Who Was Milton Friedman? | by Paul Krugman | The New York Review of Books Who Was Milton Friedman? February 15, 2007 Issue 1. The history of economic thought in the twentieth century is a bit like the history of Christianity in the sixteenth century. Until John Maynard Keynes published The General Theory of Employment, Interest, and Money in 1936, economics—at least in the English-speaking world—was completely dominated by free-market orthodoxy. Heresies would occasionally pop up, but they were always suppressed. Classical economics, wrote Keynes in 1936, “conquered England as completely as the Holy Inquisition conquered Spain.” And classical economics said that the answer to almost all problems was to let the forces of supply and demand do their job. But classical economics offered neither explanations nor solutions for the Great Depression. By the middle of the 1930s, the challenges to orthodoxy could no longer be contained. Keynes played the role of Martin Luther, providing the intellectual rigor needed to make heresy respectable.

Although Keynes was by no means a leftist—he came to save capitalism, not to bury it—his theory said that free markets could not be counted on to provide full employment, creating a new rationale for large-scale government intervention in the economy. Keynesianism was a great reformation of economic thought. It was followed, inevitably, by a counter-reformation. A number of economists played important roles in the great revival of classical economics between 1950 and 2000, but none was as influential as Milton Friedman. If Keynes was Luther, Friedman was Ignatius of Loyola, founder of the Jesuits. And like the Jesuits, Friedman’s followers have acted as a sort of disciplined army of the faithful, spearheading a broad, but incomplete, rollback of Keynesian heresy. By the century’s end, classical economics had regained much though by no means all of its former dominion, and Friedman deserves much of the credit. I don’t want to push the religious analogy too far. Economic theory at least aspires to be science, not theology; it is concerned with earth, not heaven.

Keynesian theory initially prevailed because it did a far better job than classical orthodoxy of making sense of the world around us, and Friedman’s critique of Keynes became so influential largely because he correctly identified Keynesianism’s weak points. And just to be clear: although this essay argues that Friedman was wrong on some issues, and sometimes seemed less than honest with his readers, I regard him as a great economist and a great man. 2. Milton Friedman played three roles in the intellectual life of the twentieth century. There was Friedman the economist’s economist, who wrote technical, more or less apolitical analyses of consumer behavior and inflation. There was Friedman the policy entrepreneur, who spent decades campaigning on behalf of the policy known as monetarism—finally seeing the Federal Reserve and the Bank of England adopt his doctrine at the end of the 1970s, only to abandon it as unworkable a few years later. Finally, there was Friedman the ideologue, the great popularizer of free-market doctrine. Did the same man play all these roles? Yes and no. All three roles were informed by Friedman’s faith in the classical verities of free-market economics.

Moreover, Friedman’s effectiveness as a popularizer and propagandist rested in part on his well-deserved reputation as a profound economic theorist. But there’s an important difference between the rigor of his work as a professional economist and the looser, sometimes questionable logic of his pronouncements as a public intellectual. While Friedman’s theoretical work is universally admired by professional economists, there’s much more ambivalence about his policy pronouncements and especially his popularizing. And it must be said that there were some serious questions about his intellectual honesty when he was speaking to the mass public. But let’s hold off on the questionable material for a moment, and talk about Friedman the economic theorist. For most of the past two centuries, economic thinking has been dominated by the concept of Homo economicus. The hypothetical Economic Man knows what he wants; his preferences can be expressed mathematically in terms of a “utility function.” And his choices are driven by rational calculations about how to maximize that function: whether consumers are deciding between corn flakes or shredded wheat, or investors are deciding between stocks and bonds, those decisions are assumed to be based on comparisons of the “marginal utility,” or the added benefit the buyer would get from acquiring a small amount of the alternatives available.

It’s easy to make fun of this story. Nobody, not even Nobel-winning economists, really makes decisions that way. But most economists—myself included—nonetheless find Economic Man useful, with the understanding that he’s an idealized representation of what we really think is going on. People do have preferences, even if those preferences can’t really be expressed by a precise utility function; they usually make sensible decisions, even if they don’t literally maximize utility. You might ask, why not represent people the way they really are? The answer is that abstraction, strategic simplification, is the only way we can impose some intellectual order on the complexity of economic life. And the assumption of rational behavior has been a particularly fruitful simplification. The question, however, is how far to push it. Keynes didn’t make an all-out assault on Economic Man, but he often resorted to plausible psychological theorizing rather than careful analysis of what a rational decision-maker would do. Business decisions were driven by “animal spirits,” consumer decisions by a psychological tendency to spend some but not all of any increase in income, wage settlements by a sense of fairness, and so on. But was it really a good idea to diminish the role of Economic Man that much?

No, said Friedman, who argued in his 1953 essay “The Methodology of Positive Economics” that economic theories should be judged not by their psychological realism but by their ability to predict behavior. And Friedman’s two greatest triumphs as an economic theorist came from applying the hypothesis of rational behavior to questions other economists had thought beyond its reach. In his 1957 book A Theory of the Consumption Function—not exactly a crowd-pleasing title, but an important topic—Friedman argued that the best way to make sense of saving and spending was not, as Keynes had done, to resort to loose psychological theorizing, but rather to think of individuals as making rational plans about how to spend their wealth over their lifetimes. This wasn’t necessarily an anti-Keynesian idea—in fact, the great Keynesian economist Franco Modigliani simultaneously and independently made a similar case, with even more care in thinking about rational behavior, in work with Albert Ando. But it did mark a return to classical ways of thinking—and it worked.

The details are a bit technical, but Friedman’s “permanent income hypothesis” and the Ando-Modigliani “life cycle model” resolved several apparent paradoxes about the relationship between income and spending, and remain the foundations of how economists think about spending and saving to this day. Friedman’s work on consumption behavior would, in itself, have made his academic reputation. An even bigger triumph, however, came from his application of Economic Man theorizing to inflation. In 1958 the New Zealand–born economist A.W. Phillips pointed out that there was a historical correlation between unemployment and inflation, with high inflation associated with low unemployment and vice versa. For a time, economists treated this correlation as if it were a reliable and stable relationship. This led to serious discussion about which point on the “Phillips curve” the government should choose. For example, should the United States accept a higher inflation rate in order to achieve a lower unemployment rate? In 1967, however, Friedman gave a presidential address to the American Economic Association in which he argued that the correlation between inflation and unemployment, even though it was visible in the data, did not represent a true trade-off, at least not in the long run.

“There is,” he said, “always a temporary trade-off between inflation and unemployment; there is no permanent trade-off.” In other words, if policymakers were to try to keep unemployment low through a policy of generating higher inflation, they would achieve only temporary success. According to Friedman, unemployment would eventually rise again, even as inflation remained high. The economy would, in other words, suffer the condition Paul Samuelson would later dub “stagflation.” How did Friedman reach this conclusion? (Edmund S. Phelps, who was awarded the Nobel Memorial Prize in economics this year, simultaneously and independently arrived at the same result.) As in the case of his work on consumer behavior, Friedman applied the idea of rational behavior. He argued that after a sustained period of inflation, people would build expectations of future inflation into their decisions, nullifying any positive effects of inflation on employment. For example, one reason inflation may lead to higher employment is that hiring more workers becomes profitable when prices rise faster than wages. But once workers understand that the purchasing power of their wages will be eroded by inflation, they will demand higher wage settlements in advance, so that wages keep up with prices.

