Perennial critic now says the Fed should be abolished
Milton Friedman, as he admits, is unrepentant and unreformed. The feisty leader of the ''monetarist school'' of economics still attacks the nation's Federal Reserve System. He's still defending his theory of monetary policy against charges that it failed the nation during the past recession. And he continues making statements that sound shocking.
For instance, asked in a telephone interview what should be done next about monetary policy, he replied: ''Abolish the Federal Reserve System.''
Dr. Friedman isn't just being ornery. His key monetary policy recommendation is that new money - the fuel that feeds economic growth - should be fed into the economy in steady amounts. The supply shouldn't vary, as it has in the past. This, he argues, would result in a reduction in the magnitude of the business cycle. Any recessions would be weaker; expansions would not end up as inflationary booms.
The Fed, the nation's central bank, proclaimed in October of 1979 that, in effect, it would follow a basically monetarist policy by paying less attention to steadying interest rates in carrying out monetary policy and more attention to keeping money growth within specific target ranges. Monetarist economists, although still suspicious, had great hopes that the Fed would actually adapt their ideas.
In fact, the Fed at first did not attempt to control interest rates, allowing them to rise to record highs. But despite the growth targets, money growth was the ''most erratic'' of any three- or four-year period, according to Dr. Friedman. In fact, growth rates were outside the targets for 90 percent of the time in the last three years, he estimates.
''If the policy the Federal Reserve has followed is monetarism, I am not a monetarist,'' he said.
Dr. Friedman has lost any faith he had in the Fed. ''What good does it do to tell them about what money supply policy should be? They are not willing to take measures to do what they say it should be.'' So he suggests the Fed be replaced by some simple system for creating new money at a fixed rate.
Monetarism (at least some elements of it) has been growing in popularity for nearly two decades. This is shown by the intensity with which money market participants follow the weekly money supply figures.
But the depth of the last recession, which ended last November, shook some believers. The theory of monetarism depends on a relatively steady relationship between the growth of the money supply and the growth in gross national product (GNP) - the output of goods and services - in current prices. That relationship, critics charged, fell apart. The ''velocity'' of money - how fast it turns over to create GNP - dropped dramatically. This sharply worsened the recession and unemployment.
If monetarism is to be of value to economic policymakers, they must be able to understand and take account of such a large change in velocity - down some 8 percent between the peak in the first quarter of 1981 and the fourth quarter of 1982.
Dr. Friedman offers three explanations. First, there is a normal cyclical variation of about 3 percent in velocity. During a slump, people are anxious and more likely to hold onto money rather than put it quickly back into circulation. Second, the sharp drop in interest rates meant it was less costly for people to hold onto money rather than invest or spend it. This, the Nobel Prize-winning economist calculates, accounts for another 3.5 percent of the total drop. The final, lesser factor, he reckons, is the greater degree of economic instability for the past few years in prices, GNP, interest rates, and so on.
At this time, Dr. Friedman, based now at the Hoover Institution in Stanford, Calif., is concerned that velocity will snap back in its usual cyclical pattern, adding to an upsurge in inflation he predicts for 1984.
Between July 1982 and July 1983, he notes, money supply (M-1, which is currency plus checking-type accounts) grew about 14 percent, which Dr. Friedman believes is the largest such increase in the post-World War II period. That period of rapid growth accounts for the recovery moving, as he puts it, ''like gangbusters.'' And, he adds, it will start boosting inflation next year, with the consumer price index rising between 7 and 9 percent by mid-1984.
Money growth has since slowed. But if the Fed really slams on the monetary brakes, as Dr. Friedman fears, inflation will be somewhat lower. But he also talks of the nation's experiencing ''almost a precise replica of 1980-81.'' Because of sharp shifts in monetary policy, the nation's economy expanded briefly between July 1980 and July 1981, then fell into the last recession. Overly tight money now could push business into another slump in 1984, he warns.
The Fed, he says, ''tends to overdo it.'' His drastic solution: Abolish it.