Social Policy in Ontario

Monetarism is dead, finally

Posted on January 18, 2015 in Debates

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TheStar.com – Opinion/Commentary – Milton Friedman’s argument that printing money would inevitably lead to soaring prices no longer seems to hold water.
Jan 17 2015.   By: Philip Demont, Eugene Lang

Milton Friedman, the Nobel Prize-winning economist who died in 2004, became famous for his influential theory known as monetarism, which tried to explain what produces inflation and offer a prescription on how to control it. Monetarism became the foundation for a great deal of monetary policy in this and other countries for decades. It has now been half a century since Friedman first expounded on monetarism and it is increasingly apparent that the time has come to lay his theory to rest.

Friedman’s basic idea, which was really the brainchild of early 20th century economist Irving Fisher, was elegant in its simplicity. Measure the amount of money — cash and near-cash deposits and investments — sloshing around in the economy. If the growth in this variable exceeded the increase in national gross domestic product (GDP), you got inflation. If the expansion of the money supply was faster than GDP growth by a large percentage, you got a lot of inflation.

Yet after more than seven years of double-digit growth in Canada’s money supply, we still do not have a whiff of the high inflation that many economists steeped in the monetarist credo predicted. Friedman’s argument that printing money would inevitably lead to soaring prices no longer seems to hold water.

The Bank of Canada first latched onto monetarism during the 1970s, when both inflation and unemployment were near double digits and increasing simultaneously. With Gerald Bouey as governor, the bank began limiting the growth of Canada’s money supply à la Friedman to produce an acceptable rate of inflation.

Eventually, Canada’s inflation rate, which had exceeded 10 per cent in some years, declined, although some economists argued that the fall was more because of a recession in the early ’80s than due to monetary policy.

But by the early 1990s, with inflation high again despite a 15-year monetarist experiment at the central bank, Canada’s policy-makers moved away from a strict focus on the money supply and toward targeting the country’s inflation rate. That was the first inkling that monetarism was losing its lustre in Ottawa. Within a couple of years of inflation targeting, consumer prices dropped. Inflation, the scourge of the Canadian economy for two decades, has remained low ever since.

Then came 2008, when a localized mortgage crisis turned into a worldwide recession. Economic growth plunged and unemployment soared. In response, most governments started pumping new money into their economies — often through programs in which central banks would buy non-performing loans from teetering banks and other companies. During this period we witnessed a revival of another old economic theory known as Keynesianism, an approach to macroeconomic policy that Friedman thought was inflationary and which led him to develop his monetarist counter-revolution.

The last half decade or so has demonstrated that old theories die hard and slow. Many economists and investment types, who came of age in the monetarist rather than the Keynesian era, began warning of impending hyperinflation following the stimulative actions of central banks and governments after the 2008 global economic and financial crisis. But it didn’t turn out that way. Inflation in Canada, throughout Europe and in the United States has remained relatively low for years despite so much new money getting pumped into these economies. For whatever reason, money supply growth in most countries no longer tracks the consumer price index in any meaningful way.

Between 2009 and 2013, for example, Canada’s money supply grew by an annual average of almost 10 per cent. During the same period, the national inflation rate averaged less than 1.5 per cent, a result Friedman and his acolytes would have seen as impossible. And in 2012, Canada’s money supply grew 25-per-cent faster than in 2011, yet the country’s inflation rate dropped by almost 50 per cent.

Experts are finally changing their minds on this issue.

Where a few years ago hand-wringing about the impending inflation disaster was popular fodder on North America’s business stations, analysts talking about hyperinflation now appear overly gloomy or even antediluvian, much as Keynesians did a generation ago when monetarism was in the ascendant. Even bond markets, often the canary in the coal mine when it comes to rising inflation, are ignoring the issue.

The key lesson here is that economic theories are not immutable truths, rather they come and go. Henry George’s single-tax theory was popular at the end of the 19th century. Walt Rostow’s The Stages of Economic Growth was required reading in universities in the 1960s. And, of course, Keynesianism has come and gone out of fashion twice in the past 70 years. Now Friedman’s monetarism, once the darling of countries as diverse as New Zealand and Chile, seems poised for the intellectual dust bin.

Philip Demont is a freelance writer, economist and co-author of Turning Point: Moving Beyond Neoconservatism.
Eugene Lang is BMO Visiting Fellow and Interim Co-Director, Glendon School of Public and International Affairs, and also co-author of Turning Point.

< http://www.thestar.com/opinion/commentary/2015/01/17/monetarism-is-dead-finally.html >

Tags: economy, featured, globalization, ideology, poverty, standard of living, tax

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