As a result, after inflation has gone on for a while, it will no longer deliver the original boost to employment. In fact, there will be a rise in unemployment if inflation falls short of expectations. At the time Friedman and Phelps propounded their ideas, the United States had little experience with sustained inflation. So this was truly a prediction rather than an attempt to explain the past. In the 1970s, however, persistent inflation provided a test of the Friedman-Phelps hypothesis. Sure enough, the historical correlation between inflation and unemployment broke down in just the way Friedman and Phelps had predicted: in the 1970s, as the inflation rate rose into double digits, the unemployment rate was as high or higher than in the stable-price years of the 1950s and 1960s. Inflation was eventually brought under control in the 1980s, but only after a painful period of extremely high unemployment, the worst since the Great Depression. By predicting the phenomenon of stagflation in advance, Friedman and Phelps achieved one of the great triumphs of postwar economics.

This triumph, more than anything else, confirmed Milton Friedman’s status as a great economist’s economist, whatever one may think of his other roles. One interesting footnote: although Friedman made great strides in macroeconomics by applying the concept of individual rationality, he also knew where to stop. In the 1970s, some economists pushed Friedman’s analysis of inflation even further, arguing that there is no usable trade-off between inflation and unemployment even in the short run, because people will anticipate government actions and build that anticipation, as well as past experience, into their price-setting and wage-bargaining. This doctrine, known as “rational expectations,” swept through much of academic economics. But Friedman never went there. His reality sense warned that this was taking the idea of Homo economicus too far. And so it proved: Friedman’s 1967 address has stood the test of time, while the more extreme views propounded by rational expectations theorists in the Seventies and Eighties have not. 3. “Everything reminds Milton of the money supply. Well, everything reminds me of sex, but I keep it out of the paper,” wrote MIT’s Robert Solow in 1966.

For decades, Milton Friedman’s public image and fame were defined largely by his pronouncements on monetary policy and his creation of the doctrine known as monetarism. It’s somewhat surprising to realize, then, that monetarism is now widely regarded as a failure, and that some of the things Friedman said about “money” and monetary policy—unlike what he said about consumption and inflation—appear to have been misleading, and perhaps deliberately so. To understand what monetarism was all about, the first thing you need to know is that the word “money” doesn’t mean quite the same thing in Economese that it does in plain English. When economists talk of the money supply, they don’t mean wealth in the usual sense. They mean only those forms of wealth that can be used more or less directly to buy things. Currency—pieces of green paper with pictures of dead presidents on them—is money, and so are bank deposits on which you can write checks. But stocks, bonds, and real estate aren’t money, because they have to be converted into cash or bank deposits before they can be used to make purchases.

If the money supply consisted solely of currency, it would be under the direct control of the government—or, more precisely, the Federal Reserve, a monetary agency that, like its counterpart “central banks” in many other countries, is institutionally somewhat separate from the government proper. The fact that the money supply also includes bank deposits makes reality more complicated. The central bank has direct control only over the “monetary base”—the sum of currency in circulation, the currency banks hold in their vaults, and the deposits banks hold at the Federal Reserve—but not the deposits people have made in banks. Under normal circumstances, however, the Federal Reserve’s direct control over the monetary base is enough to give it effective control of the overall money supply as well. Before Keynes, economists considered the money supply a primary tool of economic management. But Keynes argued that under depression conditions, when interest rates are very low, changes in the money supply have little effect on the economy. The logic went like this: when interest rates are 4 or 5 percent, nobody wants to sit on idle cash.

But in a situation like that of 1935, when the interest rate on three-month Treasury bills was only 0.14 percent, there is very little incentive to take the risk of putting money to work. The central bank may try to spur the economy by printing large quantities of additional currency; but if the interest rate is already very low the additional cash is likely to languish in bank vaults or under mattresses. Thus Keynes argued that monetary policy, a change in the money supply to manage the economy, would be ineffective. And that’s why Keynes and his followers believed that fiscal policy—in particular, an increase in government spending—was necessary to get countries out of the Great Depression. Why does this matter? Monetary policy is a highly technocratic, mostly apolitical form of government intervention in the economy. If the Fed decides to increase the money supply, all it does is purchase some government bonds from private banks, paying for the bonds by crediting the banks’ reserve accounts—in effect, all the Fed has to do is print some more monetary base.

By contrast, fiscal policy involves the government much more deeply in the economy, often in a value-laden way: if politicians decide to use public works to promote employment, they need to decide what to build and where. Economists with a free-market bent, then, tend to want to believe that monetary policy is all that’s needed; those with a desire to see a more active government tend to believe that fiscal policy is essential. Economic thinking after the triumph of the Keynesian revolution—as reflected, say, in the early editions of Paul Samuelson’s classic textbook * —gave priority to fiscal policy, while monetary policy was relegated to the sidelines. As Friedman said in his 1967 address to the American Economic Association: The wide acceptance of [Keynesian] views in the economics profession meant that for some two decades monetary policy was believed by all but a few reactionary souls to have been rendered obsolete by new economic knowledge. Money did not matter. Although this may have been an exaggeration, monetary policy was held in relatively low regard through the 1940s and 1950s.

Friedman, however, crusaded for the proposition that money did too matter, culminating in the 1963 publication of A Monetary History of the United States, 1867–1960, with Anna Schwartz. Although A Monetary History is a vast work of extraordinary scholarship, covering a century of monetary developments, its most influential and controversial discussion concerned the Great Depression. Friedman and Schwartz claimed to have refuted Keynes’s pessimism about the effectiveness of monetary policy in depression conditions. “The contraction” of the economy, they declared, “is in fact a tragic testimonial to the importance of monetary forces.” But what did they mean by that? From the beginning, the Friedman-Schwartz position seemed a bit slippery. And over time Friedman’s presentation of the story grew cruder, not subtler, and eventually began to seem—there’s no other way to say this—intellectually dishonest. In interpreting the origins of the Depression, the distinction between the monetary base (currency plus bank reserves), which the Fed controls directly, and the money supply (currency plus bank deposits) is crucial.

The monetary base went up during the early years of the Great Depression, rising from an average of $6.05 billion in 1929 to an average of $7.02 billion in 1933. But the money supply fell sharply, from $26.6 billion to $19.9 billion. This divergence mainly reflected the fallout from the wave of bank failures in 1930–1931: as the public lost faith in banks, people began holding their wealth in cash rather than bank deposits, and those banks that survived began keeping large quantities of cash on hand rather than lending it out, to avert the danger of a bank run. The result was much less lending, and hence much less spending, than there would have been if the public had continued to deposit cash into banks, and banks had continued to lend deposits out to businesses. And since a collapse of spending was the proximate cause of the Depression, the sudden desire of both individuals and banks to hold more cash undoubtedly made the slump worse. Friedman and Schwartz claimed that the fall in the money supply turned what might have been an ordinary recession into a catastrophic depression, itself an arguable point.

But even if we grant that point for the sake of argument, one has to ask whether the Federal Reserve, which after all did increase the monetary base, can be said to have caused the fall in the overall money supply. At least initially, Friedman and Schwartz didn’t say that. What they said instead was that the Fed could have prevented the fall in the money supply, in particular by riding to the rescue of the failing banks during the crisis of 1930–1931. If the Fed had rushed to lend money to banks in trouble, the wave of bank failures might have been prevented, which in turn might have avoided both the public’s decision to hold cash rather than bank deposits, and the preference of the surviving banks for stashing deposits in their vaults rather than lending the funds out. And this, in turn, might have staved off the worst of the Depression. An analogy may be helpful here. Suppose that a flu epidemic breaks out, and later analysis suggests that appropriate action by the Centers for Disease Control could have contained the epidemic. It would be fair to blame government officials for failing to take appropriate action.

