Comparing Presidents Reagan and Trump: The Case of International Trade

“I am a tariff man...” President Trump, December 2018

“We should beware of the demagogues who are ready to declare a trade war against our friends—weakening our economy, our national security, and the entire free world—all while cynically waving the American flag.” President Reagan, November 1988

(If you have five extra minutes -- and tissues to wipe away tears of joy, affection, and patriotism -- watch the full Reagan defense of free trade.)

Many people would end the comparison here, but this is a blog for scholars, who look at actions as well as words.  Even for Reagan fans such as me, measurement is especially required when the rhetoric comes from an accomplished actor and politician succeeding at the highest levels – winning two governor elections in the largest U.S. state and two presidential elections – and thus not isolated from political pressures.

Thanks to a book written in 1986 by former Reagan CEA member William Niskanen, it is easy for an economist from the Trump CEA to rigorously compare economic policies and processes between the two presidents.  The comparisons for international trade restrictions are surprising, both in direction and magnitude.  The table below summarizes.  (Although not exhaustive, the list of Reagan restrictions are long enough to be exhausting!)

Words versus Actions

Contrary to many of the President’s speeches, Niskanen in 1986 saw the Reagan Administration as restricting international trade rather than promoting it:

 “…the administration imposed more new restraints on trade than any administration since Hoover.” 

“…the administration was on both sides of [trade issues], articulating a policy of free trade and implementing an extensive set of new import quotas.” 

(Niskanen, pp. 137, 143, emphasis added)

“the share of American imports covered by some sort of trade restriction soared under ‘free-trader’ Reagan, moving from only 8% in 1975 to 21% by 1984.” (Hanke, a friend and colleague of Niskanen)

I emphasize “import quotas” (much the same as export restraints made by foreign countries) because President Reagan was a quota man whereas President Trump is a tariff man.  There is an important difference.  As discussed elsewhere, quotas have different winners and losers than tariffs do.  Quotas are an “America last” policy because, unless the quotas are allocated to domestic businesses or are sold by the U.S. government, foreign businesses are major beneficiaries while the Treasury loses revenue on import duties and other taxes.  Tariffs at least bring revenue to the U.S. Treasury without necessarily creating profits for foreign businesses at U.S.-consumer expense. Milton Friedman compared Reagan’s trade policy with the infamous Smoot-Hawley Tariff Act of 1930,

“[The Reagan Administration had] been making Smoot Hawley look positively benign. Despite the harm it did, Smoot-Hawley had at least one virtue—the tariffs it imposed did yield revenue to the Treasury.”

I agree with Friedman’s qualitative assessment, but note that tariffs shift some revenue from other taxes and may also result in retaliatory tariffs (as beneficiaries of quotas, foreigners have little reason to retaliate against them).  It should also be noted that tariff rules often have quota elements to them, such as quotas on exemptions from tariffs (“tariff quotas”) that create windfall profits for the foreign businesses possessing an exemption.

Protecting Automobile and Motorcycle Producers

Let's begin by agreeing that protectionism is and has been the norm in the U.S. automobile market.  A 25 percent tariff on light trucks and cargo vans (almost half of the current U.S. auto market), dating back to the 1960s and known as “the chicken tax,” remains in place with no changes during that time except that Mexico and Canada became exempt with the 1993 NAFTA agreement.  Why would we have a tariff that obtains essentially no revenue?  Protectionism is the only credible answer.

Presidents Nixon, Ford, Carter, Reagan, Bush, Clinton, Bush, and Obama all maintained the chicken tax.  So far President Trump has too, although there have been occasions when Presidents set out plans (later discarded) to phase out the chicken tax after they left office.  Looking through the ERPs back to Reagan, I see zero mentions of this tariff.  (The 2018 ERP alludes to it on page 247. The 2002 ERP mentioned a Mexican tariff on light trucks, without acknowledging the U.S. tariff.  Multiple ERPs asserted that fuel-economy standards distorted sales toward light trucks, without mentioning that the chicken tax distorts in the other direction.)

