy, he could hardly have done better.

It did not help that vetoed proposals to announce an 18.5 per cent or even 20 per cent value added tax at some future date leaked out. Nor was the smallness of the immediate VAT cut – from 17.5 per cent to 15 per cent – a brilliant idea. Having decided to risk being hanged, why not for a sheep instead of for a lamb? If VAT had been cut to, say, 12.5 per cent, it would have been far more difficult for populists to dismiss it as a small factor among the many other influences affecting prices in the shops. Can Gordon Brown really have feared the European Commission?

The most important error, however, was to take too seriously the voices clamouring for a re-entry path to sound finance once the recession is over. Hence the projections showing a return to current budget balance by 2015-16. Hence, too, the assumption of a sharp but short-lived V-shaped recession. Thinking about alternatives led me to re-read a 1948 paper by Milton Friedman entitled A Monetary and Fiscal Framework for Economic Stability, reprinted in Essays in Positive Economics (1953).

I found this early essay much more helpful than his better-known later proposal for a constant growth of the money supply. The 1948 paper contained four proposals:

First, a long-term policy of determining government expenditure on goods and services, either in money or real terms, entirely on the basis of the community’s desire and willingness to pay for such services.

Second, a predetermined programme of transfer payments for items such as pensions and unemployment pay. “Such payments will be high when unemployment is high and low when unemployment is low.”

Third, a progressive tax system primarily based on the personal income tax. The rates set should be sufficient to balance government spending at a hypothetical level of national income corresponding to “reasonably full employment at a predetermined price level”.

Fourth, budget deficits would be financed entirely by the creation of money by the Fed and surpluses used to retire money. This would best be accomplished by adopting the 100 per cent reserve proposal for banks, “thereby separating the depositary from the lending functions of the banking system”.

The first three proposals look at first sight like the “automatic stabilisers” that governments came to rely on as the main fiscal contribution to economic stability before the present emergency. But there is a crucial difference. In a recession, governments would not have to forecast the path of recovery, as the British government has done, or the timing of the return to budget balance. In a normal cycle, the return would be automatic. But, if forebodings of secular stagnation, with the desire to save at high employment levels exceeding investment opportunities, were fulfilled, then budgetary stimulants would continue as long as necessary.

The banking and monetary side might appear novel. Friedman regards them as desirable in their own right. In this context, they have the advantage of making the monetary response to the business cycle automatic. But he concedes that the same results could be achieved under the present fractional reserve system by appropriate monetary policy rules.

Clearly much work would be required to adapt the Friedman framework to today’s institutional structures. In any case, it would not make sense to stake out a public expenditure path and corresponding tax rates until we have a better idea of the sustainable employment level (or output gap) likely to emerge from the present turmoil and also the new trend growth rate. But it is not too early to start preparing.

Postscript. Those alarmed by UK official projections showing public sector net debt climbing from 36 per cent of gross domestic product last year to 57 per cent in 2012 should bone up on their history. There are long passages in Macaulay showing how the nation prospered despite increases in the national debt – regarded by sages as catastrophic. In his one and only Budget speech, Harold Macmillan noted how the national debt had risen from £600m in 1914 to £8.4bn in 1939 and £27bn in 1956 – representing 27, 133 and 146 per cent of GDP. As Macmillan put it: “Whatever the temporary difficulties from trying to run too fast, if we stand still, we are lost.”

IMF explicitly warns that it fears debt deflation - the hallmark, according to US economist Irving Fisher of the Great Depression’s economics

From Alphaville:

"IMF: “worrisome parallels” with the Great Depression Posted by Sam Jones on Apr 17 12:13.

The IMF has pre-released two chapters from its forthcoming World Economic Outlook.

Chapter 3: From recession to recovery: How soon and how strong?

Chapter 4: How linkages fuel the fire: The transmission of financial stress from advanced to emerging economies

The following excerpts rather put all the recent talk of green shoots into perspective. A few banking swallows do not a spring make. Quite the contrary. The IMF is now explicitly briefing of an economic catastrophe second, if not equal to, the Great Depression of 1929-33.

Emphasis ours.

The global economy is experiencing the deepest downturn in the post–World War II period, as the financial crisis rapidly spreads around the world. A large number of advanced economies have fallen into recession, and economies in the rest of the world have slowed abruptly. Global trade and financial flows are shrinking, while output and employment losses mount. Credit markets remain frozen as borrowers are engaged in a drawn-out deleveraging process and banks struggle to improve their financial health. Many aspects of the current crisis are new and unanticipated. Uniquely, the current disruption combines a financial crisis at the heart of the world’s largest economy with a global downturn.