But it would be quite a stretch to say that the government caused the epidemic, or to use the CDC’s failure as a demonstration of the superiority of free markets over big government. Yet many economists, and even more lay readers, have taken Friedman and Schwartz’s account to mean that the Federal Reserve actually caused the Great Depression—that the Depression is in some sense a demonstration of the evils of an excessively interventionist government. And in later years, as I’ve said, Friedman’s assertions grew cruder, as if to feed this misperception. In his 1967 presidential address he declared that “the US monetary authorities followed highly deflationary policies,” and that the money supply fell “because the Federal Reserve System forced or permitted a sharp reduction in the monetary base, because it failed to exercise the responsibilities assigned to it”—an odd assertion given that the monetary base, as we’ve seen, actually rose as the money supply was falling.

(Friedman may have been referring to a couple of episodes along the way in which the monetary base fell modestly for brief periods, but even so his statement was highly misleading at best.) By 1976 Friedman was telling readers of Newsweek that “the elementary truth is that the Great Depression was produced by government mismanagement,” a statement that his readers surely took to mean that the Depression wouldn’t have happened if only the government had kept out of the way—when in fact what Friedman and Schwartz claimed was that the government should have been more active, not less. Why did historical disputes about the role of monetary policy in the 1930s matter so much in the 1960s? Partly because they fed into Friedman’s broader anti-government agenda, of which more below. But the more direct application was to Friedman’s advocacy of monetarism. According to this doctrine, the Federal Reserve should keep the money supply growing at a steady, low rate, say 3 percent a year—and not deviate from this target, no matter what is happening in the economy. The idea was to put monetary policy on autopilot, removing any discretion on the part of government officials.

Friedman’s case for monetarism was part economic, part political. Steady growth in the money supply, he argued, would lead to a reasonably stable economy. He never claimed that following his rule would eliminate all recessions, but he did argue that the wiggles in the economy’s growth path would be small enough to be tolerable—hence the assertion that the Great Depression wouldn’t have happened if the Fed had been following a monetarist rule. And along with this qualified faith in the stability of the economy under a monetary rule went Friedman’s unqualified contempt for the ability of Federal Reserve officials to do better if given discretion. Exhibit A for the Fed’s unreliability was the onset of the Great Depression, but Friedman could point to many other examples of policy gone wrong. “A monetary rule,” he wrote in 1972, “would insulate monetary policy both from arbitrary power of a small group of men not subject to control by the electorate and from the short-run pressures of partisan politics.” Monetarism was a powerful force in economic debate for about three decades after Friedman first propounded the doctrine in his 1959 book A Program for Monetary Stability.

Today, however, it is a shadow of its former self, for two main reasons. First, when the United States and the United Kingdom tried to put monetarism into practice at the end of the 1970s, both experienced dismal results: in each country steady growth in the money supply failed to prevent severe recessions. The Federal Reserve officially adopted Friedman-type monetary targets in 1979, but effectively abandoned them in 1982 when the unemployment rate went into double digits. This abandonment was made official in 1984, and ever since then the Fed has engaged in precisely the sort of discretionary fine-tuning that Friedman decried. For example, the Fed responded to the 2001 recession by slashing interest rates and allowing the money supply to grow at rates that sometimes exceeded 10 percent per year. Once the Fed was satisfied that the recovery was solid, it reversed course, raising interest rates and allowing growth in the money supply to drop to zero. Second, since the early 1980s the Federal Reserve and its counterparts in other countries have done a reasonably good job, undermining Friedman’s portrayal of central bankers as irredeemable bunglers.

Inflation has stayed low, recessions—except in Japan, of which more in a second—have been relatively brief and shallow. And all this happened in spite of fluctuations in the money supply that horrified monetarists, and led them—Friedman included—to predict disasters that failed to materialize. As David Warsh of The Boston Globe pointed out in 1992, “Friedman blunted his lance forecasting inflation in the 1980s, when he was deeply, frequently wrong.” By 2004, the Economic Report of the President, written by the very conservative economists of the Bush administration, could nonetheless make the highly anti-monetarist declaration that “aggressive monetary policy”—not stable, steady-as-you-go, but aggressive—“can reduce the depth of a recession.” Now, a word about Japan. During the 1990s Japan experienced a sort of minor-key reprise of the Great Depression. The unemployment rate never reached Depression levels, thanks to massive public works spending that had Japan, with less than half America’s population, pouring more concrete each year than the United States. But the very low interest rate conditions of the Great Depression reemerged in full.

By 1998 the call money rate, the rate on overnight loans between banks, was literally zero. And under those conditions, monetary policy proved just as ineffective as Keynes had said it was in the 1930s. The Bank of Japan, Japan’s equivalent of the Fed, could and did increase the monetary base. But the extra yen were hoarded, not spent. The only consumer durable goods selling well, some Japanese economists told me at the time, were safes. In fact, the Bank of Japan found itself unable even to increase the money supply as much as it wanted. It pushed vast quantities of cash into circulation, but broader measures of the money supply grew very little. An economic recovery finally began a couple of years ago, driven by a revival of business investment to take advantage of new technological opportunities. But monetary policy never was able to get any traction. In effect, Japan in the Nineties offered a fresh opportunity to test the views of Friedman and Keynes regarding the effectiveness of monetary policy in depression conditions. And the results clearly supported Keynes’s pessimism rather than Friedman’s optimism. 4.

In 1946 Milton Friedman made his debut as a popularizer of free-market economics with a pamphlet titled “Roofs or Ceilings: The Current Housing Problem” coauthored with George J. Stigler, who would later join him at the University of Chicago. The pamphlet, an attack on the rent controls that were still universal just after World War II, was released under rather odd circumstances: it was a publication of the Foundation for Economic Education, an organization which, as Rick Perlstein writes in Before the Storm (2001), his book about the origins of the modern conservative movement, “spread a libertarian gospel so uncompromising it bordered on anarchism.” Robert Welch, the founder of the John Birch Society, sat on the FEE’s board. This first venture in free-market popularization prefigured in two ways the course of Friedman’s career as a public intellectual over the next six decades. First, the pamphlet demonstrated Friedman’s special willingness to take free-market ideas to their logical limits. Neither the idea that markets are efficient ways to allocate scarce goods nor the proposition that price controls create shortages and inefficiency was new.

But many economists, fearing the backlash against a sudden rise in rents (which Friedman and Stigler predicted would be about 30 percent for the nation as a whole), might have proposed some kind of gradual transition to decontrol. Friedman and Stigler dismissed all such concerns. In the decades ahead, this single-mindedness would become Friedman’s trademark. Again and again, he called for market solutions to problems—education, health care, the illegal drug trade—that almost everyone else thought required extensive government intervention. Some of his ideas have received widespread acceptance, like replacing rigid rules on pollution with a system of pollution permits that companies are free to buy and sell. Some, like school vouchers, are broadly supported by the conservative movement but haven’t gotten far politically. And some of his proposals, like eliminating licensing procedures for doctors and abolishing the Food and Drug Administration, are considered outlandish even by most conservatives. Second, the pamphlet showed just how good Friedman was as a popularizer. It’s beautifully and cunningly written.