In the quota area, President Reagan’s trade negotiators persuaded (forced?) Japan

“to adopt a VER [Voluntary Export Restraint] on automobile exports to the United States, a trade restraint that dramatically increased the price of Japanese (and European) cars to U.S. consumers … the main beneficiaries of higher automobile prices were the Japanese (and European) automakers who captured scarcity rents: Japanese automakers reaped more than $2 billion in 1982 alone, while their European counterparts also raised their prices, to capture $1.5 billion that year” (Irwin 1994, p. 6)

President Trump has threatened auto tariffs, but as of my writing this (August 2019) had not imposed them.  Meanwhile, President Trump’s Department of Transportation (DOT) and Environmental Protection Agency (EPA) have formally proposed to remove regulations that are in many ways the economic equivalent of auto import tariffs: emissions and fuel-economy standards that are most costly to European auto manufacturers.

If the joint DOT-EPA rulemaking were finalized, and tariffs were not permanently imposed, then President Trump would be making international automobile trade freer whereas President Reagan (and also Obama) had made it less free.  Because the apparent contrast between the Trump Administration and previous administrations is so stark, and I know first hand that special interest pressures on Federal policymaking did not wholly disappear in January 2017, only time will tell whether these aspirations become reality.

As part of regional trade agreement negotiations, the Reagan Administration proposed to base tariffs on the regional content (“rules of origin”) of automobile imports (Niskanen p. 141).  This proposal was not adopted as of 1986.  In its negotiation of the United States Mexico Canada Agreement (USMCA), the Trump Administration has proposed to tighten the rules of origin for automobile imports.  This proposal has not yet been approved by Congress.

The Reagan Administration imposed a 45 percent tariff on motorcycle imports from Japan, “which dominate[d] every sector of the American motorcycle market” (a Section 201 action: see p. 140 of Irwin’s 2009 book).  Motorcycle tariffs have been discussed by the Trump Administration, but not implemented as of my writing this.

Protecting Steel and Aluminum Producers

President Reagan protected the steel industry with VERs and quotas (see also pp. 114-6 of the 1986 ERP; or pp. 77, 138 of Irwin’s 2009 book).  The U.S. International Trade Commission (ITC) recommended countervailing duties (CVDs) on steel, but CVDs require Presidential approval, and he chose VERs instead.  This choice was a redistribution of revenue from the U.S. Treasury to foreign steel manufacturers.

In both economic and legal contrast to President Reagan's quotas, President Trump levied tariffs on steel (25 percent) and aluminum (10 percent) imports (although Reuters reported that Department of Agriculture Secretary Perdue has tried to persuade the President to replace those tariffs with quotas; presumably he is reacting to foreign retaliatory tariffs on agriculture that make the tariff-quota contrast less stark than the textbooks make it out to be).  The tariff on South Korean, Brazilian and Argentinian steel, however, was replaced with a quota by agreement with the Trump Administration.

I am not aware of any aluminum tariffs or quotas from the Reagan Administration.

(One person present at the Hoover Institution explains how Governor Reagan spoke there about steel tariffs for national security purposes.  That sounds like Trump Administration policy (Section 232 tariffs) ... I wonder what changed the Reagan Administration to quotas/VERs?  Perhaps the threat of retaliation?)

Asian Adversaries

During the Reagan years, the U.S. had a large bilateral trade deficit with Japan and much trade policy rhetoric related to that.  Today it is China rather than Japan.

The Reagan Administration restricted trade with Japan in the ways noted above (esp. autos and steel), as well as semiconductors, machine tools, computers, televisions, forklifts, and roller bearings.  The largest of these were quotas rather than tariffs: that is, they typically removed revenue from the U.S. Treasury and created profits for Japanese businesses.  As Milton Friedman described the semiconductor restrictions (see also Irwin’s paper on the subject),

“After engineering a cartel between Japanese and U.S. chip makers—again something clearly illegal if done by domestic companies alone—[Reagan officials] profess to be outraged that, like most cartel agreements, it proved to be a leaky sieve—fortunately, I may add. In retaliation, they threatened heavy tariffs against Japanese electronic products, which they have now reluctantly imposed, while broadcasting their intention that the tariffs last only until they have succeeded in bludgeoning Japan into enforcing the cartel agreement on its own firms. If successful, that would lead to the transfer of microchip production to areas other than the U.S. and the Japanese microchip industries. An OPEC in microchips at the demand of the customers! It boggles the imagination.”

