Keynes vs. Friedman – The Economic Wrestling Match That Will Determine Our Future

A Finance Commentary by George Cappannelli

Considering the precarious, challenging and one can certainly say, vulnerable state of the world’s economy, it is not surprising that the dialogue, it would not be wrong to call it a heated argument, that has been going on in the world of economics for many years and most particularly since the mid- 1930’s is getting even hotter.

At the height of the Great Depression British economist, John Maynard Keynes published The General Theory of Employment, Interest and Money.

Keynes and his supporters who have since come to be known as The Keynesian School believe that ‘aggregate demand created by households, businesses and governments and not the demand of free markets constitute the driving force in an economy.’

The other side of this argument has been championed by number of economists, but in the modern era, it is best represented in the work of Milton Friedman, an American economist and statistician who taught at the University of Chicago.  Although Friedman passed away in 2006, The Chicago School, as his theory has come to be known continues to promote the idea that it is the free market that determines the well being of the economic climate.  Indeed, Friedman, and many other advocates of The Chicago School believe that ‘the world runs on individuals pursuing their self agendas’ and that ‘there is no alternative way to improve the lot of the common people other than through free enterprise.’

It is not the purpose of this series to resolve this argument between opposing schools, you can make up your own mind by reading the work of Keynes and Freidman and following the impact their theories have had on the world around us.  Nor is it the intent of rEVO to pretend that we have ‘the answer’ to this age-old conundrum. It is, however, the intent of this series to recognize that depending on which of these two courses we choose, we will soon discover whether our country and the world community as a whole will find its way out of the current world economic crisis in the near future or whether we will languish in a period of slow to no growth or even worse, experience a period of deepening economic downturn.

As a result this is a very important topic, one that we believe should not be avoided because our academics and politicians seem intent on presenting it in language that is unnecessarily complex and very confusing.  So from time to time over the next several months we will bring you different points of view on how this important topic plays out in the real world. For, in the end, the solution to our economic challenges will be found when and only when enough of us are better informed and more aware of the impact the decisions of our economists and political leaders make.  Indeed, we believe that the stakes are too high to allow our future to be determined by those who by design or omission are intent on advancing their agendas by behind overly complex or overly simplistic descriptions.

In a recent article from DailyFinance:  entitled – ‘Why The Fed’s ‘Trickle-Down Economics’ is Failing, by Charles Hugh Smith, we get a first hand look at how hot this topic is becoming.

In the Smith article, the author takes an in depth look at the strategy being following by the Federal Reserve in addressing our financial challenges.

“The heart of the Federal Reserve’s policy, Smith writes, “to extricate the nation from the lasting grip of a deep recession is in essence a variation of what’s known as “trickle down economics.” The government aims to boost the net income of the wealthiest Americans, so that as these top earners spend, their wealth will “trickle down” to average Americans via service and production jobs.”

Clearly this is not the kind of approach we followed in the aftermath of the Great Depression and it certainly is not the approach recommended by John Maynard Keynes.

In this instance, according to Charles Hugh Smith,

“The Fed’s current policy has two intentions:

1. By lowering interest rates to near-zero (called “zero-interest-rate policy,” or ZIRP) and flooding the banks with liquidity (the banks can borrow from the Federal Reserve for almost no cost), then the banks will be able to loan more money to households and enterprises. This also helps the banks to slowly rebuild their capital by reaping easy profits because they can borrow from the Fed at 0% and loan it out at much higher rates. This fat profit margin is in effect a gift from the Federal Reserve.

2. All this “easy to borrow” money resulting from the Fed’s “quantitative easing” is supposed to flow into the real economy (as opposed to flowing into speculation) as households borrow and spend, and as enterprises borrow to expand their production.”

In short this is ‘free market’ thinking at its most explicit and no doubt, Milton Friedman must be sitting back in Heaven or wherever it is that former economists go, with a large and very self-satisfied smile on his face.

Unfortunately, Smith believes this approach has some very significant down sides to it.  He believes it,

“penalizes average Americans, encourages borrowing and speculation in risky assets, reduces the interest the average American can get on their cash, and crushing the purchasing power of the U.S. dollar.”

Furthermore he thinks the Fed has forgotten that

“average Americans have little stake in the stock market.  The top 20% of Americans own 93% of all financial wealth.”

Clearly, this fact alone – the staggering and disproportionate amount of wealth owned by a relatively small percentage of the American public – challenges the believe, held my many in this country, that our is still a land of opportunity and relative equity for all of our citizens.  Finally, if what Smith says is true, we would be wise to keep our eyes on the current direction our Federal Reserve is taking.