There is no jargon; the points are made with cleverly chosen real-world examples, ranging from San Francisco’s rapid recovery from the 1906 earthquake to the plight of a 1946 veteran, newly discharged from the army, searching in vain for a decent place to live. The same style, enhanced by video, would mark Friedman’s celebrated 1980 TV series Free to Choose. The odds are that the great swing back toward laissez-faire policies that took place around the world beginning in the 1970s would have happened even if there had been no Milton Friedman. But his tireless and brilliantly effective campaign on behalf of free markets surely helped accelerate the process, both in the United States and around the world. By any measure—protectionism versus free trade; regulation versus deregulation; wages set by collective bargaining and government minimum wages versus wages set by the market—the world has moved a long way in Friedman’s direction. And even more striking than his achievement in terms of actual policy changes has been the transformation of the conventional wisdom: most influential people have been so converted to the Friedman way of thinking that it is simply taken as a given that the change in economic policies he promoted has been a force for good.

But has it? Consider first the macroeconomic performance of the US economy. We have data on the real income—that is, income adjusted for inflation—of American families from 1947 to 2005. During the first half of that fifty-eight-year stretch, from 1947 to 1976, Milton Friedman was a voice crying in the wilderness, his ideas ignored by policymakers. But the economy, for all the inefficiencies he decried, delivered dramatic improvements in the standard of living of most Americans: median real income more than doubled. By contrast, the period since 1976 has been one of increasing acceptance of Friedman’s ideas; although there remained plenty of government intervention for him to complain about, there was no question that free-market policies became much more widespread. Yet gains in living standards have been far less robust than they were during the previous period: median real income was only about 23 percent higher in 2005 than in 1976.

Part of the reason the second postwar generation didn’t do as well as the first was a slower overall rate of economic growth—a fact that may come as a surprise to those who assume that the trend toward free markets has yielded big economic dividends. But another important reason for the lag in most families’ living standards was a spectacular increase in economic inequality: during the first postwar generation income growth was broadly spread across the population, but since the late 1970s median income, the income of the typical family, has risen only about a third as fast as average income, which includes the soaring incomes of a small minority at the top. This raises an interesting point. Milton Friedman often assured audiences that no special institutions, like minimum wages and unions, were needed to ensure that workers would share in the benefits of economic growth. In 1976 he told Newsweek readers that tales of the evil done by the robber barons were pure myth: There is probably no other period in history, in this or any other country, in which the ordinary man had as large an increase in his standard of living as in the period between the Civil War and the First World War, when unrestrained individualism was most rugged.

(What about the remarkable thirty-year stretch after World War II, which encompassed much of Friedman’s own career?) Yet in the decades that followed that pronouncement, as the minimum wage was allowed to fall behind inflation and unions largely disappeared as an important factor in the private sector, working Americans saw their fortunes lag behind growth in the economy as a whole. Was Friedman too sanguine about the generosity of the invisible hand? To be fair, there are many factors affecting both economic growth and the distribution of income, so we can’t blame Friedmanite policies for all disappointments. Still, given the common assumption that the turn toward free-market policies did great things for the US economy and the living standards of ordinary Americans, it’s striking how little support one can find for that proposition in the data. Similar questions about the lack of clear evidence that Friedman’s ideas actually work in practice can be raised, with even more force, for Latin America. A decade ago it was common to cite the success of the Chilean economy, where Augusto Pinochet’s Chicago-educated advisers turned to free-market policies after Pinochet seized power in 1973, as proof that Friedman-inspired policies showed the path to successful economic development.

But although other Latin nations, from Mexico to Argentina, have followed Chile’s lead in freeing up trade, privatizing industries, and deregulating, Chile’s success story has not been replicated. On the contrary, the perception of most Latin Americans is that “neoliberal” policies have been a failure: the promised takeoff in economic growth never arrived, while income inequality has worsened. I don’t mean to blame everything that has gone wrong in Latin America on the Chicago School, or to idealize what went before; but there is a striking contrast between the perception that Friedman was vindicated and the actual results in economies that turned from the interventionist policies of the early postwar decades to laissez-faire. On a more narrowly focused topic, one of Friedman’s key targets was what he considered the uselessness and counterproductive nature of most government regulation. In an obituary for his one-time collaborator George Stigler, Friedman singled out for praise Stigler’s critique of electricity regulation, and his argument that regulators usually end up serving the interests of the regulated rather than those of the public. So how has deregulation worked out? It started well, with the deregulation of trucking and airlines beginning in the late 1970s.

In both cases deregulation, while it didn’t make everyone happy, led to increased competition, generally lower prices, and higher efficiency. Deregulation of natural gas was also a success. But the next big wave of deregulation, in the electricity sector, was a different story. Just as Japan’s slump in the 1990s showed that Keynesian worries about the effectiveness of monetary policy were no myth, the California electricity crisis of 2000– 2001—in which power companies and energy traders created an artificial shortage to drive up prices—reminded us of the reality that lay behind tales of the robber barons and their depredations. While other states didn’t suffer as severely as California, across the nation electricity deregulation led to higher, not lower, prices, with huge windfall profits for power companies. Those states that, for whatever reason, didn’t get on the deregulation bandwagon in the 1990s now consider themselves lucky. And the luckiest of all are those cities that somehow didn’t get the memo about the evils of government and the virtues of the private sector, and still have publicly owned power companies.

All of this showed that the original rationale for electricity regulation—the observation that without regulation, power companies would have too much monopoly power—remains as valid as ever. Should we conclude from this that deregulation is always a bad idea? No—it depends on the specifics. To conclude that deregulation is always and everywhere a bad idea would be to engage in the same kind of absolutist thinking that was, arguably, Milton Friedman’s greatest flaw. In his 1965 review of Friedman and Schwartz’s Monetary History, the late Yale economist and Nobel laureate James Tobin gently chided the authors for going too far. “Consider the following three propositions,” he wrote. “Money does not matter. It does too matter. Money is all that matters. It is all too easy to slip from the second proposition to the third.” And he added that “in their zeal and exuberance” Friedman and his followers had too often done just that. A similar sequence seems to have happened in Milton Friedman’s advocacy of laissez-faire. In the aftermath of the Great Depression, there were many people saying that markets can never work.

Friedman had the intellectual courage to say that markets can too work, and his showman’s flair combined with his ability to marshal evidence made him the best spokesman for the virtues of free markets since Adam Smith. But he slipped all too easily into claiming both that markets always work and that only markets work. It’s extremely hard to find cases in which Friedman acknowledged the possibility that markets could go wrong, or that government intervention could serve a useful purpose. Friedman’s laissez-faire absolutism contributed to an intellectual climate in which faith in markets and disdain for government often trumps the evidence. Developing countries rushed to open up their capital markets, despite warnings that this might expose them to financial crises; then, when the crises duly arrived, many observers blamed the countries’ governments, not the instability of international capital flows. Electricity deregulation proceeded despite clear warnings that monopoly power might be a problem; in fact, even as the California electricity crisis was happening, most commentators dismissed concerns about price-rigging as wild conspiracy theories. Conservatives continue to insist that the free market is the answer to the health care crisis, in the teeth of overwhelming evidence to the contrary.