… recessions associated with financial crises tend to be unusually severe and their recoveries typically slow. Similarly, globally synchronized recessions are often long and deep, and recoveries from these recessions are generally weak. Countercyclical monetary policy can help shorten recessions, but its effectiveness is limited in financial crises. By contrast, expansionary fiscal policy seems particularly effective in shortening recessions associated with financial crises and boosting recoveries. However, its effectiveness is a decreasing function of the level of public debt. These findings suggest the current recession is likely to be unusually long and severe and the recovery sluggish.

In fact, says the IMF, global downturns are typically one and a half times as long as typical recessions.

Most worrying though is the explicit comparison the IMF makes with the Great Depression - something even bearish commentators have skirted around so far for fear of being alarmist. The IMF lays it on the line:

A recession began in the United States in August 1929. A tightening of monetary policy during the previous year, aimed at stemming stock market speculation, is widely seen as the initial cause. The stock market crashed in October 1929, which prompted a sharp decline in consumption, partly because of increased uncertainty about future income.

The recession intensified and turned into a depression over the course of 1931–32. Pernicious feedback loops between the financial sector and the real economy emerged, leading to entrenched debt deflation and four waves of bank runs and failures between 1930 and 1933. Private consumption and investment contracted sharply.

and today:

Despite the differences in mechanics, the effects on the behavior of financial intermediaries are similar. Funding problems have led to balance sheet contraction (deleveraging), fire sales of assets (adding to downward pressure on prices), increased holdings of liquid assets, and decreased lending (or holdings of risky assets) as a share of total assets. Moreover, with today’s highly interconnected financial system, there has been gridlock because of network effects in a world of multiple trading and large gross positions. The ultimate effects of these financial factors on the real economy are similar in the two episodes.

The IMF explicitly warns that it fears debt deflation - the hallmark, according to US economist Irving Fisher of the Great Depression’s economics:

There is continued pressure on asset prices, lending remains constrained by financial sector deleveraging and widespread lack of confidence in financial intermediaries, financial shocks have affected real activity on a global scale , and inflation is decelerating rapidly and is likely to approach values close to zero in a number of countries. Moreover, declining activity is beginning to create feedback effects that affect the solvency of financial intermediaries, which risks of debt deflation have increased.

The IMF is clear: it really is all in the hands of the G20. The right policies will see recovery “in 2011″, the wrong ones… who knows.

This entry was posted by Sam Jones on Friday, April 17th, 2009 at 12:13 and is filed under Capital markets. Tagged with Great depression, IMF.

Me:

Don the libertarian Democrat Apr 17 16:49

I have used Fisher's model for the basis of my own views since the beginning of this crisis. Of his two possible solutions, reflation seems the sensible one, since a Debt-Deflationary Spiral has no natural stopping point. That's why it's terrifying. Arguing that we should let it play itself out is not on from my point of view.Consequently, reflation should have been much stronger than it has been.

Also, Lehman never should have been allowed to fail. Only an implicit or explicit government guarantee can stop a Calling Run, which began this crisis, because only governments have the resources available to credibly backstop the losses. Now, the point of the total guarantee is not to have to actually spend the money, but, rather, to allow the parties involved to more rationally and with with less loss unwind their deals. In this, the guarantees are like FDIC insurance to help stop Bank Runs.

We could have had a much less awful crisis with:
1) Large QE ( Buiter and Friedman's helicopter money )
2) A guaranteed income as our automatic stabilizer ( Friedman and Charles Murray )
3) See Brittan's current post with other suggestions from Friedman that I support ( this addresses the problem of Spender Countries needed to spend more in the short term )
4) In the US, a stimulus of:
a. Infrastructure
b. Sales tax decrease ( notice the recent analysis about the VAT decrease in the UK )
c. Targeted tax cuts for investment
In my opinion, these would have done a better job of getting the kind of behavioral incentives that Shiller correctly wants.
We should have also had a Swedish Plan for Banks, etc., but that was a monster headache to implement. We should also have a massive investigation into fraud, collusion, negligence, and fiduciary mismanagement.
Obviously there were a number of things that we could have done earlier, but I'd rather focus on the here and now.

We should also move towards a system of Narrow/Limited Banking ( Friedman and Fisher ), complemented by a financial sector that is supervised, self-insured, and not government guaranteed, to the extent that anyone actually ever believes that, with a Lender of Last Resort in existence. We should also tax or penalize the size of banks and financial concerns.

