Anna Schwartz, longtime colleague of the late Milton Friedman and celebrated free-market economist in her own right, had some interesting things to say about the current credit crunch. In a story published on December 23 in the London newspaper the Telegraph, Schwartz told reporter Ambrose Evans-Pritchard that the buckets of money being thrown into the system by central banks in the U.S. and Europe were not getting to the root of problem. In fact, they were probably making things worse. “Liquidity doesn't do anything in this situation,” Schwartz said. “It cannot deal with the fear that lots of firms are going bankrupt.” Schwartz's comments are especially significant given that in her research with Friedman, published in the monumental A Monetary History of the United States, 1867-1963, determined that lack of liquidity — not enough money being printed — was the main cause of the Great Depression. Schwartz and Friedman blamed the Federal Reserve for not printing enough money to avoid a deflation. But of the current problems, Schwartz sees valuation of the mortgage oriented financial instruments as the main problem. “The banks and the hedge funds have not fully acknowledged who is in trouble,” she said. “That is the critical issue.” Although Evans-Pritchard's story has an unfortunate alarmist headline about the current “crisis” making 1929 look like “a walk in the park,” his story is really about whether policy makers are dispensing the wrong prescription for the economy's current ailments. It's the policy errors, he writes, that could turn current problems into a full-blown catastrophe. As the story notes “a chorus of economists has begun to warn that the world's central banks are fighting the wrong war, and perhaps risk a policy error of epochal proportions.” As Eli Lehrer, others at CEI, and I have written, monetary policy isn't the way politicians and bureaucrats can risk an “error of epochal proportions.” Eli's and my study on proposals for subsidies and regulations show how the regs would unnecessarily limit credit and the subsidies may encourage more foolish lending. My op eds in USA TODAY and The American Spectator on the Bush-Paulson “voluntary” freezing of borrower's interest rates in adjustable rate mortgages notes the effects that this government-encouraged abrogation of contracts will have on future borrowers as well as ordinary savers who have exposure to mortgage-backed securities through their money market funds. My article last week in National Review shows why expanding the Federal Housing Administration will likely add to the agency's “moral hazard” that helped cause the current mortgage situation in the first place. The economy experienced a recent spurt of good news over the holiday season, but we are far from out of the woods on credit issues. However, as 2008 approaches, it looks like the biggest danger might be the policy equivalent of amputating the economy's foot to “cure” a painful but manageable ingrown toenail.