[economics 201] the nasty side of monetarism

In my tiny bit of trade work, we were discussing today Friedman's monetarism and a bit of Hayek, Lucas, Fischer, Sargent and Wallace.

For readers not much into macro-economics, Wiki gives a reasonable summary:

Friedman wrote extensively on the Great Depression, which he called the Great Contraction, arguing that it had been caused by an ordinary financial shock whose duration and seriousness were greatly increased by the subsequent contraction of the money supply caused by the misguided policies of the directors of the Federal Reserve.

"The Fed was largely responsible for converting what might have been a garden-variety recession, although perhaps a fairly severe one, into a major catastrophe. Instead of using its powers to offset the depression, it presided over a decline in the quantity of money by one-third from 1929 to 1933 ... Far from the depression being a failure of the free-enterprise system, it was a tragic failure of government."

Interesting the equating of the Fed with government, which it is anything but, especially these days. Interesting how some people still see the Fed as government today, when the FOMC runs the show. Interesting to talk of rational expectations and assume non-intervention when the FOMC is very much intervening by means of discount and other rates and where other economic triggers have deliberately been allowed to come into play by its governing body, e.g. sub-prime lending by domestic banks and credit institutions.

Nastiness like sub-prime mortgages and other such lending is not held to be part of either their brief or that of government and the question is why not, given that they can regulate the money supply itself. Sub-primes are a major component fuelling the economy and the likely outcomes are predictable in a macro sense.

Swinging over to our situation here. The manager of [hypothetical] Swift Supermarket has money invested through the banks and other agencies. He wants to pull it out of one fund and into another but is offered attractive rates to keep it where it is.

Rather than going along with this, he smells a rat - no one offers better rates without a reason and the grapevine says there's a liquidity crisis in the offing. He panics and his prices skyrocket, with people paying the increase short term but then faced with two choices - to pull money out of the bank to pay for household goods or to cut consumption drastically.

Everyone then scrambles to get cash into their pockets and with his supermarket now virtually deserted, he doubles prices to make what he can on what is left.

He closes and so do all the others, unless someone will bale them out. That's where this little fairytale ends.