The Reagan Administration also levied 100 percent tariffs on imports of Japanese computers, televisions and power tools.

The Trump Administration has levied tariffs on a significant fraction of imports from China, using Section 301 of the Trade Act of 1974.  It added the Chinese company Huawei to the U.S. Department of Commerce’s Entity List, thereby effectively prohibiting U.S. businesses from trading with Huawei.  Huawei’s status has been a matter of ongoing negotiations.

Protecting Producers of Textiles, Apparel, and Sugar

President Reagan vetoed the Textile and Apparel Trade Enforcement Act, which would have tightened textile import quotas (pp. 116-8 of the 1986 ERP).  However, with the support of the Reagan Administration, quotas were tightened twice with the Multifibre Agreement when it was renewed in 1982 and 1986 (see p. 139 of Irwin’s 2009 book or pp. 212-13 of this article).

The Reagan Administration tightened quotas on imported sugar (see also pp. 70-71 of Irwin’s 2009 book), which is one of the most notorious trade restrictions in modern America.

Navarro Farts

The Trump Administration supports a House bill known as the "US Reciprocal Trade Act."  Before it was introduced, Peter Navarro was leading the White House effort in this area, which he called the Fair And Reciprocal Tariff act.  To the amusement of the rest of the White House staff, Mr. Navarro got an "F" in marketing; this was one of several occasions that the President was understandably upset with Mr. Navarro.

It stinks that neither the House bill nor the FART act have any chance of becoming Federal law.

(I am unaware of a Navarro-type character in the Reagan White House, but perhaps there was one.)

Other trade restrictions

President Reagan’s Proclamation 4901 extended the 1979 quotas on imported clothespins.  The Reagan Administration increased tariffs on Canadian lumber.

Using Section 301 of the Trade Act of 1974, President Reagan threatened tariffs in several cases that resulted in no U.S. tariffs and reductions in foreign tariff or nontariff barriers to U.S. exports, as they did for the Japanese tobacco-product market or the South Korean film market (pp. 132-33 of the 1987 ERP and p. 177 of the 1989 ERP).

The Trump Administration levied tariffs on solar panels and washing machines, using Section 201 of the Trade Act of 1974.

The Reagan Administration initiated the Plaza Accord where major countries agreed to coordinated interventions in currency markets.  Yesterday the Trump Administration declared China to be a currency manipulator, which the Wall Street Journal called "mostly symbolic" although financial market reactions were not trivial.  The Trump Administration has also proposed to include currency values in determining the applicability of countervailing duties.

For over 100 years, the U.S. postal service has subsidized shipments originating in foreign (esp. developing) countries, pursuant to the rules of the Universal Postal Union (UPU).  As Alfredo Ortiz explained in this article, "it costs around $20 to mail a small parcel weighing 4.4 pounds from one U.S. state to another, yet mailing the same package from China only costs about $5."  The Reagan Administration was aware of this problem, but no solution was implemented.  The Trump Administration has directed that either the UPU reduce the distortions in its terminal dues structure, or the U.S. will set its own terminal dues (withdrawing from the UPU).

Administration components

Niskanen (p. 138) reports that White House components disagreed as to the desirability of trade restrictions, with the Council of Economic Advisers (CEA), Office of Management and Budget, and Department of Treasury emphasizing the economic benefits of free trade while the Department of Commerce, Office of Science and Technology Policy (OSTP), and Office of the U.S. Trade Representative (USTR) emphasized the (political?) need to protect domestic producers.

The component configuration is similar in the Trump White House, although I cannot be sure about OSTP due to few first hand interactions with them.  Also in some instances USTR opposed proposed trade restrictions.