Cooperation at the international level would be wise as well, but the US and UK getting right would do a lot to encourage other countries going forward.

tax rates should be set to balance government spending at a hypothetical level of national income

TO BE NOTED: From The FT:

"A long cool look at budget deficits

Published: April 16 2009 22:04 | Last updated: April 16 2009 22:04

The year 1992 was the last in which the Conservative party won a British election – to the surprise of most political pundits. It had some superficial similarities to the present. Public sector borrowing was on the rise and at its peak in 1993-94 reached 7.8 per cent of gross domestic product, regarded then as shockingly high.

The strategy of Norman Lamont, the then chancellor of the exchequer, was a parody of St Augustine’s “Let me be chaste but not yet”. He began a series of phased tax increases and spending curbs which were to take place over three years and thus ensured long- term fiscal prudence while avoiding depressing the economy during a recession. His successors, Kenneth Clarke and Gordon Brown (then in his prudent phase) continued that policy so that in 2000 there was a public sector net repayment of 1.9 per cent of GDP.

Could the tactic be repeated this time round? The magnitudes are much larger. The Institute for Fiscal Studies expects the annual “baseline” deficit to average £150bn over the next three years, equivalent to about 10 per cent of GDP. The IFS predicts the debt-to-GDP ratio will climb to more than 70 per cent of GDP by the middle of the next decade, excluding support for banks, compared with Mr Brown’s original objective of 40 per cent.

The Centre for Economics and Business Research expects the deficit to peak at £213bn in 2010 or about 15 per cent of GDP, and the debt ratio to exceed 100 per cent two years later. The chancellor’s own headline projections may not be directly comparable, as they are likely to take into account policy moves.

In fact, the debt ratio has historically been much higher – more than 200 per cent after the Napoleonic wars and again after the second world war – without the disasters predicted by prophets of doom. These prophets may point to the current Irish crisis as a contrary example.

This ignores the fact that 80 per cent of the Irish national debt is held by international investors, compared with 30-40 per cent in the case of the UK and the US. Moreover, Ireland has the disadvantage of being tied into the eurozone at a fixed exchange rate that was initially too low and is now too high.

Of course, it would have been much better if the UK could have entered the recession with much lower initial deficit and borrowing ratios – if only because the financial markets do not understand the very good arguments for fiscal deficits in depressed times. It is childish just to blame Gordon Brown. Economic forecasts are not made by the chancellor personally and the Treasury’s fiscal assumptions are endorsed by the National Audit Office.

These bodies are not free to write fiction. At a rough guess, I would put a third of the blame on an over-optimistic assessment of the underlying growth rate and amount of spare capacity in the economy, a third on an over-estimate of financial sector profits and perhaps a third on over-optimism by Mr Brown himself.

What fundamentally is wrong with a budget deficit? The basic argument is that if borrowing is too high the government can get into a debt trap, having to borrow more and more simply to pay the interest on past borrowings. Estimates of the safety limit tend towards an annual deficit of 3 per cent of GDP – the limit that is incorporated in the eurozone’s growth and stability pact.

Such calculations were perfectly all right before the credit crunch, when booms and busts were fluctuations around a given trend. Keynes in his General Theory maintained however that the propensity to save was much greater than the private propensity to invest, not just at the bottom of a recession but more or less permanently – a state known as secular stagnation.

This seemed plausible in the 1930s but was belied by events in the half century or so after the second world war. We could easily have a good few years in which secular stagnation might seem to prevail again, if only because of the near destruction of the world financial system. If we are in such a state then an attempt to adhere rigidly to a fiscal rule could lead to a permanent and unnecessary loss of output outweighing any welfare loss from the debt trap risk itself.

I have sympathy with those economists who favour a mainly monetary approach to sustaining demand. But I fear that the present dangers are great enough to require a belt and braces – monetary and fiscal – approach. I go back to an early suggestion of Milton Friedman that I disinterred in response to December’s pre-Budget stimulus.

The suggestion was that tax rates should be set to balance government spending at a hypothetical level of national income corresponding to “reasonably full employment at a pre-determined price level”. What this is cannot be estimated until the world and UK economies have settled down after the present turmoil.

