vol. 34, no. 4 (October), 1996
Friedman's "Plucking Model"
Roger W. Garrison*
In a report on research in progress issued more than a quarter-century
ago and again in a recent article consisting largely of excerpts from the
earlier report, Milton Friedman [1969a; 1993] calls into question an entire
class of business cycle theories which treat boom and subsequent bust as
a logical and chronological sequence. He points to the Austrian theory
of the business cycle as an example of the class of theories at odds with
his own plucking model, which depicts the economy's output as falling (or
being "plucked") below trend at random intervals and to various extents.
In each episode of plucking, the return to trend mirrors the preceding
fall, differing only by the underlying secular growth. Friedman [1993,
172] indicated decades ago that "If further substantiated empirically,"
the lack of boom-bust correlation "would cast grave doubt on those theories
that see as a source of a deep depression the excesses of the prior expansion
[the Mises cycle theory is a clear example]." 1 More recently,
he has claimed in an interview with Hammond [1992,102] that the "evidence
[showing a zero correlation between boom and succeeding bust but
a high correlation between boom and preceding bust] is decisive
refutation of von Mises."
II. Levels of Aggregation
Austrians can question the decisiveness of this refutation on the basis
of the different levels of aggregation employed by Friedman and by Mises.
Monetarists report their findings in terms of the economy's total output,
which includes the output of both the investment-goods sector and the consumer-goods
sector. Although investment has long been recognized (by Monetarists and
others) as being the more volatile, equilibrium forces are believed generally
to prevail in both sectors as the economy moves along its growth path.
But periods of presumably healthy economic growth are occasionally interrupted
by an extramarket force, namely, an inept central bank that allows the
money supply to contract relative to output. Real output is thus plucked
loose from its trend. During the economy's temporary departure from trend,
the outputs of both sectors move together, first down and then up. This
temporal pattern of output, which involves no significant relative
movements of investment and consumption, seems to justify the use of a
single output aggregate.
In contrast, Austrians work
at a lower level of aggregation in order to allow for the outputs of the
two sectors to move relative to one another and even to allow for differential
movements within the investment-goods sector. As envisioned early
on by Menger [1981, 80-87] and developed by Hayek [1967, 32-68], the economy's
production process is disaggregated into a number of temporally sequenced
stages of production. The stages can be conceived in abstract terms as
second, third, fourth, and nth order goods—with the higher orders
denoting stages further removed in time from the emergence of consumer
goods. For pedagogical concreteness, the different stages can be identified
with particular kinds of activities: mining, for instance, is far removed
from the consumption it will eventually make possible; retailing is in
close temporal proximity to consumption.
Replacing the single investment
aggregate with temporally sequenced stages that make up the economy's capital
structure provides a basis for a substantive distinction between sustainable
and unsustainable growth. Intertemporal equilibrium, as maintained by the
rate of interest, requires a consistency between the allocation of resources
among the various stages at any given point in time and the desired pattern
of consumption over time. If reduced interest rates reflect a change in
intertemporal consumption preferences, then the resulting reallocation
of resources away from current consumption and toward investment—and from
relatively low to relatively high stages of production—will eventually
play itself out as a temporal shifting of consumption. This, apart from
technological advance, is the essence of economic growth. If, by contrast,
reduced interest rates reflect credit creation by the central bank, then
the resulting process that governs the intertemporal allocation of resources
will not play itself out but rather will do itself in. The capital-theoretic
demonstration that a policy-induced boom contains the seeds of its own
undoing constitutes the Austrian theory of the business cycle as first
introduced by Mises [1953, 339-66]. Artificial booms inevitably end in
Taking account of the differing
levels of aggregation, the data described by the plucking model are wholly
consistent with the Austrian theory. The Austrians—and particularly Mises—were
on using the term malinvestment instead of the more conventional
overinvestment. During a credit-induced boom, investment in the relatively
high stages of production is excessive in that resources are drawn away
(by an artificially low rate of interest) from the relatively low stages
of production and from the final stage, consumption. The decrease in the
amount of resources allocated to the low and final stages is forced saving;
the misallocation of resources from low to high stages is malinvestment.
Empirically, a credit-induced boom would be but weakly reflected in the
conventional investment aggregate and hardly at all in the Monetarists'
output aggregate, which includes consumption. The boom for the Austrians
refers to something going on largely
within the output aggregate.
It is represented in Friedman's plucking model not by a conspicuous recovery
to trend but rather by some period preceding a pluck which Friedman, operating
at a higher level of aggregation, presumes to be healthy growth.
Although Austrians and Monetarists
are working at different levels of aggregation, they are dealing with the
selfsame macroeconomy, as evidenced by each school's recognition of the
movements of output that constitute the other's primary concern. Austrians
recognize that the bust, which ends a period of credit-induced intertemporal
disequilibrium, can affect the magnitude as well as the composition of
the economy's output. The market process that liquidates the malinvestments
is likely to involve complications—especially if the central bank behaves
counterproductively—that result in a substantial reduction in total output.
A self-aggravating, income-constrained process can entail an idling of
capital and labor far in excess of that made necessary by the intertemporal
disequilibrium. Hayek refers to this spiraling downward of demand in all
stages, as distinguished from the reallocation of resources among the stages,
as a "secondary deflation" [Bellante and Garrison, 1988, 229].