Robert Lighthizer heads USTR in the Trump Administration.  He was the USTR first deputy during the Reagan Administration.

In both Reagan and Trump White Houses, CEA provided a catalog of trade actions in the annual Economic Report of the President designed to assist researchers outside the Federal government who are gathering facts about Federal trade policy.  Compare, for example, Table 4-3 of the 1988 ERP and Table 10-1 of the 2019 ERP.

Trade policy reprise

To reprise the quotas cited above (all Reagan): autos, steel, sugar, semiconductors, textiles, machine tools, and clothespins.  The Trump Administration did create steel quotas for South Korea, Brazil, and Argentina as substitutes for its Section 232 steel tariffs.

To reprise the tariff increases cited above: steel (Trump), aluminum (Trump), motorcycles (Reagan), Canadian lumber (Reagan), Chinese goods (Trump), various Japanese goods (Reagan), solar panels (Trump), and washing machines (Trump).

To reprise the (economic equivalent of) tariff decreases cited above: autos (Trump), and postal terminal dues (Trump).

It is clear that the Reagan administration restricted trade, and did so more than the Trump Administration has.  The Reagan administration harmed consumers in doing so.

While not making comparisons with the Reagan years, Robert Barro and many others have said that the Trump Administration has been reducing economic growth with its trade policies, and enough to fully offset the pro-growth effects of tax and regulatory reform.  What is the quantitative analysis to show how they conclude that the offset is full?  A first pass at the numbers suggests the opposite, even if the tariff increases were permanent: the corporate tax cut alone generated static taxpayer savings of about $200 billion per year, while taxpayers would be paying about $30 billion per year more for tariffs (again, a static calculation).  Yes, there is uncertainty as to whether the annual tariffs will ultimately prove to be $0 billion, $60 billion, or somewhere in between, but is there any doubt as to whether it would be less than $200 billion? In terms of quantifying the cost of a trade war, perhaps they are thinking about the fairly large stock market swings that coincide with trade news.  But would the stock market drop less if there was a credible threat of eliminating the corporate tax cut and reversing all of the deregulation?

(See also CEA’s assessment of the significant benefits of deregulatory policy, which did not include the DOT-EPA rule).

The way I look at it, the proposed DOT-EPA rule would enhance U.S. international trade and consumer benefits so significantly that it would, if finalized, overwhelm the various tariff actions cited above.  In addition, the Reagan experience with Section 301 actions also shows that it is possible for those actions to enhance trade by reducing tariff and nontariff barriers that foreign countries have erected against U.S. imports.  Therefore, while it is clear that trade restrictions from the Trump Administration are significantly less than President Reagan's, more time is needed to determine the overall sign of the Trump Administration’s trade restrictions.

The War on Poverty

According to Milton Friedman

The war on poverty of which so much has been made since then has been a very good thing indeed for many thousands of civil servants who have been able to make excellent careers and many thousands of academic people who have been able to do study after study on poverty.

From Friedman on Galbraith

JEL Review of The Redistribution Recession

“Somewhere, Milton Friedman is smiling.
Casey Mulligan ... has provided an unalloyed Chicago-style explanation for the U.S. economy’s poor performance during and immediately after the Great Recession.”

-Read the rest of Christopher L. Foote's review (jump to p. 1194).

Links to other reviews of the book.

The Labor Market and Labor Policy Since Kennedy

Copyright, The New York Times Company

Fundamental changes in economic performance since the John F. Kennedy presidency help explain why economic policy debates are so polarized these days.

In its 34 months, the Kennedy administration embraced a range of interesting federal economic policies. Kennedy proposed permanently cutting personal and corporate income tax rates to promote economic growth, and his cuts became law. During his administration, the maximum duration of unemployment benefits was temporarily extended only 13 weeks, less than in any other recession since then.

He expanded the federal space program. He wanted a strong peacetime military and was willing to use it to stand up to communism. His Department of Justice, led by his brother Robert F. Kennedy, was tough on labor unions.

