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By Friedman's reckoning, history supports his argument. As he notes in his definitive work, A Monetary History of the United States 1867-1960, a decline in the nation's money supply has preceded every recession except one (1869-70) in the last hundred years. After World War I, for example, the Government cut its spending by an amount equal to 16% of the U.S. gross national product. On top of that, the Federal Reserve contracted the money supply by 5.2%. Says Paul McCracken: "The remarkable thing is not that there was a 1921 recession but that our economic system survived under this massive fiscal and monetary whipsaw."
Friedman blames unknowing monetary policy in large measure for the magnitude of the Depression of the 1930s. Partly because so many banks failed between 1929 and 1933, the U.S. supply of money shrank by 33%—and that compounded a worldwide economic collapse. The Federal Reserve, which took a narrow view of its responsibilities, felt itself almost powerless to reverse the tide of events. Not really understanding what should be done, it did practically nothing to offset the contraction of the money supply.
One consequence, in Friedman's view, was that John Maynard Keynes concluded that monetary policy had only a limited impact on economic trends. That led him to underrate the money supply as an economic regulator. Friedman maintains that Keynesian economists made the same error for decades afterward—and indeed, that many still do today. In reality, Friedman argues, the Federal Reserve in the 1930s had ample power to prevent the monetary contraction. "Had the facts been as Keynes assumed them to be," Friedman has written, "I could not hold the views I do about the role of money. Had Keynes recognized that the facts were what they were, he would have had to modify his views."
Today's stubborn inflation, according to Friedman and his adherents, has been greatly magnified by Federal Reserve Board mistakes. From April 1965 to April 1966, the money supply expanded at an abnormally high 9½%-per-year rate, even though inflation was on the rise. Too late, says Friedman, the board reversed itself too emphatically, and caused the "credit crunch" of August 1966. In 1968, the board, fearful that the tax surcharge would overburden the private economy, increased the money supply at an average annual rate of 10%—almost twice the rate that the economy could absorb without inflation. Then, a year ago, the board switched to its restrictive money policies. Six to nine months after these gyrations occur—and sometimes much later—they significantly affect the performance of the whole U.S. economy.
Friedman's fact-laden criticisms of the Federal Reserve have considerably undermined its once sacrosanct standing as the arbiter of U.S. monetary affairs. Mindful of his formulations, the Congressional Joint Economic Committee has been pressuring the board to expand money supply at a rate of between 2% and 6% a year. The board has refused to go that far. but it has begun providing the committee with quarterly reports explaining its money-supply maneuvers.
Dazzling