It is popular in economics to employ metaphors in order to provide support to a particular idea. For example, concepts like “priming the pump” through expansionary monetary policy. In another case, Milton Friedman—the leader of the monetarist school of thought—employed a guitar string metaphor or the “plucking model.” By this metaphor, the stronger one pulls the string down, the stronger the string will go up. Hence, Friedman concluded that a strong bust is followed by a strong boom.
For Friedman, what matters is to have a theory that can replicate the fluctuations of the data. He was not concerned with whether the theory corresponds to the real world. According to Friedman,
The ultimate goal of a positive science is the development of a theory or hypothesis that yields valid and meaningful (i.e., not truistic) predictions about phenomena not yet observed….
…the relevant question to ask about the “assumptions” of a theory is not whether they are descriptively “realistic,” for they never are, but whether they are sufficiently good approximations for the purpose in hand. And this question can be answered only by seeing whether the theory works, which means whether it yields sufficiently accurate predictions.
Again, Friedman held that, similar to a guitar string, the harder the economy is pulled down the stronger it should come back. In Friedman’s theory, a large contraction in output is followed by a large business expansion. A mild contraction is followed by a mild expansion. Therefore, Friedman concluded that there appears to be no systematic connection between the extent of an economic expansion and the extent of the following economic contraction.
Various studies seemed to provide support to Friedman’s view. On November 4, 2019, Bloomberg referred to a study by Tara Sinclair that employed advanced mathematical techniques that confirmed Friedman’s hypothesis—that in the US, deep recessions are followed by strong recoveries, but not the other way around. According to Bloomberg, some other researchers obtained similar results for other countries. Based on these studies, views like those of Ludwig von Mises and Murray Rothbard—that the extent of an economic bust is related to the extent of the previous boom—are seemingly false.
On the other hand, Friedman’s framework is based on his supposition that the extent of a recession determines the extent of an economic boom. To provide support to this view, he employed a guitar string metaphor. What we have here is the use of a metaphor to justify a particular theory. We could label this as “curve fitting.” Many believe that, by means of various statistical and mathematical methods, one could provide further support or credibility to a theory. By these methods, once the data is “tortured” long enough, one could secure results in line with the hypothesis.
Now, it is questionable whether various statistical and mathematical methods can prove or disprove a theoretical framework. These methods are a way of describing but not explaining the data. These methods do not ascertain the nature of the causes in the data, therefore, these quantitative methods can only describe the fluctuations in the data.
Boom-Bust Cycles and the Central Bank
Friedman’s framework lacks the definition of boom-bust cycles. Without the definition it is not possible to explain what the boom-bust cycles are and how they operate. In order to ascertain the definition of boom-bust cycles it is helpful to go back in time when the boom-bust cycle phenomenon started. 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.
It seems that the boom-bust cycle is somehow linked to the modern world. But what is the link? The source of the recurring boom-bust cycles is the alleged “protector” of the economy—the central bank itself—in the context of a modern money economy with economic calculation. The central bank’s ongoing inflationary policies, aimed at fixing the unintended consequences that arise from its earlier attempts at stabilizing the economy, are key factors behind the recurrent boom-bust cycles.
Fed policymakers regard themselves as being the responsible entity, authorized to bring the economy onto the path of stable economic growth and prices. (Policymakers decide what the “right” stable growth path should be). Consequently, any deviation from the stable growth path sets the Fed’s responses in terms of either a tighter or a looser monetary stance. These responses to the effects of previous policies on economic data give rise to the fluctuations in the growth rate of the money supply and, in turn, to the recurrent boom-bust cycles.
An expansionary central bank monetary policy, which results in an expansion of money supply, sets in motion an exchange of nothing for something. This leads to a diversion of savings from wealth-generating activities to non-wealth-generating activities. In the process, this diversion weakens wealth-generators and this, in turn, weakens their ability to grow the economy. Further, the emergence of activities on the back of an expansionary monetary policy is what an economic boom is. Once, however, the central bank tightens its monetary stance, this slows down the diversion of savings to non-wealth-producers. Activities that were brought about via expansionary monetary policy, which distorted the structure of production, are now getting less support; they fall into trouble—an economic bust emerges. From this, we can derive that the essence of boom-bust cycles is the inflationary monetary policies of the central bank.
Artificial Boom Size Determines the Bust Size and Extent
During an economic slump, the liquidation of various activities that emerged due to artificial expansion of money and credit during the previous boom is taking place. Hence, the more of these bubble activities that were generated during the economic boom, the greater the cleansing of such activities is required. Consequently, the greater the economic recession will be.
Artificial increases in the money supply are the outcome of the expansionary monetary policies of the central bank. These increases give rise to various activities that would not otherwise emerge and cannot survive absent loose money. We call them “bubble activities.” The inflationary expansion of money and credit by the central bank and a subsequent increase of bubble activities is the boom. The necessary tightening of the money supply to avoid monetary collapse leads to their demise which is the bust.
Without ascertaining the essence of the subject of investigation, one could come up with all sorts of theories, which could be “validated” by means of statistical and mathematical methods. For Friedman and many others, anything goes as long as the theory can generate some accurate predictions. Given that Friedman did not establish the essence of boom-bust cycles, it is questionable that his framework can ascertain the causes behind these cycles. Consequently, Friedman’s conclusion that strong recessions precede strong booms, and not the other way around, is questionable.
Conclusion
Various studies that employ advanced mathematical techniques have supposedly confirmed Milton Friedman’s hypothesis that strong economic busts pave the way for strong economic booms. According to 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 extent of the previous boom—are false. Now, Friedman’s framework is not derived from the essence of what boom-bust cycles are. Hence, his conclusion that strong recessions precede strong booms, and not the other way around, is questionable at best. To justify his hypothesis, Friedman employs a guitar string metaphor, which is, in turn, supposedly confirmed by the statistical methods. But no statistical or mathematical method can confirm a hypothesis. This can only be done by means of a logical discourse.
