Krugman on Friedman on the Depression

I just recently came across this profile of Milton Friedman by Paul Krugman in the February 15, 2007 New York Review of Books. Krugman pays homage to Friedman’s research as a macroeconomist, including his and Schwartz’s Monetary History of the United States, best known for its explanation of the Great Depression as a monetary phenomenon. However, Krugman castigates Friedman for “intellectual dishonesty” in his popularizations.

On the Great Depression, the core of Krugman’s accusation is that Friedman claimed to have found that the Federal Reserve “caused” the Great Depression when the money supply collapsed by a third during 1931-33 due to bank failures. But, says Krugman, the fault in the Fed was not reducing the monetary base (they increased it), but instead failure to act. So it’s dishonest to claim that the Fed caused the Depression, when Friedman’s research actually demonstrates the case for more government intervention, not less.

I take the point, but it’s an unfair stretch to characterize Friedman’s interpretation as intellectually dishonest. After all, when public choice economists criticize government regulation on the grounds that such agencies are often “captured” by the interests they’re supposed to be regulating, no one would say it’s intellectually dishonest to oppose certain government regulations on those grounds. Similarly, one can legitimately oppose monetary discretion on the grounds that central banks will sometimes make catastrophic mistakes on the side of acting too hesitantly or timidly.

Second, as I recall Friedman and Schwartz’s original argument, they also argued that an alternative to rescuing the banks would be either deposit insurance or allowing solvent but illiquid banks to suspend payments to depositors, as had been the case prior to 1913. It was the combination of no deposit insurance, no bailouts, and the prohibition on suspension of payments that caused the catastrophe. Had that last government regulation not been in place, the U.S. Depression might not have turned out to be the worst slump in the industrialized world in the 1930s.

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