Milton Friedman – Money and Economic Freedom

Everything reminds Milton Friedman of the money supply. Everything reminds me of sex, but I try to keep it out of my papers.

Robert Solow

Milton Friedman, who died yesterday at the age of 94, is one of the most influential economist ever. His contributions to Economics are numerous and far-reaching. Here are the main ones.

1 . Inflation is always and everywhere a monetary phenomenon. It is caused by too much money chasing too few goods.

2. There is no long-run trade-off between inflation and unemployment (there is no long-run Phillips curve). Hence, central banking should be devoted to fighting inflation rather than unemployment and this can be done by controlling the monetary base.

3. Deep recessions, like the Great Depression of 1929 are caused by a contraction in the monetary base. Thus, money matters in the short-run, but does not matter in the long-run (i.e. money is inflationary).

4. The Permanent Income Hypothesis. The idea that a household’s consumption and savings decisions are more affected by changes in its permanent income than by income changes perceived to be temporary.

There are many who are skeptical of economists, sometimes rightly so. They often ask about how economists contribute to anything. To this, one may not be totally convincing (indeed, economists will never have as visible a contribution as, say, heart surgeons). But economists now know a lot about inflation and central banking. Unlike what happened during the Great Depression of 1929 when the Federal Reserve refused to expand the money supply to counteract the fall in industrial production, monetary policy was accomodative during the Greenspan era, so much so that the stock market crashes of 1987 and 2000-2001 have almost been forgotten. More generally, the gradual conquest of inflation in the developed world, through central bank independence and inflation-targeting owes a lot to Friedman (although he thought central banks were useless and inflation-targeting inferior to targeting the monetary base).

The local papers are usually full of private sector initiatives, from small entrepreneurs to big corporations launching new products and risking new markets. Amid the ubiquitous political mud-slinging, these papers also devote some pages to public sector commissions examining past public wastes and to recommendations (white papers, it’s called) about how to waste them even further in the future.

In Capitalism and Freedom, Milton Friedman makes a passionate call for extending individual economic freedom and limiting government action. His premises are three-fold: (1) inspite of good intentions, government policies may be flawed because of wrong incentives (an illustration of this is a minimum wage policy which aims at protecting poor workers, but which may inadvertently lead to their unemployment) , (2) wasting public money is not as painful as wasting one’s own, thus why there is little incentive to learn from past mistakes, (3) that government policy may be plagued with vested interest and hence not represent people’s will.

Here are excerpts from an interview with him in 1992:

You cannot tell me that the consumers of the United States would have approved a policy which in fact led to everyone paying about $2,000 or more a year per automobile purchased. Yet that was the effect of the policy of imposing so-called voluntary import quotas on Japanese cars. Nobody will tell me that the people of this country really favor paying two or three times the world price for sugar. Nobody will tell me that the people of this country believe it is desirable to spend money to provide water to farmers at less than cost in order to enable them to produce crops which the government buys up in part at more than the world price and then has to dispose as surpluses. You cannot explain those activities of government, and there are hundreds more, as reflecting the will of “we the people.” They reflect a system in which concentrated vested interests have been able to obtain great power and impose costs on a diffused consumer interest.

Friedman’s academic work has permeated the field of Economics like no one else’s. His political views, on the other hand, are highly debatable. One can find his unflinching call for a limited government rather unsettling, given the role played by pro-active policies in the economic success of South-East Asia ( and indeed Mauritius). The role of government needs therefore to be nuanced into what constitutes good and bad policies and the political mechanisms to avoid the latter be spelled out.

A pure product of the American dream, Milton Friedman, who was the son of Ukranian immigrants, grew up modestly in New Jersey. Yet, he has always been against income redistribution of any sort (except the use of school vouchers to the poor) and argued that the role of government is to ensure economic efficiency and ‘equality of economic power.’ Thirty years ago, the academic view on the connection between inequality and efficiency was very much along these lines, perhaps influenced by people like Friedman. In the last 10 years, there has been a revival of the idea that inequality may lead an economy to a no-growth trap and redistribution may help avoiding it. Obviously, these issues are still unresolved and one is therefore entitled to one’s own attitude towards inequality.

References:

Paul of Truck and Barter provides a wealth of references on Milton Friedman. Particularly interesting are the video/audio resources.