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Friedman's Monetary Economics in Practice

This paper views the policy response to the recent financial crisis from the perspective of Milton Friedman's monetary economics. Five major aspects of the policy response were: 1) discount window lending was provided broadly to the financial system, at rates that were low in relation to the market rates prevailing before the crisis; 2) the Federal Reserve's holdings of government securities were adjusted with the aim of putting downward pressure on the path of several important interest rates for a given path of short-term rates; 3) deposit insurance was extended, helping to insulate the money stock from credit market disruption; 4) the commercial banking system received assistance via a recapitalization program, while existing equity holders bore losses; and 5) an interest-on-reserves system was introduced. These five elements of the policy response were in keeping with those that would arise from Friedman's framework, while a number of the five departed appreciably from other prominent benchmarks (such as the Bagehot prescription for discount rate policy, and New Keynesian approaches to stabilization policy). One notable part of the policy response, the TALF initiative, drew largely on frameworks other than Friedman's. But, in important respects, the overall monetary and financial policy response to the crisis can be viewed as Friedman's monetary economics in practice.