President Kennedy pushed for national health reform, although he did not see any legislation passed during his term. As a candidate and then president, Kennedy was initially cautious on civil rights issues, but ultimately worked to put together a civil-rights bill that became the Civil Rights Act of 1964.

From today’s perspective, Kennedy looks like a hybrid of a Democrat and a Republican, and as America remembers his assassination in November 1963, journalists and scholars continue to debate whether Kennedy was a liberal.

In my view, Kennedy was entirely a Democrat, but that’s less visible today because Democrats and Republicans, and their respective economists, were a lot less different than they are now, especially on matters of microeconomics. Kennedy was advised by James Tobin of Yale, a Nobel laureate who advised other Democratic presidents, too.

Both Tobin and Milton Friedman, who subsequently advised several Republican candidates and was an adviser to President Richard M. Nixon, were concerned that antipoverty programs would perpetuate poverty by giving people too little reward for taking care of themselves. Tobin wrote that high marginal tax rates cause “needless waste and demoralization,” adding:

This application of the means test is bad economics as well as bad sociology. It is almost as if our present programs of public assistance had been consciously contrived to perpetuate the conditions they are supposed to alleviate.

Tobin thought public programs had gone seriously awry whenever program participants kept less than a third of what they earned on a job, rather than losing it to extra taxes or withdrawn benefits. Friedman thought that people should keep at least half of their earnings after taking into account taxes or lost benefits. Yet in modern times, Friedman and Tobin appear to be quibbling, because now we have millions of citizens who keep a quarter of what they make, or less, in net earnings beyond the benefits they forgo, yet few Democrats are concerned that federal antipoverty programs might be counterproductive.

In “Roofs or Ceilings?” Milton Friedman and George J. Stigler wrote about the economic damage done by minimum wages, rent controls and other restrictions on market prices. Tobin offered similar explanations, writing:

People who lack the capacity to earn a decent living need to be helped, but they will not be helped by minimum wage laws, trade union wage pressures or other devices which seek to compel employers to pay them more than their work is worth. The more likely outcome of such regulations is that the intended beneficiaries are not employed at all.

(Unlike Friedman, Tobin did subsequently support a minimum-wage increase, because he thought better antipoverty tools would not be used).

These days, Democrats push for higher minimum wages, without any apparent concern that poor people might have more trouble finding work.

My point is not that Democrats are more wrong about economics that they used to be, but that, regardless of who is right or wrong, the gaps between Democrats and Republicans in economic reasoning are greater now than they used to be.

The economy is different now than it was in the 1960s, especially in that the incomes of the poor have not kept up with national incomes. When the poor are prevented from working by minimum wages or high marginal tax rates, a lesser fraction of national income is lost than in Kennedy’s era, when the poor could produce a more significant piece of the national economic pie.

So proponents of big social programs have less reason to be cautious about program expansions.

As long as the American economy produces such a wide range of labor market outcomes, we may never see a president, who, like Kennedy, has such wide-ranging economic policies.

Since October 1, Obamacare has created positive social value

The best industrial organization economists understand that products have many attributes. Coca-Cola is not simply a substance for quenching consumers' thirst. Consumers value its brand image, familiarity, packaging, etc., which is why it dominates competing sodas despite tasting the same.

I urge Obamacare critics stick to legitimate critiques rather than fabricating them through economic misunderstandings. For example, healthcare.gov was supposedly built at a cost of over $600 billion. Although I agree that healthcare.gov has delivered hardly any value by enrolling (a handful of) people in health insurance, we cannot conclude that the social value created by Obamacare since October 1 has been negative.

First, the social purposes served by healthcare.gov go beyond enrolling people in health insurance, just as the social purposes of Coca-Cola go beyond quenching thirst. I am no fan of Obamacare and thereby don't bear the burden of proof of said value, but can point to entertainment value as an example. Many times lousy unknown films make $50 million in a few months, and that understates the social value created because intellectual property like films cannot monetize all of the social value. I'm confident that healthcare.gov has created more aggregate entertainment than, say, The Smurfs 2 or The Last Exorcism Part 2, which, in the span of a few months, each generated social values in the $20-120 million range.

