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Bernanke’s Philosopher

The Fed chairman is portrayed as a follower of John Maynard Keynes, but his real inspiration is Milton Friedman.

When Ben Bernanke took charge of the Federal Reserve in 2006, the media made a few passing references that suggested he secretly subscribed to libertarianism. “I worked with him for years before I even knew he was a libertarian-leaning Republican,” the former Fed vice chairman Alan Blinder told CNN. The Wall Street Journal reported that Bernanke, “though a libertarian Republican …displays few partisan leanings.”

Last summer President Barack Obama re-nominated Bernanke to another four-year term atop the central bank, a reward for allegedly saving the world from a second Great Depression. Bernanke will arrive at his Senate confirmation hearings this January with an unbeatable recommendation. “As an expert on the causes of the Great Depression,” Obama raved in August, “I’m sure Ben never imagined that he would be part of a team responsible for preventing another. But because of his background, his temperament, his courage and his creativity, that’s exactly what he has helped to achieve.”

“Mission Accomplished,” the banner might have read.

Missing from Obama’s speech was any mention of Bernanke’s economic philosophy. These days, the media have taken to calling him a Keynesian—a believer in fiscal stimulus and the mixed economy. “We are all Keynesians again,” the liberal Washington Monthly headlined a January 2009 feature on the Fed chief.

In reality, Bernanke is following a monetarist depression-prevention model laid out by Nobel laureate and libertarian patron saint Milton Friedman. The Fed chairman has invoked the late economist in support of lowering interest rates to zero and bailing out banks. Trillions of dollars have been staked on the insights of “monetarism,” the economic theory of central banking and inflation-management associated with Friedman and Anna Schwartz. Though Schwartz now distances herself from Bernanke, opposing his reappointment on the grounds that he’s gone too far, the irony remains that a series of Fed policies many libertarians find repugnant are being championed by a man claiming to take his chief inspiration from the most influential libertarian economist of the 20th century.

A Monetary History of Ben Bernanke

The story begins in 1963, when Friedman and co-author Anna Schwartz published A Monetary History of the United States, an opening salvo in what Friedman called a “counterrevolution” against Keynesian theory. Their chapter on the Great Depression was spun off into a stand-alone book, The Great Contraction: 1929–1933, an epic revisionist history that changed America’s understanding of the causes of the Depression. Friedman and Schwartz contended that the Federal Reserve—not capitalism or Wall Street—was to blame for the dismal ’30s.

“The fact of the matter is that it was the [Fed’s] decision to tighten credit policy in 1928 that produced the Great Contraction,” the 93-year-old Schwartz says by phone from her office at the National Bureau of Economic Research in New York City. The Fed hiked interest rates in 1928 to curb what it saw as rampant speculation on Wall Street—a conflagration of leverage, margin buying, and outright Ponzi scheming fueled in the first instance by cheap credit from the Federal Reserve. (Goldman Sachs’ various pyramid schemes from that era, after they collapsed in 1929, generated losses of $475 billion in today’s dollars.)

Friedman and Schwartz rejected the widely held theory that speculation had been a major problem, or that there had even been a credit bubble in the 1920s. Bad loans and reckless banking practices were a “minor factor,” at most, in the Great Depression, they said. In this narrative, a Federal Reserve paranoid about speculation had needlessly constricted the money supply, imploding an otherwise sound economy.

After the Great Crash of 1929, the Federal Reserve drastically cut interest rates from a brief high of 6 percent to 1.5 percent by mid-1931. But during the first few years of the crisis, the Fed occasionally felt forced to abruptly raise rates again in complicated maneuvers to stem outflows of gold into Europe. Friedman and Schwartz blamed these sporadic interest rate hikes for smothering incipient recoveries, opening a vortex of deflation, and transforming a recession into the Great Depression.

“What the Fed had to do was increase the money supply,” Schwartz tells me. “By taking that action, it would have revived the economy. That’s the lesson of the Great Depression.” In The Great Contraction, she and Friedman argued that the Fed squandered its ample latitude to combat deflation. “The monetary authorities,” they wrote, “could have prevented the decline in the stock of money—indeed, could have produced almost any desired increase in the money stock.”

When it comes to his academic specialty, Bernanke is a disciple of Friedman and Schwartz. In 2002, at Friedman’s 90th birthday party at the University of Chicago, Bernanke was effusive. “Among economic scholars,” he began, “Friedman has no peers.” He developed the “leading and most persuasive” explanation of the Depression, whose impact on economics and the popular mind “cannot be overstated.”

At the end of his encomium, Bernanke made a soon-to-be-famous apology on behalf of the Federal Reserve, where he was then president of the powerful New York branch: “I would like to say to Milton and Anna…regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” (The speech was published as the afterword to the latest edition of The Great Contraction.)

