John Maynard Keynes Versus Milton Friedman

The tale of the economy over the next couple of years is really a test of the theories of John Maynard Keynes, the father of deficit spending, or Milton Friedman, the Novel Laureatee, who believed that inflation was a monetary phenomenon. Bernanke has thrown his lost with Keynes.

The tale of the economy over the next couple of years is really a test of the theories of John Maynard Keynes, the father of deficit spending, or Milton Friedman, the Nobel Laureatee, who believed that inflation was a monetary phenomenon.

An interesting article on this subject on Bloomberg states:

"Bernanke’s gamble that the highest jobless rate in 25 years and the most idle factory capacity on record will hold down inflation is straight out of the late British economist Keynes. Should late Nobel-prize-winner Friedman’s dictum that 'inflation is always and everywhere a monetary phenomenon' prove right, the $1 trillion or more in liquidity Bernanke has pumped into the financial system by expanding the Fed’s balance sheet may leave him to cope with surging consumer prices."

So far, investors and economic data both back up the Bernanke-Keynes view. The market in Treasury Inflation-Protected Securities as of April 6 indicated long-term inflation expectations of 2.5 percent, below the 2.8 percent average inflation rate of the past 10 years. "

Of course, we haven't seen much of the stimulus spending yet.  And the Fed has continued to pump money into the economy with a 0% Fed Funds rate as well as the increase in its balance sheet.

The real question is how long will the slack in the economy restrain prices and will the Fed be able to raise rates fast enough once inflation is seen?  In the 1970s, the Fed kept rates too low for too long due to political pressure from Nixon.  If inflation remains above 8% it's feasible we'll see this same type of pressure.

Still, the Fed's philosophy is that it knows how to deal with high inflation (raise rates) while deflation is a much tougher nut to crack.  So, the first priority it to prevent deflation and then deal with any resulting inflation.

TIPS and I Bonds offer protection against future inflation.

Sol Nasisi
Sol Nasisi: Sol Nasisi is the co-founder and a past president of BestCashCow, an online resource for comprehensive bank rate information. In this capacity, he closely followed rate trends for all savings-related and loan products and the impact of rate fluctuations on the economy. He specifically focused on how rates impact consumers' ability to borrow and save. He also has authored a wee

Your code to embed this article on your website* :

*You are allowed to change only styles on the code of this iframe.

 

Comments

  • ktexas

    April 14, 2009

    March 2009 CPI data will be released tomorrow (4/15/09). With that we can figure out the inflation component of the I Bond for the next 6 months starting in May. Due to the huge drop in gas prices late last year, this will very likely be the first time in I Bond history with a negative inflation component. At least with I Bonds, the composite rate is guaranteed never to fall below zero.

  • «
  • Page 1 of 1
  • »
Add your Comment