Millions of Americans are chuckling over videos like these:

You might say that the enjoyment is offset by the pain experienced by Obamacare supporters when they view such videos. But as of October 1 there weren't that many Obamacare supporters (why would NBC and other major networks feature this kind of entertainment if it were offensive to half of the potential viewers?), and the few of them who exist can and do choose to ignore the allegedly major problems with healthcare.gov.

Like international trade, farce is usually a positive-sum game. My best guess is that the entertainment value generated by healthcare.gov during October 2013 is about $200 million, with more value forthcoming, albeit at a diminishing rate.

Second, healthcare.gov didn't cost $600+ million to build. Nobody knows for sure (that's part of the entertainment value!), but healthcare.gov appears to cost $125-150 million. If healthcare.gov created value only via entertainment, it has already generated a surplus in the neighborhood of $50 million.

As I said, healthcare.gov has still more valuable product attributes. Somebody needs to quantify the value of reminding the public (and economists) about "Bright Promises, Dismal Performance" better than Milton Friedman ever did. Who knows what corruption might be uncovered in the Congressional hearings -- corruption that would have persisted undetected but for healthcare.gov.

The Best

In case you were wondering how legendary economist Gary Becker is doing, or where our economy is headed, take a look at yesterday's Wall Street Journal.

HT: My Mom!

Which Matters: A Program's Name or Its Actual Consequences?

Milton Friedman poses the question in this video posted here.

The "Stimulus" Law of 2009 is a huge example of a public program with consequences opposite of its name.

The Optimum Quantity of Money, 2010

Milton Friedman's Optimum Quantity of Money rule said that government liabilities (of which "money" is one example) should by supplied in large enough quantity that they earn the same return as private sector liabilities.

Today it was reported that now U.S. Treasuries yield about the same as some high grade corporate debt, after decades of yielding significantly less. Berkshire Hathaway debt actually yields less (but see the comment below that Bloomberg made a mistake)!

Unfortunately, Milton Friedman and economists since him do not have an empirically accurate theory of why private sector securities have such different expected returns, so it's not clear which of the many private returns would be the same as the Treasury yield in a world with the optimum quantity of government liabilities. Is the average private return? Or the returns on private securities with similar "risk" as Treasuries?

The answer depends on what is your theory of why private assets can have different returns, but arguably we have now reach the optimum quantity of government liabilities.

David Brooks' 170 degree turn

Take a look at this video of a discussion between Milton Friedman and David Brooks (and two others). Turn to the 38:15 mark.

Wow! Has he changed! I'm not talking about looking younger (we all looked different in 1990) ... I'm talking about statements like:

• "regulations must be minimal"
• "The FDA has made outcomes worse, not better"
• "Everyone agrees that the minimum wage destroys employment opportunities for poor people"
  
  

I suppose this change is correlated with switching his employment from WSJ to NYT?

More Government Debt, Please

Copyright, The New York Times Company

Large amounts of government debt are sometimes said to harm the economy. But, by some metrics, there is still too little United States government debt.

The federal debt recently passed $12 trillion, a $3 trillion increase since 2007, as a result of the unprecedented budget deficits incurred during the last year of the Bush administration and the first year of the Obama administration. The Obama administration expects to add trillions more.

With recent federal budgets adding so generously to the supply of United States government debt, it is natural to wonder how many trillions more the marketplace can absorb.

In markets, an excess supply is easy to detect: Prices are low. Conversely, high prices indicate a supply shortage, not an excess.

United States government bills, notes and bonds are traded in markets too, so the same price diagnostic is useful. The fact is that United States government bill, note, and bond prices are higher than the prices of comparable private sector securities, and have been that way for decades. Or to put it another way, government securities continue to offer the lowest yields. (A bond’s price is inversely related to its yield.)

