Republican economists love Milton Friedman. But some of them are finding a strange way to show it. They're taking the most important conclusions from the famous conservative economist and saying the opposite. It's not just a few conservatives. It's lots of them.
For example, Bloomberg View's Amity Shlaes argues that Friedman would counsel Bernanke not to combat deflation and depression today. Actually, she goes further, claiming that Bernanke has essentially betrayed Friedman's legacy by embarking on quantitative easing. This is like saying that Paul Krugman has betrayed Keynes' legacy by advocating gobs of government spending.
Friedman hated deflation. Among his many, many contributions to economics, Friedman revolutionized our understanding of the Great Depression by pointing out that the worst of the slump could have been averted if only the Federal Reserve had stopped the banking panics of the era that caused prices to go tumbling down. Capitalism hadn't failed. Just the Fed.
It's counterintuitive that falling prices can be bad. After all, nobody ever complained about stuff being cheaper. The problems, though, are twofold. First, if prices fall across the board, so too will wages -- but debts won't. Borrowers will have a harder time making their payments. More of them will default. And defaults will push down prices and wages even more. This so-called debt deflation is basically a doomsday machine for mass bankruptcy -- and it's exactly what happened in the 1930s. The other way of thinking about why deflation is so toxic is that it effectively increases interest rates just when we want to reduce them. What matters for borrowers is the real interest rate: that is, the interest rate minus inflation. But falling prices mean inflation is negative, so real interest rates go up. Again, bad for borrowers.