Schwartz was present at the birthday party. “I’m sure he was sincere when he said that,” she says. And Bernanke stayed true to his word. In 2006 he replaced Alan Greenspan as chairman of the Federal Reserve. Greenspan, a self-described “libertarian Republican” who had once been part of Ayn Rand’s inner circle, had engineered an era of low-inflation growth that won Friedman’s endorsement. “There is no other period of comparable length in which the Federal Reserve System has performed so well,” Friedman declared in The Wall Street Journal on January 31, 2006.

Monetarism and Freedom

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anon|11.17.09 @ 7:56AM|

Friedman was one of the better mainstream economists from a free market perspective, but he was still wrong on the Depression. Too bad Bernanke didn't take his inspiration from Hayek and Mises, or we may not have even gotten into this mess.

HAC|11.17.09 @ 8:24AM|

yep.. problem with monetarists.. their capital theory is as bad as keynesians'... (see link)

Xeones|11.17.09 @ 8:29AM|


ron|11.17.09 @ 8:29AM|

It's easy to confuse Chicago with Keynes.. 80% of their methodology is shared.
The key is fractional reserve banking and it's central banking enablers at the Fed.
Friedman was a good guy (well, except for the witholding tax peccadillo) but as long as he was inconsistent..."price controls are bad.. but not for the price of money"... he helped the central planners more than freedom..

robc|11.17.09 @ 9:34AM|


He was young and stupid at the time of the withholding tax error. He admitted this later on. Dont see why people hold that against him instead of his real problems (which you also mentioned).

Pingback| 11.17.09 @ 10:08AM

Loans For Bad Credit - Student who fell from roof had gone to smoke - Milwaukee Journ links to this page. Here’s an excerpt:

…a building bearing the logo of the CIT Group is seen in New York. Commercial lender CIT Group, which recently filed for bankruptcy protection, said Tuesday, Nov. 17, 2009, it lost $1.07 billion Bernanke’s Philosopher - When Ben Bernanke took charge of the Federal Reserve in 2006, the media made a few passing references that suggested he secretly subscribed to libertarianism. “I worked with him for years…

|11.17.09 @ 10:15AM|

Young, stupid and helping expand the government is no way to go through life.

|11.17.09 @ 10:24AM|

So funny to listen to the fed now. "The output gap is high so inflation is not a threat." I hope they keep interest rates at zero for another year as CRB doubles, then triples....and keep repeating the crap about the output gap. Smart people don't want to hold dollars when they know the fed has to try and inflate away trillions in bad debt and pension obligations.

What is more politically feasible,

1)Obama gives a big speach tomorrow telling all the government workers that there is really no way that there pension defined benefits will be honored or

2)the Fed will inflate the shit out of the dollar while all the illiterate state workers get the wool pulled over their eyes by the great wizard. The smarter 5% makes lots of money speculating in commodities and the dumber 95% is still as dumb and poor as ever. This is evolution at work.

ray|11.17.09 @ 11:02AM|

all the "output gap" talk is meaningless... more money + fewer goods = higher prices (ceteris paribus)... all that cash has to go somewhere... and it will.

ray|11.17.09 @ 11:04AM|

..but don't ask me where. If I knew for sure I'd be getting a mortgage to buy rice/oil/gold/ammo/chinese stock...

since I don't know, I'm just buying gold, but only with money I can spare (no leverage..)

|11.17.09 @ 2:09PM|

Why not borrow?

Pingback| 11.17.09 @ 10:40AM

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|11.17.09 @ 11:15AM|

While it is tempting to use leverage, the bad guys hold the strings to that and they are not afraid to shake all the leveraged folks out when it would most help their side....or that is just how it seems. Use a balanced and reason approach witha healthy fear of leverage and fraud...pretty sure those ETF's will end up fucking people over in the end.

|11.17.09 @ 11:19AM|

"all the "output gap" talk is meaningless... " it also is implying that goods and production is homogeneous...but in reality it is takes time to switch over our capital base from producing condominiums to producing....uh...well it is easy to produce nothing(see present)...but it is kinda hard for unemployed mortgage brokers to make super conductors that haven't been invented yet.

andy|11.18.09 @ 5:59AM|

exactly... capital goods are heterogenous..

Kroneborge|11.17.09 @ 11:48AM|

Infaltion isn't much of a concern as long as the velocity of money is still decreasing. Moreover, the velocity probably won't return to what it did for quite a while due to less financial innovation etc.

As far as the crises goes, there is still a lot of pain to go through, the question is whether it's better all at once, or spread out a bit.

I think the main concern is that if they picked all at once, it would have gotten out of control.

