Why Friedman Was Wrong About Booms And Busts


In his attempt at explaining what business cycles are all about, Milton Friedman held that the economy’s output is bumping along the ceiling of maximum feasible output except that every now and then it is plucked down by a cyclical contraction. He attributed this contraction to various shocks.

He was of the view that economic contractions involve declines in the economy’s output below its full potential ceiling or maximum level.

Friedman held that similarly to a guitar string the harder the economy is plucked down the stronger it should come back.

In Friedman’s plucking model, a large contraction in output follows by a large business expansion. A mild contraction, by a mild expansion.1

Following the plucking model, Friedman had also concluded that there appears to be no systematic connection between the magnitude of an economic expansion and the extent of the following economic contraction. 

Various studies seem to have vindicated Friedman’s plucking model. On November 4, 2019, a Bloomberg article by Noah Smith titled “Milton Friedman Got Another Big Idea Right” referred to a study by Tara Sinclair that employed advanced mathematical techniques that appeared to confirm Friedman’s hypothesis that in the US large recessions are followed by strong recoveries – but not the other way around. According to Bloomberg, some other researchers obtained similar results for other countries.

On this way of thinking, views such as those presented by Ludwig von Mises and Murray Rothbard that the extent of an economic bust is related to the magnitude of the previous boom is false.

The main problem with Friedman’s framework of thinking, however, is that it lacks the fundamental definition of what boom-bust cycles are all about. Note that a fundamental definition identifies the essence of the subject of analysis.

Boom-Bust Cycles and the Central Bank

To establish the fundamental definition of the boom-bust cycle phenomenon we must trace it back as to how this phenomenon had emerged.

According to Murray Rothbard,

Before the Industrial Revolution in approximately the late 18th century, there were no regularly recurring booms and depressions. There would be a sudden economic crisis whenever some king made war or confiscated the property of his subjects; but there was no sign of the peculiarly modern phenomena of general and fairly regular swings in business fortunes, of expansions and contractions.2

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