Investors continue to purchase United States government securities, despite the fact that they pay them a lesser expected yield than do privately issued securities. Economists have long wondered why investors have such affection for United States government securities, but we agree that the demand for those securities is extraordinary.

Judging by the prices prevailing in the market, $12 trillion is not enough to satisfy current demand for government securities. So, despite the recent surge in supply, more government securities would likely improve economic efficiency, not harm it.

That’s not to say that government should spend without restraint, or that government spending is cheap because it helps satisfy investment demand for debt. The best way for the government to create debt is to purchase private sector securities (the Federal Reserve moved in this direction when it recently purchased mortgage-backed securities rather than government securities). In this way, it can increase the supply of government debt without spending a lot.

Fiscal conservatives who call for tax increases in order to “bring down the debt” ignore the fact that investors are so glad to purchase it (and also ignore the private savings offset I wrote about last week).

I’ve said it before and I’ll say it again: Presidents Bush and Obama do not need to apologize for the federal debt, just the excessive federal spending.

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You may recognize this argument as Milton Friedman's Optimum Quantity of Money, in which he said that government liabilities would, when optimally supplied, pay the same rate of interest (that is, have the same price) as private sector liabilities. Currency is one example of a government liability, a Treasury bond is another.

Name Dropping

This blog is supposed to be about the economy, not economists. The last two weeks may appear to be an aberration -- I have written a couple of times about John Maynard Keynes and Milton Friedman. While names like those attract attention, IMO it is the economic activity that's worth attention. And some of the economic activity today has close parallels with the activities Keynes and Friedman observed decades ago.

What Monetary Policy Cannot Do

Copyright, The New York Times Company

Six months ago, the Federal Reserve chairman, Ben S. Bernanke, announced that he might widen the scope of monetary policy by purchasing long-term Treasury securities. Market commentators had high expectations for the results of Mr. Bernanke’s new actions, but the results so far have been what Milton Friedman anticipated: disappointing in terms of both interest rates and inflation.

More than 40 years ago Mr. Friedman said in his famous address to the American Economic Association that “we are in danger of assigning to monetary policy a larger role than it can perform, in danger of asking it to accomplish tasks that it cannot achieve” (American Economic Review, March 1968, p. 5).

Perhaps because Mr. Friedman’s warning was 40 years old, or because it was offered during “normal” times, or because the financial crisis rekindled the fantasy that our government can control the economy, Mr. Friedman’s warning was ignored last December. Mr. Bernanke said his approach would help “spur aggregate demand.” Market commentators went further and said that long-term rates would fall, and that this would help people buy homes and help businesses make investments.

Milton Friedman warned “The initial impact … is to make interest rates lower for a time … after a somewhat longer interval, say, a year or two, [this would] return interest rates to the level they would otherwise have had.” (p. 6, emphasis in the original). Was Milton Friedman right? Or did Mr. Bernanke’s shift stimulate the housing market?

The chart below graphs the yield on 10-year Treasuries for the days of 2008 and 2009, together with a vertical line indicating the day of Mr. Bernanke’s announcement. It suggests that Mr. Friedman’s warning — considered somewhat radical at the time — was actually too modest for today. Yes, Treasury yields did drop the day Mr. Bernanke made the announcement and later that month reached a low of almost 2 percent. But yields closed at almost 3 percent — higher than when Mr. Bernanke made his announcement — only 67 days later.



By now, long-term Treasuries yield 3.5 percent to 4 percent — typical of the range of yields during most of last year, before Mr. Bernanke made the policy change.

If monetary policy cannot have much of an effect on long-term interest rates — the rates that drive housing and capital markets — what can it do? It might try to maintain a steady rate of inflation, but Mr. Friedman said even that might prove too difficult because of the weak short-run links between monetary policy and inflation. Mr. Friedman seems to have been correct about that, too, because prices have fallen much as they did in 1929-30, despite the differences in monetary policy.

Milton Friedman was right that “it would constitute a major improvement if the monetary authority followed the self-denying ordinance of avoiding wide swings.” (p. 16) He certainly was right about the consequences of doing otherwise.