What’s odd about Friedman’s absolutism on the virtues of markets and the vices of government is that in his work as an economist’s economist he was actually a model of restraint. As I pointed out earlier, he made great contributions to economic theory by emphasizing the role of individual rationality—but unlike some of his colleagues, he knew where to stop. Why didn’t he exhibit the same restraint in his role as a public intellectual? The answer, I suspect, is that he got caught up in an essentially political role. Milton Friedman the great economist could and did acknowledge ambiguity. But Milton Friedman the great champion of free markets was expected to preach the true faith, not give voice to doubts. And he ended up playing the role his followers expected. As a result, over time the refreshing iconoclasm of his early career hardened into a rigid defense of what had become the new orthodoxy. In the long run, great men are remembered for their strengths, not their weaknesses, and Milton Friedman was a very great man indeed—a man of intellectual courage who was one of the most important economic thinkers of all time, and possibly the most brilliant communicator of economic ideas to the general public that ever lived.

But there’s a good case for arguing that Friedmanism, in the end, went too far, both as a doctrine and in its practical applications. When Friedman was beginning his career as a public intellectual, the times were ripe for a counterreformation against Keynesianism and all that went with it. But what the world needs now, I’d argue, is a counter-counterreformation. Letters Milton Friedman: The Concise Encyclopedia of Economics | Library of Economics and Liberty | Biographies | Milton Friedman Milton Friedman was the twentieth century’s most prominent advocate of free markets. Born in 1912 to Jewish immigrants in New York City, he attended Rutgers University, where he earned his B.A. at the age of twenty. He went on to earn his M.A. from the University of Chicago in 1933 and his Ph.D. from Columbia University in 1946. In 1951 Friedman received the John Bates Clark Medal honoring economists under age forty for outstanding achievement.

In 1976 he was awarded the Nobel Prize in economics for “his achievements in the field of consumption analysis, monetary history and theory, and for his demonstration of the complexity of stabilization policy.” Before that time he had served as an adviser to President Richard Nixon and was president of the American Economic Association in 1967. After retiring from the University of Chicago in 1977, Friedman became a senior research fellow at the Hoover Institution at Stanford University. Friedman established himself in 1945 with Income from Independent Professional Practice, coauthored with Simon Kuznets. In it he argued that state licensing procedures limited entry into the medical profession, thereby allowing doctors to charge higher fees than they would be able to do if competition were more open. His landmark 1957 work, A Theory of the Consumption Function, took on the Keynesian view that individuals and households adjust their expenditures on consumption to reflect their current income. Friedman showed that, instead, people’s annual consumption is a function of their “permanent income,” a term he introduced as a measure of the average income people expect over a few years.

In Capitalism and Freedom, Friedman wrote arguably the most important economics book of the 1960s, making a case for relatively free markets to a general audience. He argued for, among other things, a volunteer army, freely floating exchange rates, abolition of licensing of doctors, a negative income tax, and education vouchers. (Friedman was a passionate foe of the military draft: he once stated that the abolition of the draft was almost the only issue on which he had personally lobbied Congress.) Many of the young people who read it were encouraged to study economics themselves. His ideas spread worldwide with Free to Choose (coauthored with his wife, Rose Friedman), the best-selling nonfiction book of 1980, written to accompany a TV series on the Public Broadcasting System. This book made Milton Friedman a household name. Although much of his trailblazing work was done on price theory—the theory that explains how prices are determined in individual markets—Friedman is popularly recognized for monetarism . Defying Keynes and most of the academic establishment of the time, Friedman presented evidence to resurrect the quantity theory of money—the idea that the price level depends on the money supply .

In Studies in the Quantity Theory of Money, published in 1956, Friedman stated that in the long run, increased monetary growth increases prices but has little or no effect on output. In the short run, he argued, increases in money supply growth cause employment and output to increase, and decreases in money supply growth have the opposite effect. Friedman’s solution to the problems of inflation and short-run fluctuations in employment and real GNP was a so-called money-supply rule. If the Federal Reserve Board were required to increase the money supply at the same rate as real GNP increased, he argued, inflation would disappear. Friedman’s monetarism came to the forefront when, in 1963, he and Anna Schwartz coauthored Monetary History of the United States, 1867–1960, which contends that the great depression was the result of the Federal Reserve’s ill-conceived monetary policies. Upon receipt of the unpublished manuscript submitted by the authors, the Federal Reserve Board responded internally with a lengthy critical review. Such was their agitation that the Fed governors discontinued their policy of releasing minutes from the board’s meetings to the public. Additionally, they commissioned a counterhistory to be written (by Elmus R.

Wicker) in the hope of detracting from Monetary History. Friedman’s book has had a substantial influence on the economics profession. One measure of that influence is the change in the treatment of monetary policy given by MIT Keynesian Paul Samuelson in his best-selling textbook, Economics. In the 1948 edition Samuelson wrote dismissively that “few economists regard Federal Reserve monetary policy as a panacea for controlling the business cycle.” But in 1967 Samuelson said that monetary policy had “an important influence” on total spending. The 1985 edition, coauthored with Yale’s William Nordhaus, states, “Money is the most powerful and useful tool that macroeconomic policymakers have,” adding that the Fed “is the most important factor” in making policy. Throughout the 1960s, Keynesians—and mainstream economists generally—had believed that the government faced a stable long-run trade-off between unemployment and inflation—the so-called phillips curve . In this view the government could, by increasing the demand for goods and services, permanently reduce unemployment by accepting a higher inflation rate. But in the late 1960s, Friedman (and Columbia University’s Edmund Phelps ) challenged this view.

Friedman argued that once people adjusted to the higher inflation rate, unemployment would creep back up. To keep unemployment permanently lower, he said, would require not just a higher, but a permanently accelerating inflation rate (see Phillips curve). The stagflation of the 1970s—rising inflation combined with rising unemployment—gave strong evidence for the Friedman-Phelps view and swayed most economists, including many Keynesians. Again, Samuelson’s text is a barometer of the change in economists’ thinking. The 1967 edition indicates that policymakers faced a trade-off between inflation and unemployment. The 1980 edition says there was less of a trade-off in the long run than in the short run. The 1985 edition says there is no long-run trade-off. Selected Works Monetarism: The Concise Encyclopedia of Economics | Library of Economics and Liberty | 2nd edition | Monetarism Monetarism is a macroeconomic school of thought that emphasizes (1) long-run monetary neutrality, (2) short-run monetary nonneutrality, (3) the distinction between real and nominal interest rates , and (4) the role of monetary aggregates in policy analysis.

It is particularly associated with the writings of Milton Friedman , Anna Schwartz, Karl Brunner, and Allan Meltzer, with early contributors outside the United States including David Laidler, Michael Parkin, and Alan Walters. Some journalists—especially in the United Kingdom—have used the term to refer to doctrinal support of free-market positions more generally, but that usage is inappropriate; many free-market advocates would not dream of describing themselves as monetarists. An economy possesses basic long-run monetary neutrality if an exogenous increase of Z percent in its stock of money would ultimately be followed, after all adjustments have taken place, by a Z percent increase in the general price level, with no effects on real variables (e.g., consumption, output, relative prices of individual commodities). While most economists believe that long-run neutrality is a feature of actual market economies, at least approximately, no other group of macroeconomists emphasizes this proposition as strongly as do monetarists. Also, some would object that, in practice, actual central banks almost never conduct policy so as to involve exogenous changes in the money supply .

