Milton Friedman & Keynes Both Thought Government Could Stop Recessions

Governments possess no demand. They just have taxing power, which means governments can only spend insofar as there’s less spending, or “demand,” from the private sector.

Some will ask why this opinion piece is stating the obvious. The answer can be found in some of the commentary about the latest Nobel Prize in Economic Science winners, Robert Hall and Michael Woodford.

A piece by David Henderson at the Wall Street Journal described Keynes’s thinking this way: he believed “government should increase aggregate demand for goods and services by temporarily increasing government spending.” There’s no disputing what Henderson wrote, but there is much to disagree with Keynes about. See above.

Government once again possesses no demand. Its spending once again occurs at the expense of private sector demand. And that’s merely the seen. The unseen is how much more expansive production would be (alongside commensurately greater demand) if precious resources stayed in the private sector, and found their way to businesses and entrepreneurs over consumptive politicians.

Still, even if we ignore the unseen we can see what’s true: production is the only source of demand, and governments produce nothing. Keynes ascribed a stimulative power to government that quite simply didn’t and doesn’t exist.

Which brings us to Milton Friedman. As readers know, Friedman disagreed with Keynes and his disciples, and they him. Henderson specifically cites 1970 Nobel laureate Paul Samuelson, “who argued that monetary policy was ineffective at lifting economies from recessions.” Samuelson was surely right, though surely for the wrong reasons.

What’s right is that resource-bereft governments that most certainly cannot increase “demand” through spending can hardly do so via monetary policy. Money doesn’t just “circulate,” nor is so-called “money supply” “gunned” by central banks, rather money in circulation is an effect of production. Since production is an expression of a desire to get, there’s always money circulating where production is, and as though – yes – an “invisible hand” placed it there.

As was noted here last week, it’s not a coincidence or due to Fed fiddling that there are exponentially more dollars circulating in Seattle than in Spokane. Instead, production in Seattle that’s exponentially greater than production in Spokane ensures more dollars.

Money in circulation is production determined, and would be abundant in the U.S. even if the Treasury, Fed, and the U.S. Mint didn’t exist. In the U.S. and the world, herculean production or lack thereof is the sole driver of a lot or very little exchange media circulating.

Yet according to Henderson, Friedman believed that “monetary policy, for good and ill, was quite effective” when it came to lifting an economy out of its doldrums. Friedman was ascribing a demand-expanding power to central banks or governmental monetary authorities through their employment of alleged increases or decreases of what economists refer to as “money supply.” Except that governments produce nothing, which means they can hardly increase circulation of exchange media meant to expand “demand.”

If readers doubt this, imagine the Fed utilizing open market operations to drain Palo Alto banks of money while at the same time reversing its Palo Alto actions to increase so-called “money supply” in west Baltimore. If so, readers can surely guess that market actors would reverse the Fed’s interventions within seconds. That’s because money is abundant where production is, and scarce where production isn’t.

Beyond that, central banks possess no demand. Production is always and everywhere the only source of demand, and governments yet again produce nothing.

Implied in Friedman’s view that governments could increase demand through increases in so-called “money supply” is that governments and their creations can work around the production part to boost the economy. No. Governments that possess no demand with spending hardly gain it through central bank increases of exchange media.

It’s a reminder that Friedman didn’t disagree with Keynes as much as the two economists disagreed about how governments could increase demand. Which means both economists ascribed a stimulative power to government that quite simply didn’t and does not exist.

Originally published on Forbes.