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Steven Branchflower on Sarah Palin

Notes to Self: What Are We Doing?

Nobody--save a few fringe academics like Casey Mulligan today and U.S. Depression-era Treasury Secretary Andrew Mellon and his epigones in 1930 (that's why it is called the Great Depression)--believes in the rule of the "free market" in a financial crisis. And Sweden in 1992 is a definite precedent for what we are doing now.

But what are we doing now?

I am not sure, but I think I would put it this way:

Back in 1844 British Prime Minister Robert Peel laid down the then-consensus principle that the government had to take control of the money market in emergencies: that commitment to the "free market" went out the window in a financial crisis because both the price at which bankers could get cash and the amount of cash in the economy were too important as determinants of the welfare of the people to be left to market forces.

In 1936 John Maynard Keynes argued that that was not enough: that the government had to more-or-less comprehensively take control of the overall level of investment and related forms of spending--that they were too important as determinants of the welfare of the people to be left to market forces.

In 1963 Milton Friedman argued that if the government took control of the price at which bankers could get cash and the amount of cash in the economy at all times--not just in crises--intervened constantly to keep the money stock growing steadily--that you would never get into the kinds of situations Keynes feared in which the government had to comprehensively take control of the overall level of investment and related forms of spending. And Milton Friedman more-or-less won the argument.

Today we seem to be moving back from Milton Friedman's doctrine toward, or perhaps beyond, Keynes's. What the Federal Reserve and the Treasury seem to be saying now is that Friedman was wrong. It is not enough if the government takes control of the price at which bankers could get cash and the amount of cash in the economy at all times. In emergencies, at least, the government must also take control of the discount the market applies to other assets that are not as good as cash because they are risky--that the price of risk as well as the terms on which bankers can get cash are prices that are too important for the welfare of the people to be left to market forces. And to control the price of risk we need to control (a) the quantity of risky assets outstanding, and (b) the capital of banks. Which seems to be what we are doing.

I am not sure whether this is some kind of halfway house between Friedman and Keynes, or whether we are going beyond Keynes, or whether we are heading off in some other direction. But this appears to be where we are going.

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