But the beauty of the suggestion is that, should the economy go back to a recognisable trend growth rate, then the budget would automatically achieve the target balance. Yet should there really be secular stagnation then deficits would run on as long as necessary. Of course, a lot of work would need to be done to adapt Friedman’s suggestion to modern conditions, but this would be immensely more worthwhile than the hazardous projections we are likely to see in the Budget Red Book.

www.samuelbrittan.co.uk"

‘A framework for economic stability’

By Samuel Brittan

Published: December 4 2008 20:21 | Last updated: December 4 2008 20:21

The reduction to 2 per cent and 2.5 per cent of the Bank of England’s and European Central Bank’s respective official interest rates may be historically unprecedented, but it is the least the two central banks could have got away with. Their measured step-by-step approach falls below the level of events and makes me wish that the US Federal Reserve were in charge of policy on the European side of the Atlantic as well.

The Bank’s continued reluctance to resort to extreme measures makes it all the more unfortunate that the November 24 pre-Budget report turned out, at best, a damp squib and, at worst, counterproductive. Little of the discussion was on the fiscal stimulus but rather on the subsequent tax increases required “to pay for it”. If an old-school economist had deliberately tried to arrange a demonstration against fiscal policy, he could hardly have done better.

It did not help that vetoed proposals to announce an 18.5 per cent or even 20 per cent value added tax at some future date leaked out. Nor was the smallness of the immediate VAT cut – from 17.5 per cent to 15 per cent – a brilliant idea. Having decided to risk being hanged, why not for a sheep instead of for a lamb? If VAT had been cut to, say, 12.5 per cent, it would have been far more difficult for populists to dismiss it as a small factor among the many other influences affecting prices in the shops. Can Gordon Brown really have feared the European Commission?

The most important error, however, was to take too seriously the voices clamouring for a re-entry path to sound finance once the recession is over. Hence the projections showing a return to current budget balance by 2015-16. Hence, too, the assumption of a sharp but short-lived V-shaped recession. Thinking about alternatives led me to re-read a 1948 paper by Milton Friedman entitled A Monetary and Fiscal Framework for Economic Stability, reprinted in Essays in Positive Economics (1953).

I found this early essay much more helpful than his better-known later proposal for a constant growth of the money supply. The 1948 paper contained four proposals:

First, a long-term policy of determining government expenditure on goods and services, either in money or real terms, entirely on the basis of the community’s desire and willingness to pay for such services.

Second, a predetermined programme of transfer payments for items such as pensions and unemployment pay. “Such payments will be high when unemployment is high and low when unemployment is low.”

Third, a progressive tax system primarily based on the personal income tax. The rates set should be sufficient to balance government spending at a hypothetical level of national income corresponding to “reasonably full employment at a predetermined price level”.

Fourth, budget deficits would be financed entirely by the creation of money by the Fed and surpluses used to retire money. This would best be accomplished by adopting the 100 per cent reserve proposal for banks, “thereby separating the depositary from the lending functions of the banking system”.

The first three proposals look at first sight like the “automatic stabilisers” that governments came to rely on as the main fiscal contribution to economic stability before the present emergency. But there is a crucial difference. In a recession, governments would not have to forecast the path of recovery, as the British government has done, or the timing of the return to budget balance. In a normal cycle, the return would be automatic. But, if forebodings of secular stagnation, with the desire to save at high employment levels exceeding investment opportunities, were fulfilled, then budgetary stimulants would continue as long as necessary.

The banking and monetary side might appear novel. Friedman regards them as desirable in their own right. In this context, they have the advantage of making the monetary response to the business cycle automatic. But he concedes that the same results could be achieved under the present fractional reserve system by appropriate monetary policy rules.

Clearly much work would be required to adapt the Friedman framework to today’s institutional structures. In any case, it would not make sense to stake out a public expenditure path and corresponding tax rates until we have a better idea of the sustainable employment level (or output gap) likely to emerge from the present turmoil and also the new trend growth rate. But it is not too early to start preparing.

Postscript. Those alarmed by UK official projections showing public sector net debt climbing from 36 per cent of gross domestic product last year to 57 per cent in 2012 should bone up on their history. There are long passages in Macaulay showing how the nation prospered despite increases in the national debt – regarded by sages as catastrophic. In his one and only Budget speech, Harold Macmillan noted how the national debt had risen from £600m in 1914 to £8.4bn in 1939 and £27bn in 1956 – representing 27, 133 and 146 per cent of GDP. As Macmillan put it: “Whatever the temporary difficulties from trying to run too fast, if we stand still, we are lost.”

More columns at www.ft.com/samuelbrittan"

"When fighting a slump concentrate on demand and output."