This objection is correct factually but irrelevant: the crucial matter is whether the supply and demand choices of households and businesses reflect concern only for the underlying quantities of goods and services that are consumed and produced. If they do, then the economy will have the property of longrun neutrality, and thus the above-described reaction to a hypothetical change in the money supply would occur. 1 Other neutrality concepts, including the natural-rate hypothesis, are mentioned below. Short-run monetary nonneutrality obtains, in an economy with long-run monetary neutrality, if the price adjustments to a change in money take place only gradually, so that there are temporary effects on real output (GDP) and employment. Most economists consider this property realistic, but an important school of macroeconomists, the so-called real business cycle proponents, denies it. Continuing with our list, real interest rates are ordinary (“nominal”) interest rates adjusted to take account of expected inflation , as rational, optimizing people would do when they make trade-offs between present and future. As long ago as the very early 1800s, British banker and economist Henry Thornton recognized the distinction between real and nominal interest rates, and American economist Irving Fisher emphasized it in the early 1900s.

However, the distinction was often neglected in macroeconomic analysis until monetarists began insisting on its importance during the 1950s. Many Keynesians did not disagree in principle, but in practice their models often did not recognize the distinction and/or they judged the “tightness” of monetary policy by the prevailing level of nominal interest rates. All monetarists emphasized the undesirability of combating inflation by nonmonetary means, such as wage and price controls or guidelines, because these would create market distortions. They stressed, in other words, that ongoing inflation is fundamentally monetary in nature, a viewpoint foreign to most Keynesians of the time. Finally, the original monetarists all emphasized the role of monetary aggregates—such as M1, M2, and the monetary base—in monetary policy analysis, but details differed between Friedman and Schwartz, on the one hand, and Brunner and Meltzer, on the other.

Friedman’s striking and famous recommendation was that, irrespective of current macroeconomic conditions, the stock of money should be made to grow “month by month, and indeed, so far as possible, day by day, at an annual rate of X per cent, where X is some number between 3 and 5.” 2 Brunner and Meltzer also favored monetary policy rules but recognized the attractiveness of activist rules that relate money growth rates to prevailing economic conditions. Also, they typically concentrated on the monetary base, adjusted to reflect changes in reserve requirements, whereas Friedman was more concerned with M2 or M1 and, indeed, sought major changes in banking legislation, such as 100 percent reserve requirements on deposits, designed to make the chosen aggregate precisely controllable. Friedman’s constant-money-growth rule, rather than other equally fundamental aspects of monetarism, attracted the most attention, thereby detracting from the understanding and appreciation of monetarism. In particular, this led to the comparative neglect of Friedman’s crucial “accelerationist” or “natural-rate” hypothesis, according to which there is no long-run trade-off between inflation and unemployment; that is, the long-run phillips curve is vertical.

The no-trade-off view was also promoted by Brunner and Meltzer. Accordingly, it might be argued that the two fundamental monetarist propositions are (1) that cyclical movements in nominal income are primarily attributable to movements in the stock of money, and, (2) that there is no permanent trade-off between unemployment and inflation. Together, these lead to monetarist-style policy positions. Monetarism’s rise to intellectual prominence began with writings on basic monetary theory by Friedman and other University of Chicago economists during the 1950s, writings that were influential because of their adherence to fundamental neoclassical principles. The most outstanding in this series was Friedman’s presidential address to the American Economic Association in 1967, published in 1968 as “The Role of Monetary Policy.” In this paper Friedman developed the natural-rate hypothesis (which he had clearly stated two years earlier) and used it as a pillar in the argument for a constant-growth-rate rule for monetary policy. Almost simultaneously, Edmund Phelps , who was not a monetarist, developed a similar no-trade-off theory, and, within a few years, events in the world economy apparently provided dramatic empirical support.

In the late 1970s and early 1980s, after a decade of increasing influence, monetarism’s reputation began to decline for three main reasons. One was the growing belief, based on plausible interpretations of experience, that money demand is in practice highly “unstable,” shifting significantly and unpredictably from one quarter to the next. The second was the rise of rational expectations economics, which split analysts antagonistic to Keynesian activism into distinct camps. (A majority of monetarists themselves soon embraced the rational expectations hypothesis.) The third was the Federal Reserve’s famous “monetarist experiment” of 1979–1982. The latter episode warrants an extended discussion. During the 1970s, inflation rose in the United States, as well as in many other industrial nations, to levels unprecedented on a multiyear basis during periods of relative peace. This occurred as a consequence of various “shocks”—oil price increases, the Vietnam War, and especially the 1971–1973 demise of the Bretton Woods system of fixed exchange rates (itself caused largely by the failure of the United States to maintain the gold value of the dollar).

This demise left central bankers with a major new responsibility; namely, to provide a nominal anchor for national fiat currencies to replace the gold standard . The Federal Reserve announced several times during the 1970s that it intended to bring inflation under control, but various attempts were unsuccessful. Then, on October 6, 1979, the Fed, under Paul Volcker’s chairmanship, announced and put into effect a new attempt involving drastically revised operating procedures that had some prominent features in common with monetarist recommendations. In particular, the Fed would try to hit specified monthly targets for the growth rate of M1, with operating procedures that emphasized control over a narrow and controllable monetary aggregate, nonborrowed reserves (i.e., bank reserves minus borrowings from the Fed). The M1 targets were intended to bring inflation down from double-digit levels to unspecified but much lower values. In retrospect, the events that occurred from October 1979 to September 1982 are widely viewed as the crucial beginning of a necessary and successful attack on inflation that led, eventually, to the worldwide low-inflation environment of the 1990s. At the time, however, the “experiment” seemed anything but successful to many Americans.

Short-term interest rates jumped dramatically in late 1979 under the tightened conditions, and 1980 witnessed a major fall in output in one quarter followed by a major jump in the next, due primarily to the imposition, and then removal, of credit controls. Finally, in 1981 and into the middle of 1982, a sustained period of monetary stringency brought about the deepest recession since the Great Depression of the 1930s and began to bring inflation down, more rapidly than many economists anticipated, toward acceptable values. Some relevant statistics, designed to put the episode in perspective, are reported in Table 1 . Throughout the entire episode, moreover, both interest rates and money growth rates were highly variable. To be specific, the standard deviation of monthly percentage growth rates of M1 increased from 3.73 (for the previous three years) to 8.22 for the period from October 1979 to September 1982, while the standard deviation of monthly percentage changes in the federal funds rate jumped from 2.86 to 23.1 (annualized units).

Table 1 Selected Statistics, 1960–1999, percentages (average or changes) Year or Average Over — 4.9 Sources: Economic Report of the President, 2003, except: Adjusted M1B Growth: Alfred Broaddus and Marvin Goodfriend, “Base Drift and the Longer Run M1 Growth Rate: Experience from a Decade of Monetary Targeting,” Federal Reserve Bank of Richmond Economic Review 70 (November–December 1984), pp. 3–14. Note: Adjustments to M1 growth rates were made and used by the Fed, at the time, to take account of estimated distortions brought about by the introduction of NOW (negotiated order of withdrawal) accounts. Many critics characterized the “experiment” as a macroeconomic disaster. Some believed, moreover, that it provided strong and definitive evidence invalidating monetarism—partly by showing how undesirable it was to have money growth targets and partly in showing how poor are operating procedures for controlling M1 money growth by means of tight control of a narrow monetary aggregate.