For example, at the hight of the crises, international trade was having a hard time getting letters of credit. If that had shut down, we could have had a melt down that would have made the great depression look like a walk in the park.

roy|11.18.09 @ 6:02AM|

V is just an imaginary variable to balance the equation...

you can actually try to measure empirically M, P and T. V? They just make it up. It's 100% theory.

|11.17.09 @ 1:46PM|

"I think the main concern is that if they picked all at once, it would have gotten out of control. "

Kroneborge, I think it is more complicated than that. The "spread it out" option entails increasing interventionism...increasing power of a centralised power over the individual. This always leads to a crappier situation in the long run. Yes Keynes and Greenspan may be dead in the long run, but we are gonna have to live with it. I'm just trying to be on the right side of the Fed's whipsaw attacks when they next decide to jerk us around.

|11.17.09 @ 1:51PM|

If they leave rates at zero for a long time as they are promising then inflation will pick up. Your predictions on money velocity are worthless in the face of extended expansionary monetary policies. Smart people(cnetral banks, GS traders, hedge funds etc) will be getting their hands on the cheap money and betting on commodities regardless of how quickly joe-sixpack spends his paycheck each week.

|11.17.09 @ 3:30PM|

If you read anything of Bernanke's papers on credit view models, one would argue that the stated goal is, at least in the short term, to have higher-than-normal inflation, ultimately resulting in low (if not negative) real interest rates for lending and using that amount of new loan capital to resuscitate the goods market with minimal long-term harm.

That being said, I'd break with Bernanke's model in so much as that, while the financial panic ultimately resulted in a supply shock to credit markets, the inevitable government regulation over banks that will follow in its wake is likely to cause much of that shock to become permanent, establishing a new lower equilibrium in economic output. If that is the case, the policy goal may be to keep inflation in check so as to not depress the labor market as well...

|11.17.09 @ 4:14PM|

In his book "Inflation Targeting", Bernanke says that a targeted inflation of 5% or 7% may be ok!! He doesn’t want to "pass judgment" on this until more econometric studies have been done.

|11.17.09 @ 4:16PM|

here about all the 400 oz gold bars that are filled with Tungsten?

I'd donate to $50 to Reason if they do a interview with this Ron Kirby guy on the fake gold bars he is claiming are sitting in a lot of ETFs. You don't even have to make it a friendly interview, just investigate it.

Pingback| 11.17.09 @ 4:38PM

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economist|11.17.09 @ 10:37PM|

My own views on economics are a somewhat odd mix of monetarism and Austrian theory. The Austrians are correct, namely, about the effects of artificially expanding credit (through fractional reserve banking and expanding the money base) in sewing the seeds of the business cycle. However, Friedman was correct that a slow, consistent expansion of the money supply is necessary to avoid constraining economic growth (as excessive deflation tends to disincentivize investment). I think his ideas have failed in practice because he more or less ignored the Austrians' insights on the effects of credit expansion by the central bank (although it should be noted that Friedman saw central bank policy as a "second-best" solution for expanding the money supply.

Pingback| 11.18.09 @ 6:27AM

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|11.18.09 @ 11:23AM|

Your views are well thought out, but I think there is one presumption you make that is very important.

"as excessive deflation tends to disincentivize investment"

When you say this you are making the presumption that "more investment" is always the "right" thing. I find this odd. While it is true that you need investment in order to have productivity gains later on, you must accept the idea that not all "investments" are equal right?
(investments in "security" say ammunition and gasoline for tanks to invade desert countries) != (new advanced bread factories)

Just as a thought experiment, lets assume there is a world where a sceret cabal of satanist worshipping death cultist have gained control of all the central banks, many leading media outlets and many infleuntial policy think tanks(just a thought experiment) they intend to slowly trick the masses into accepting a central governing power with greater authority so that they can basically create a prison planet where most of the population are brave new world type servants. They plan to get to this new world by making fabian socialist promises(free health care, free education k-college, gauranteed retirement plans for all, right to housing, right to food etc.) However as each new power over the individual is given to the govenment the economy gets weaker and capitalist who understand what created their past prosperity decide it is best not to invest in things the governrment can confiscate, but instead hoard durable assets and hide their wealth or buy political infleunce to protect their small domains...economist see the data flows, investment in real productive assets is falling! the decline in prosperity "must be due to less investment!", they claim. "the free-market has failed", they think "we need to incentivize greater investment"...all the mainstream economist agree and so new programs are created...

Do you think that narrowly focusing on increasing investment will fix things in this scenario?

Ben not Bernanke|11.20.09 @ 9:49AM|

No one except for the last statement talk about the real problem with all of this. Government largess is the main problem. I believe that we could debate either Friedman or the Austrian school if the govs around the world were not sending the markets the wrong signals. We need to control government first to see which theory will create the most growth. Till then it is going to be a rough road. Gabe is exactly right and all of the minds here should spend their time figuring out how to stop the madness.

|11.24.09 @ 12:41PM|

as excessive deflation tends to disincentivize investment

You have it backward. Investment will be optimized if the interest rates reflect the true cost of risk/capital. Fiat currency is not needed for this process. Price deflation and inflation can occur naturally but they aren't in themselves bad things and they are self correcting. The evils of deflation are largely mythical.. or rather deflation is indeed evil to people who earn their wealth via first use of currency.

The industrial revolution happened during a period (and was arguably causal to) a period of prolonged mild deflation. Goods prices however dropped faster than wages.. so it was not a bad time at all for labor.

As efficiency goes up more is produced with the same raw material and labor.

This isn't a bad thing and need not be compensated for with more currency.

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