What do you think?   Are we leaning too heavily toward Milton Friedman’s economic philosophy and too far away from the principles and strategies proposed by John Maynard Keynes?  If you don’t think you have a dog in this hunt or have not yet had the chance to read Charles Hugh Smith’s article we invite you to do so at ‘Why The Fed’s ‘Trickle-Down Economics’ is Failing, and then talk to us about this heavy weight wrestling match between two of the titans of economic theory of the 20th Century.  Let’s explore what you think the effect you it will have on America’s future.

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5 Responses to Keynes vs. Friedman – The Economic Wrestling Match That Will Determine Our Future

  1. Pingback: AgeNation » Keynes vs Friedman, At Stake The Economic Stability Of the 21st Century

  2. Couldnt agree more with that, very attractive article

  3. JoelSoul says:

    The Fed policy illustrated above of making money out of thin air (counterfiting) and giving it to the banks and eventually into general public circulation destroys the value of the dollar leading to inflation, the destruction of personal savings and other matters that are now coming home to roost. The nearly 70 year experiment with fiat money is coming to an end.

    The best and clearest books on the subject are by author Richard Maybury. His “Whatever happened to Justice” is a great primer on government and economics and just what is so special about the legendary American Dream. His other books go into further detail.

    A final word on my part is how can one man (President) or a group of folks (Congress) truly create an economy it took each of us individually to create over decades and generations. The creative spark exists only in the individual.

    • B says:

      “The Fed policy illustrated above of making money out of thin air (counterfiting) and giving it to the banks and eventually into general public circulation destroys the value of the dollar leading to inflation, the destruction of personal savings and other matters that are now coming home to roost. The nearly 70 year experiment with fiat money is coming to an end.”

      Where to start? Your entire post is categorically false and devoid of economic knowledge. You didn’t learn any of this in economics classes, it sounds more like you learned it from Rush Limbaugh and Glenn Beck- who know nothing at all about economics.

      Neither did F.A. Hayek, Murray Rothbard, or von Mises- so don’t even consider bringing them into this. They have all strongly been empirically proven wrong, and there’s a reason their names only exist in the minds of right-wingers like yourself, instead of classrooms.

      Onto why you are wrong. You are only correct in the sense that “printing money” (an ignorant and inflammatory term for quantitative easing) will sometimes cause inflation, however this only happens if there is a full employment of resources in the economy. Right now we have more idle resources than we have had in decades. QE will not cause inflation as long as this is true. Disagree all you want; I can open my Principles of Economics, or my American Economic Review (one of the most prestigious peer-reviewed Economics journals in the world) and immediately find a wealth of well-researched facts that prove you wrong in a heartbeat.

      You want to believe you are right. I can understand this, everyone wants to validate their little worldview. I just want you to know that your worldview is not a view grounded in economics. The theory does not support you. Your views are grounded in political philosophy (Hayek and the Austrians were not economists, contrary to popular belief, but political philosophers) which is NOT a science, as Economics is.

  4. B says:

    Separating Keynes and Friedman was the only big mistake this article made. The problem with this red herring you’ve created is that it doesn’t consider the fact that many of Friedman’s own theories owe their credibility to the fact that they descended from Keynes’ own line of reasoning.

    Friedman’s notion that monetary policy by the Fed can have an effect on the real economy (money is not ‘real’ to the neoclassical/marginalist economists) comes straight from Keynes himself. There would be no Friedman without Keynes. Friedman can be considered a “rogue disciple” of Keynes in this sense. Much of what he advocated was drawn from Keynes less-known work- his Treatise on Money- or just the General Theory.

    Now, this is not to say that the argument you pose is totally a red herring. It isn’t. Friedman obviously did some breaking away (hence me saying “rogue” disciple) and you are right– Friedman is influencing Fed economics from well beyond the grave. Almost all Fed policy comes from Friedman and Greenspan.

    I just want to establish that if you are indeed a “Keynesian” (a confusing term, since it encompasses so many modern economic models) then you are not in a position to disagree with what the Fed is doing. You might believe that more is needed via fiscal policy, but you won’t be able to disagree with .25% interest rates and QE.

    To Keynes, many small problems can be remedied with monetary adjustments. It’s during recessions like these, when little adjustments are no longer available, when we must use unconventional Fed policy, and direct congressional intervention.

    There are problems with fiscal policy and it has its share of legitimate critiques. However, most of these legit critiques do not apply to our situation. For example, people criticize that by the time the fiscal policies take effect we may not need/want them anymore. Well, this is a particularly prolonged and nasty recession, so actually we could have used the policy interventions at any point during the early recession. It’s too late now, most likely, since the economy is slowly picking up thanks to the Fed.

    My point is that the Fed should not have been the sole arbiter of our recovery. Because of this mistake, and by misguided fiscal policy (what we had of it that is) aimed mostly at taxes and not jobs, the recovery has become a years-long endeavor instead of a months-long one.

    In sum: Definitely a good, solid article. Could have been a little heavier on the history of econ. thought, though.

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