Monetarists argued that the episode was actually not monetarist in its design because growth rates of M1 fluctuated very widely on a month-to-month basis; the operating procedures in place were, because of lagged reserve requirements, extremely poorly designed for the control of M1; and the Fed never forswore discretionary responses to current cyclical conditions. It now seems clear that the Fed’s use of a narrow monetary aggregate for week-to-week control was highly effective in terms of public relations. The reason was that it permitted the Fed to escape political responsibility for the resulting high and, therefore, unpopular interest rate levels by claiming that these were simply the consequence of market forces. 3 At the same time, by adopting a putatively monetarist approach, the Fed could at least, even if the episode was a failure, discredit monetarism and the Fed’s annoying monetarist critics. As matters played out, the episode was soon seen as a strategic success, despite temporary unhappiness, and monetarism was discredited as well! What is left today of monetarism? While some disagreement remains, certain things are clear.

Interestingly, most of the changes to Keynesian thinking that early monetarists proposed are accepted today as part of standard macro/monetary analysis. After all, the main proposed changes were to distinguish carefully between real and nominal variables, to distinguish between real and nominal interest rates, and to deny the existence of a long-run trade-off between inflation and unemployment. Also, most research economists today accept, at least tacitly, the proposition that monetary policy is more potent and useful than fiscal policy for stabilizing the economy. There is some academic support, and a bit in central bank circles, for the real-business-cycle suggestion that monetary policy has no important effect on real variables, but this idea probably has marginal significance. It is hard to believe that the major recession of 1981–1983 in the United States was not caused largely by the Fed’s deliberate tightening of 1981—a tightening that shows up in ex-post real interest rates and in M1B growth rates as adjusted by the Fed at the time ( Table 1 , column 6) to take account of major institutional changes. In 2005, most academic specialists in monetary economics would probably describe their orientation as new keynesian .

Also, monetary aggregates currently play a small or nonexistent role in the monetary policy analysis of academic and central-bank economists. In terms of its underlying scientific rationale, however, today’s mainstream analysis is much closer to that of the monetarist than the Keynesian position of, for example, 1956–1978. In addition to the points noted above, current thinking clearly favors policy rules in contrast to “discretion,” however defined, and stresses the central importance of maintaining inflation at quite low rates. It is only in its emphasis on monetary aggregates that monetarism is not being widely espoused and practiced today. About the Author Bennett T. McCallum is the H. J. Heinz Professor of Economics in the Tepper School of Business at Carnegie Mellon University. He is also a research associate of the National Bureau of Economic Research, a research adviser for the Federal Reserve Bank of Richmond, a fellow of the Econometric Society, a member of the Shadow Open Market Committee, and an honorary adviser to the Institute for Monetary and Economic Studies of the Bank of Japan. Further Reading Brunner, Karl, and Allan H. Meltzer. “An Aggregate Theory for a Closed Economy.” In Jerome L.

Stein, ed., Monetarism. New York: American Elsevier, 1976. Friedman, Milton. A Program for Monetary Stability. New York: Fordham University Press, 1959. Friedman, Milton. “The Role of Monetary Policy.” American Economic Review 58 (March 1968): 1–17. Friedman, Milton, and Anna J. Schwartz. A Monetary History of the United States, 1867–1960. Princeton: Princeton University Press, 1963. McCallum, Bennett T. Monetary Economics: Theory and Policy. New York: Macmillan, 1989. Symposium: “Monetarism: Lessons from the Post-1979 Experiment.” American Economic Review Papers and Proceedings 74 (May 1984): 382–400. Taylor, John B., ed. Monetary Policy Rules. Chicago: University of Chicago Press, 1999.

Footnotes Monetarism - Wikiquote Monetarism Jump to: navigation , search Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output. ~ Milton Friedman In monetary economics, monetarism is a school of thought that emphasises the role of governments in controlling the amount of money in circulation. Monetarists believe that variation in the money supply has major influences on national output in the short run and the price level over longer periods, and that objectives of monetary policy are best met by targeting the growth rate of the money supply rather than by engaging in discretionary monetary policy. Contents Quotes[ edit ] Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output . Milton Friedman , The Counter-Revolution in Monetary Theory (1970). Reagan had the opportunity to perform this quick surgery when he came into office. Instead, he turned his economic policies over to the Friedmanite monetarists. Reaganomics is largely monetarism.

The monetarist view is that the Fed must only very, very slowly reduce the rate of counterfeiting , and thereby insure a gradual, painless recession with no unemployment or sharp readjustments. The hoax of Reaganomics was that the phony "budget cuts" and " tax cuts" were supposed to provide the razzle-dazzle to give gradualist Friedmanism the time, or the "breathing space," to work its magic. … There were two fundamental reforms the Reagan Administration could have proposed to end our Age of Inflation . First, either the abolition or the brutal checking of the Fed. Nothing was done, since monetarism wishes to give all power to the Fed and then navely urges the Fed to use that power wisely and with self-restraint. Second, the Administration could have followed Reagan's campaign pledge and reinstituted the gold standard . But the Friedmanite monetarists hate gold with a purple passion and wish all power to government fiat money . " Where the Monetarists Go Wrong " (1976) by Henry Hazlitt [ edit ] Henry Hazlitt, "Where the Monetarists Go Wrong," The Freeman (Foundation for Economic Education, 1 August 1976).

In the last decade or two there has grown up in this country , principally under the leadership of Professor Milton Friedman , a school calling itself the Monetarists. The leaders sometimes sum up their doctrine in the phrase: " Money matters," and even sometimes in the phrase: "Money matters most." It is with considerable reluctance that I criticize the monetarists, because, though I consider their proposed monetary policy unfeasible, they are after all much more nearly right in their assumptions and prescriptions than the majority of present academic economists. The simplistic form of the quantity theory of money that they hold is not tenable; but they are overwhelmingly right in insisting on how much " money matters," and they are right in insisting that in most circumstances, and over the long run, it is the quantity of money that is most influential in determining the purchasing power of the monetary unit. Other things being equal , the more dollars that are issued, the smaller becomes the value of each individual dollar. So at the moment the monetarists are more effective opponents of further inflation than the great bulk of politicians and even putative economists who still fail to recognize this basic truth .

I do not mean to suggest that all those who call themselves monetarists make this unconscious assumption that an inflation involves this uniform rise of prices. But we may distinguish two schools of monetarism. The first would prescribe a monthly or annual increase in the stock of money just sufficient, in their judgment , to keep prices stable. The second school (which the first might dismiss as mere inflationists ) wants a continuous increase in the stock of money sufficient to raise prices steadily by a "small" amount—2 or 3 per cent a year. These are the advocates of a "creeping" inflation. … I made a distinction earlier between the monetarists strictly so called and the "creeping inflationists." This distinction applies to the intent of their recommended policies rather than to the result. The intent of the monetarists is not to keep raising the price "level" but simply to keep it from falling, i.e., simply to keep it "stable." But it is impossible to know in advance precisely what uniform rate of money-supply increase would in fact do this. The monetarists are right in assuming that in a prospering economy, if the stock of money were not increased, there would probably be a mild long-run tendency for prices to decline.

But they are wrong in assuming that this would necessarily threaten employment or production. For in a free and flexible economy prices would be falling because productivity was increasing, that is, because costs of production were falling. There would be no necessary reduction in real profit margins. The American economy has often been prosperous in the past over periods when prices were declining. Though money wage -rates may not increase in such periods, their purchasing power does increase. So there is no need to keep increasing the stock of money to prevent prices from declining. A fixed arbitrary annual increase in the money stock "to keep prices stable" could easily lead to a "creeping inflation" of prices. But this brings us to what I consider the fatal flaw in the monetarist prescriptions. If the leader of the school cannot make up his own mind regarding what the most desirable rate of monetary increase should be, what does he expect to happen when the decision is put in the hands of the politicians?