Monetarists hint at the
relevance of resource movements within the output aggregate in specific
episodes in which the real rate of interest is abnormally high on the eve
of the bust. Referring to the period following October 1979, when the Federal
Reserve had turned its attention from interest rates to monetary aggregates,
Friedman claimed in an interview with Brimelow [1982, 6] that the business
community had entered into "commitments" on the basis of the monetary expansion
that began in April 1980. When the expansion ended a year later, these
commitments had effects of their own. There was "a great deal of distress
borrowing,...which has served to keep short-term real interest rates very
high." Although the terms "commitment" and "distress borrowing" make no
showing in Friedman's plucking model, they have a natural home in the Austrians'
account of boom and bust.3
The overcommitment of resources
to early stages of production, the distress borrowing associated with the
(ultimately unsuccessful) attempt to finance the completion of these production
projects, and finally the secondary deflation that may greatly magnify
the resource idleness during the adjustment period are all consistent with
the plucking model. Thus, even strong empirical support for plucking, if
based upon the output aggregate, would not rule out boom-bust theories.
Quite to the contrary, the Austrian theory offers special insights as to
how a boom-bust market process can leave a trail of bust-boom aggregates.
III. Relevant Empirical Evidence
Friedman's empirical findings are broadly consistent with both Monetarist
and Austrian views. These two schools are not best distinguished in terms
of the former's identification of broad-based macroeconomic regularities
and the latter's unwillingness to recognize the significance of these empirical
truths. They differ, rather, in their views of the market process that
translates changes in money and credit into changes in prices and quantities.
In the long run, the central bank has no control over real magnitudes,
but there is a long and variable lag between initial and subsequent applications
of the comparative-statics equation of exchange. The Monetarists have often
issued disclaimers concerning the market process that eventually translates
a monetary injection into an increase in the overall price level. "We [Friedman
and Schwartz, 1969, 222] have little confidence in our knowledge of the
transmission mechanism, except in such broad and vague terms as to constitute
little more than an impressionistic representation rather than an engineering
blueprint." Friedman [1987, 17; 1992, 49] reaffirms this theoretical lacking
in his retrospective. Citing himself and others, he notes that "A major
unsettled issue is the short-run division of a change in nominal income
between output and prices. The division has varied widely over space and
time and there exists no satisfactory theory that isolates the factors
responsible for the variability." The Monetarists' "long and variable lag"
is the Austrians' "substantial scope for intertemporal disequilibrium."
The Austrian theory of the business cycle does not fly in the face of plucking
but rather contributes—along with Friedman's own short-run/long-run Phillips
curve analysis—to our understanding of the transmission mechanism.
Both early and recent empirical
work has provided some support for Austrian views of boom and bust.4
Austrian theory suggests that tests involving movements in output magnitudes
must be formulated at a suitably low level of aggregation. The thorny issues
of capital theory, however, make direct testing difficult. One testable
implication of the malinvestment that characterizes an unsustainable boom
is the distress borrowing and hence the high real rates of interest on
the eve of the bust. Charles Wainhouse [1984, 64] uses Granger causality
tests to show that movements in interest rates and relative prices during
the 1960s and 1970s are consistent with the hypothesis that at the end
of the boom "the prices of consumer goods rise relative to the prices of
producers' goods, reversing the initial shift in relative prices."5
Further empirical work inspired
by plucking should maintain a clear distinction between Friedman's boom
(recovery to trend) and Mises' boom (credit-induced malinvestment). It
should also recognize that distress borrowing, which characterizes the
natural end of a credit-induced boom, can also result from an exogenous
credit contraction. But even in advance of further testing, we can reject
Friedman's decisive refutation: Plucking describes the economy's performance
at the highest level of aggregation; Austrian theory offers an insightful
account of the market process that might underlie those aggregates.
* Associate Professor, Auburn University. The author gratefully
acknowledges the helpful comments from Milton Friedman, Thomas McQuade,
Mark Skousen, Richard Vedder, Tom Willett, and two anonymous referees.
1. The bracketed reference to Mises was added in 1993.
2. Friedman's own boom-bust theorizing—in the form of
short-run/long-run Phillips curve analysis—can be seen as complementing
the Austrian theory of the business cycle. The differences between the
two theories stem largely from the fact that Mises, influenced by Böhm-Bawerk's
theory of capital and interest, focused on the allocation of resources
within capital markets as guided by the bank rate as opposed to the natural
rate of interest, while Friedman, influenced by Frank Knight's critique
of Böhm-Bawerk, focused on the actual as opposed to the natural level
of employment as guided by the employers' and the employees' perceptions
of the real wage rate. Taking a broad perspective, Bellante and Garrison
 argue that Mises' capital-market dynamics and Friedman's labor-market
dynamics are complementary aspects of the boom-bust cycle.
3. Friedman [1969b, 255-56] draws on Austrian ideas again
when explaining the long and variable lag that separates monetary expansion
and price inflation: Monetary expansion affects the demand for "equities,
houses, durable producer goods, durable consumer goods, and so on.... The
effects can be described as operating on 'interest rates,' if a more cosmopolitan
[i.e. Austrian] interpretation of 'interest rate' is adopted than the usual
one which refers to a small range of marketable securities.... But [subsequent
countermovements] tend to...undo the initial effects on interest rates."
4. Early work by Frederick C. Mills  of the National
Bureau of Economic Research focused on four temporally distinct subaggregates
(raw materials, manufacturing, wholesaling, and retailing) and showed that
movements in prices associated with these subaggregates are consistent
with the Austrian theory: Temporal remoteness from consumption positively
affects the interest-rate sensitivity of prices. Most recently, Butos 
found (weak) support for the Austrian theory using data on interest rates
and bank credit from the 1980s bull market.
5. This hypothesis, which deals the interest rate in Friedman's
"cosmopolitan" sense, is one of several derived from Hayek's formulation
of the Austrian theory and supported by the data. Testing failed to reject
this hypothesis for the periods 1964-67 and 1977-80.
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__________. Money Mischief: Episodes in Monetary History.
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__________. "The 'Plucking Model' of Business Cycle Fluctuations
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