An interesting post on the FT by Samuel Brittan:

"Lessons from the original New Deal

By Samuel Brittan

Published: December 18 2008 18:36 | Last updated: December 18 2008 18:36

President-elect Barack Obama is reported to have responded to the Fed’s brave new anti-depression manifesto by saying that the Fed might soon be running out of ammunition. This need not be so if the new administration co-operates in the last resort course of financing some of the budget deficit by money creation ( YES. THE HELICOPTER CLUB ). It is in any case clear that the incoming president intends to supplement monetary stimulation by greatly increased public sector activity. The hints to this effect immediately made historically conscious observers look back to President Franklin Delano Roosevelt’s New Deal of the 1930s as a prototype.

I hope that Mr Obama and his advisers will copy its better rather than worse aspects. But although, if one is not too partisan, one can extract a common element in analyses of the Great Depression there is still very little consensus about the New Deal, which attempted to tackle it. There are still many Republicans for whom it is a socialist conspiracy and many Democrats for whom it is an article of faith. The academic world is just as split. A majority of political historians give a favourable verdict, while a majority of economists are more doubtful. The one matter of agreement is that Roosevelt was a master politician who won four presidential elections in a row.

The starting point has to be the fact that Roosevelt was no kind of theorist, but embarked on a series of sometimes contradictory improvisations ( TRUE ). There is not even agreement on which of the policies of the 1930s were or were not part of the New Deal. For instance, the insurance of bank deposits was part of the Congress-initiated Glass-Steagal Banking Act of 1933 and made permanent in a subsequent 1935 act. It is this one measure more than any other that was said to have made the US depression-proof (although not of course recession proof). Yet Roosevelt himself accepted the measure only reluctantly because, in the words of Professor Eric Rauchway, he feared that “the government would one day find itself forced to pay out too large a sum for failed banks”( HE WAS RIGHT, BUT IT WAS STILL A GOOD IDEA ) (The Great Depression and New Deal: A Very Short Introduction, OUP).

This illustrates the president’s instinctive opposition to budget deficits, although he came at times to accept them as a regrettable necessity( VERY TRUE. HE WAS FAIRLY CONSERVATIVE, BUT PRAGMATIC ).

The New Deal can be divided into three overlapping phases. The first ( 1ST ) heroic phase began when Roosevelt took office on March 4 1933. He began with a six-day enforced banking holiday followed by an emergency act that gave federal authorities increased power over the banking system. He himself then embraced the view that he was saving capitalism rather than destroying it ( HE WAS ). The emergency act also cut the dollar’s link with gold, which was then repegged at a lower rate ( GOOD IDEA ).

This de facto devaluation, together with a subsequent inflow of gold from Europe, facilitated a recovery in the money supply from its catastrophic fall in 1930-32 to resume a more expansionary if erratic course.

These monetary measures were accompanied by a whole alphabet of new agencies to promote employment and relieve distress. Whatever free market rhetoric might assert, I cannot find it in me to condemn Roosevelt for attempting to accelerate job creation more quickly than monetary policy could do on its own at a time when unemployment was near 25 per cent and the best known popular song ran: “Buddy can you spare a dime.” ( I AGREE ENTIRELY )

The first phase gradually gave way to a second ( 2ND ). The more enthusiastic New Dealers were not content with economic recovery and wanted to construct a new economic system, which was not so much socialism as corporatism ( THEY DID THAT ), that is a system in which market forces were replaced as far as possible in the determination of prices by political negotiation between unions and employers’ bodies. Under the National Recovery Act enforceable codes could be issued to do just that – until the NRA was declared unconstitutional by the Supreme Court in 1935. The fight over these measures prompted a more radical phase in the president’s rhetoric in 1936 when he welcomed the hatred of “malefactors of great wealth”.

There followed a third phase ( 3RD ) as the second world war approached in which the New Deal ran out of steam. There was a lurch into financial conservatism in 1937-38 when the administration cut social spending in a renewed attempt to balance the budget and the Fed tightened policy prematurely.

Taking the New Deal period as a whole, the expansion in demand was accompanied by a much larger rise in wholesale prices and a correspondingly lower recovery in output and employment than on previous occasions. Indeed unemployment did not regain its 1929 low until 1943, well into the second world war. Milton Friedman attributes this disappointing experience at least in part to deliberate measures to raise prices and wages by encouraging unionisation. John Maynard Keynes himself gently and wittily reproached the president for unnecessarily antagonising business.

I would draw a simple moral. When fighting a slump concentrate on demand and output ( FINE ). Do not interfere with prices and wages ( YES ); and above all avoid doing anything that wittingly or unwittingly strengthens business, labour or agricultural lobbies ( FINE )."