In his New York Review of Books article “Who Was Milton Friedman?,” Paul Krugman notoriously charged Friedman with “intellectual dishonesty”. In a nutshell, Krugman views the Fed’s behavior in the 1930s as evidence that government should do more to manage the macroeconomy, whereas Friedman viewed it as evidence of the opposite. Krugman accused Friedman of “intellectual dishonesty” because he thinks Friedman in his popular writings misrepresented Friedman and Schwartz’s own account of the 1930s found in the Monetary History. Anna Schwartz and co-author Edward Nelson have now responded to Krugman with a letter to the NYRB, and Krugman has replied.

Krugman summarizes his position nicely in his reply:

First, the letter from Anna Schwartz and Edward Nelson actually illustrates Friedman's slippery treatment of the Fed's role in the Depression even better than the examples I used in the article. On one side the letter says, as Friedman did, that the problem was that the Fed did too little—that it failed to exercise its power to rescue the banks. But on the other side the letter approvingly quotes Friedman saying that the Fed did too much—that in the absence of the Fed, with its "enormous power," we wouldn't have had a downturn on "anything like the scale we experienced." I'm sorry, but those are contradictory positions.

Krugman is wrong: those are not contradictory positions.

To see why they are not contradictory, we need to spell out Friedman’s institutional counter-factual. That is, what did Friedman think would have happened without a central bank? Friedman understood something that Krugman never mentions, namely that before the Federal Reserve Act financial panics in the US were mitigated by the actions of private commercial bank clearinghouses. (The key article here is “The Central Banking Role of Clearinghouse Associations," JMCB Feb. 1984, by Richard H. Timberlake, a Friedman student. JSTOR pdf here.) Friedman and Schwartz’s view of the 1930s was that the Fed, having nationalized the roles of the clearinghouse associations, particularly the lender-of-last-resort role, did less to mitigate the panic than the CHAs had done in earlier panics like 1907 and 1893. In that sense, the economy would have been better off if the Fed had not been created.

This position is perfectly consistent with the position that, provided we take the Fed’s nationalization of the clearinghouse roles for granted, the Fed was guilty of not doing its job. Given that proviso, Krugman is right that Friedman’s account indicates that the Fed should have been more active. But because we can consider a world where the proviso doesn't hold, Krugman is wrong to think that Friedman’s account can’t honestly support the view that government should have stayed out.

ADDENDUM: Pushmedia1 uses symbolic logic to characterize Krugman's mistake.

Krugman's initial article here. Schwartz and Nelson's letter and Krugman's reply here. Hat tip: Cyril Morong.