… The fatal flaw in the monetarist prescription, in brief, is that it postulates that money should consist of irredeemable paper notes and that the final power of determining how many of these are issued should be placed in the hands of the government—that is, in the hands of the politicians in office. The assumption that these politicians could be trusted to act responsibly, particularly for any prolonged period, seems incredibly naive. The real problem today is the opposite of what the monetarists suggest. It is how to get the arbitrary power over the stock of money out of the hands of the government, out of the hands of the politicians. Roger W. Garrison, " Is Milton Friedman a Keynesian?," in Mark Skousen , ed., Dissent on Keynes: A Critical Appraisal of Keynesian Economics (New York, N. Y.: Praeger Publishers, 1992). While many of the conflicting claims can be reconciled in terms of the short-run and long-run orientation of Keynesians and monetarists, respectively, and in terms of their contrasting philosophical orientations, neither vision takes into account the workings or failings of the market mechanisms within the investment aggregate.

Austrian macroeconomics is set apart from both Keynesianism and monetarism by its attention to the differential effects of interest-rate changes within the investment sector, or—using the Austrian terminology—within the economy's structure of production. Page 136. Accounting for the artificial boom and the consequent bust is not part of Keynesian income-expenditure analysis, nor is it an integral part of monetarist analysis. The absence of any significant relationship between boom and bust is an inevitable result of dealing with the investment sector in aggregate terms. The analytical oversight derives from theoretical formulation in Keynesian analysis and from empirical observation in monetarist analysis. But from an Austrian perspective, the differences in method and substance are outweighed by the common implication of Keynesianism and monetarism, namely, that there is no boom-bust cycle of any macroeconomic significance. Pages 136–137. An Austrian Perspective on the History of Economic Thought (1995) by Murray N.

Rothbard [ edit ] One of the superb features of Cantillon 's Essai is that he was the first, in a pre- Austrian analysis, to understand that money enters the economy as a step-by-step process and hence does not simply increase or raise prices in a homogeneous aggregate.8 Hence he criticized John Locke 's naive quantity theory of money—a theory still basically followed by monetarist and neoclassical economists alike—which holds that a change in the total supply of money causes only a uniform proportionate change in all prices. In short, an increased money supply is not supposed to cause changes in the relative prices of the various goods. Economic Thought Before Adam Smith (vol. 1)[ edit ] Murray N. Rothbard, An Austrian Perspective on the History of Economic Thought Volume 1: Economic Thought Before Adam Smith (Edward Elgar Publishing Ltd., 1995). Even more than William Potter, John Law assured the nation that the increased money supply and bank credit would not raise prices , especially under Law's own wise aegis.

On the contrary, Law anticipated Irving Fisher and the monetarists by assuring that his paper money inflation would lead to 'stability of value ', presumably stability of the price of labour , or the purchasing power of money . … The cataclysm of John Law's experiment and his Mississippi bubble provided a warning lesson to all reflective writers and theorists on money throughout the eighteenth century. As we shall see below, hard-money doctrines prevailed easily throughout the century, from Law's former partner and outwitter Richard Cantillon down to the founding fathers of the American Republic . But there were some who refused to learn any lessons from the Law failure , and whose outlook was heavily influenced by John Law. "The inflationists," §11.5 of ch. 5, "Mercantilism and freedom in England from the Civil War to 1750," pp. 329, 331.

One of the superb features of Cantillon 's Essai is that he was the first, in a pre- Austrian analysis, to understand that money enters the economy as a step-by-step process and hence does not simply increase or raise prices in a homogeneous aggregate.8 Hence he criticized John Locke 's naive quantity theory of money—a theory still basically followed by monetarist and neoclassical economists alike—which holds that a change in the total supply of money causes only a uniform proportionate change in all prices . In short, an increased money supply is not supposed to cause changes in the relative prices of the various goods . "Money and process analysis," §12.7 of ch. 6, "The founding father of modern economics: Richard Cantillon," p. 355. Classical Economics (vol. 2)[ edit ] Murray N. Rothbard, An Austrian Perspective on the History of Economic Thought Volume 2: Classical Economics (Edward Elgar Publishing Ltd., 1995). John Wheatley's exclusive emphasis on the money supply and unitary price levels foreshadowed the modern severe monetarist and macroeconomic split between the monetary and real realms.

More pointedly, his mechanistic emphasis on the price level also foreshadowed the unfortunate Fisherine, Chicagoite and later monetarist preoccupation with stabilizing the 'price level' and with fanatically opposing any and all changes in such 'levels'. Even in his early books of 1803 and 1807 , Wheatley denounced the alleged evils of falling prices as well as of inflation , and indeed claimed that falling prices were even more damaging. Indeed, the influence of Wheatley's early tracts was gravely weakened by his being soft-core and timid in drawing any policy conclusions from his hard-core analysis. Instead of returning to the gold standard , Wheatley could only suggest the withdrawal of note issue powers from the country banks and the redemption of all small bank notes under £5. … [A]s in the case of all too many monetarist and mechanistic quantity theorists, Wheatley began as an ardent hard-money bullionist, and was driven over the years by his frenetic hatred of deflation to wind up as a fiat money inflationist. "The emergence of mechanistic bullionism: John Wheatley," §5.8 of ch.

5, "Monetary and banking thought, I: the early bullionist controversy," p. 189. Christiernin, however, was far from a hard-core hard-money man. He defended bank notes as useful , increasing activity and employment , and opposed deflation because, he pointed out, prices and wages were sticky downward. It is doubtful , however, that downward stickiness could last for long in the eighteenth century. But Christiernin's main objection to deflation was that his ideal was not sound, metallic money but a pre- Friedmanite desire to stabilize the value of the daler and make the price level constant. In pursuit of that goal, he urged open market operations by the central bank . Furthermore, again in anticipation of the monetarists, he admittedly preferred inflation to deflation, if that was the choice . "Monetary and banking thought on the Continent," §6.5 of ch. 6, "Monetary and banking thought, II: the bullion Report and the return to gold," p. 220.

" Explaining Japan's Recession " (2002) by Benjamin Powell [ edit ] Benjamin Powell, "Explaining Japan's Recession," Mises Daily (Auburn, AL: Lugwig von Mises Institute, 19 November 2002). The Austrian description of the boom 's timing and cause seems similar to the monetarist theory, but there is an important difference. Both schools agree that the contraction of the monetary expansion triggered the recession , but the monetarists view this contraction as something that should be avoided so that prosperity can continue. In Austrian theory, the contraction is necessary to restore balance to the real economy—the preceding expansion is the problem . This is one reason why the two schools differ in their policy recommendations. Austrian theory, like the Keynesian and monetarist theories, can give a reason for the start of the Japanese recession. Unlike the other schools, the Austrian policy recommendation of laissez-faire has not been tried.

" In Defense of Monetarism " (2008) by George Selgin [ edit ] It is indeed true that the reduction of inflation came at a big price—that Volcker 's tightening, for instance, succeeded in lowering inflation only in the wake of a severe recession. But this possibility was, first of all, one concerning which monetarists were perfectly aware : they understood the danger that, once inflation, and accelerating inflation especially, came to be anticipated by the public, putting the breaks on money growth would result in prices and wages continuing for some time to rise beyond their new, less-rapidly rising equilibrium values, with a consequent rise in unemployment .

Question: Which economic doctrine, popular in the 1980's, was propounded by Milton Friedman?
Answer: MONETARISM