Milton Friedman said a lot of things that were very controversial 40 years ago, but are now part of the economics mainstream. The natural rate hypothesis, and the view that monetary policy should have prime responsibility for aggregate demand and inflation, are now part of the New Keynesian orthodoxy. This shows how much Milton Friedman won his war. But there was one tactical battle he clearly lost, and lost badly.
Milton Friedman said that if the money supply kept growing at k% per year, where k was some small positive constant like 4%, nothing much could go very wrong with the macroeconomy, so that's what central banks should do. That never became part of conventional wisdom. Some people believed it in the 1970's. Almost nobody believes it now. I stopped believing it 30 years ago. So did the Bank of Canada, when it stopped targeting money growth. "We didn't abandon M1; M1 abandoned us" as Governor Bouey is reputed to have said. Money demand just isn't stable enough, and fluctuations in money demand can be just as damaging as fluctuations in money supply. And so central banks need to offset fluctuations in money demand while maintaining some sort of nominal anchor like an inflation target.
Milton Friedman was wrong on that one, and the current recession seemed to be just one more example of him being wrong. The current recession looked like an increase in money demand, either as part of a general excess demand for safe assets (as Brad DeLong argues), or a general demand for liquid assets. It didn't look like a fall in the money supply.
Now I'm not so sure. Reading Gary Gorton and Andrew Metrick (H/T Tyler Cowen) I realise I don't have a clue what's in the stock of money any more. And when I say "money" I don't just mean credit, or money substitutes; I mean full-blown media of exchange, like currency, or chequable demand deposits in fractional reserve banks. I mean stuff you can buy things with, without first having to sell them for money, or follow up by paying money later.
Suppose you were a monetary economist in the US in the 1930's. And suppose you knew that currency was a medium of exchange, but you didn't know that demand deposits at fractional reserve banks were also media of exchange. You would have noticed the runs on banks, and bank closures, but you wouldn't think that these had anything to do with the supply of money. As far as you knew, the money supply, which you thought of as currency, would have seemed OK. You would completely miss the fall in the money supply.
Maybe we are like that now. Maybe a large part of the money supply is dark matter. We didn't see it fall. We saw the runs on the shadow banking system, but didn't see how it affected the money supply.
I have no idea if this is right. It probably isn't. But I'm not as confident as I used to be that Milton Friedman was wrong on the k% rule. Of course, it makes it even harder actually to implement a k% rule, if we include dark matter in the thing we're supposed to make grow at k%. Because if they are that hard to see, they are even harder to control.