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Pioneer of Monetary Economics

Milton Friedman’s breakthrough work put Monetary policy on an equal pedestal to Keynesian only-fiscal approach; which continues to shape the political economy of nations

Pioneer of Monetary Economics

The Nobel Prize in Economic Sciences was awarded to Milton Friedman in 1976. As the Nobel Prize website tells us, the motivation for the prize was:

"for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy." And contributions to consumption analysis and to monetary history and theory, including observations of the complexity of stabilization policy.

While Friedman was more known for his libertarian and strong pro-market views, he got the Nobel prize for academic works on monetary theory and consumption analysis as noted above. As has happened for most other Nobel winners, there was a gap between the research undertaken and the moment when the prize was awarded. This is all the more so for the Economics Nobel since it was first awarded in 1969 and there were many sterling contributions to be recognized. Hence, Friedman conducted all his academic research, which got him the Nobel in the period between 1930 to 1960 and turned to public policy and political economy issues only in the 1960s. As stated above, he came to be better known for his ideas of laissez-faire and small government intervention to the extent that leaders such as Reagan and Thatcher modelled their policies of liberalisation on Friedman's recommendations.

In this article, we will review the main works of Friedman and see how they continue to be relevant to public policy.

The Main Works of Friedman

Friedman grew up in New Jersey and got his undergraduate degree in Economics in 1932 from Rutgers University nearby. In Rutgers, his mentors were Arthur Burns (who later became the Chairman of the Federal Reserve) and Homer Jones. At this time, the Great Depression had set in. After Rutgers, he left for the University of Chicago where he completed his Masters in 1933. At Chicago, his teachers included Jacob Viner and Frank Knight, the famous economists. Between 1933 and the time that he got his PhD from Columbia University, Friedman worked in Washington, D.C. at the National Resources Committee and was also a Research Assistant to Simon Kuznets at Columbia. He jointly published 'Incomes from Independent Professional Practice', with Kuznets, which also became his doctoral dissertation at Columbia. The dissertation introduced the concepts of permanent and transitory income.

His works in Washington, D.C. became the basis of his famous paper 'Theory of the Consumption Function', which was published much later in 1957. According to this theory, a person's consumption and savings decisions are more greatly impacted by permanent changes to income rather than changes to income that are perceived as temporary. This theory led to the famous permanent income hypothesis, which said that a person's consumption will be largely stable in the long run since it will be in line with his average long-run expectations of income.

After this, he taught at the Universities of Wisconsin and Minnesota, before coming back to the University of Chicago in around 1946, where he stayed till the end of his career. After retirement from the University of Chicago, Friedman moved as Director of the Hoover Institution at Stanford University.

In addition to the Theory of the Consumption Function, Friedman produced a large body of work, first in pure economics and later in the area of policy and political economy. In all his works, there was one underlying philosophy— that there was a limited role for the government in a free society and most of the work should be left to the market. Among his many publications, three stood out for original ideas: 'Capitalism and Freedom' published in 1962, 'A Monetary History of the United States, 1867-1960', co-authored with Anna Schwartz and published in 1963 and 'Free to Choose', co-authored with his wife Rose Friedman and published in 1982.

'Capitalism and Freedom' argued that there should be a limited role for the government and that it should refrain from intervening in the markets unnecessarily. For instance, interventions such as price support in agriculture, the imposition of tariffs, rent control, minimum wages and fixed exchange rates only serve to distort the market and lead to outcomes that lower overall welfare. He also argued against direct involvement of the government in areas such as national parks, toll roads etc. He had famously remarked that: "one of the great mistakes is to judge policies and programmes by their intentions rather than their results".

In his book 'The Monetary History', Friedman developed his ideas on the importance of monetary policy during the Great Depression. His theory, which came to be called Monetarism, states that changes in the money supply have real short-term and long-term effects on price levels and are responsible for economic fluctuations. In doing so, Friedman was providing a contrarian view to the existing Keynesian consensus, which spoke of the primacy of fiscal policy in alleviating the woes of the Great Depression. It may be recalled that the prevalent view in the early 1960s argued the fiscal expansion in the form of government spending would boost aggregate demand and lead to lower unemployment. In this scheme of things, monetary forces had no impact on the economic contraction of the 1930s. However, The 'Monetary History' argues that the bank failures and the massive withdrawals of currency from the financial system that followed, significantly shrank the money supply (the total amount of currency and outstanding bank deposits), which greatly exacerbated the economic contraction. The book also criticised the Federal Reserve Bank for not keeping the supply of money steady and not acting as lender of the last resort, instead allowing commercial banks to fail and worsen the economic depression. It spoke of the 'great contraction' between 1929 and 1933— contraction, not of the GDP or prices but the availability of money as a result of the widespread bank failures.

In 'The Monetary History', Friedman also gave a restatement of the Quantity Theory of Money, which was different from the Keynesian version. It may be recalled that Keynes had said that the quantity of money depended on the purchasing power or aggregate demand. Friedman, on the other hand, presented the quantity theory as the theory of the demand for money, and the demand for money is assumed to depend on asset prices or relative returns and wealth or income. He showed how a theory of the stable demand for money becomes a theory of prices and output. A famous excerpt from Friedman's writings and speeches is, "Inflation is always and everywhere a monetary phenomenon." In a 1956 paper titled "Studies in the Quantity Theory of Money," Friedman found that, in the long run, increased monetary growth increases prices but does not really affect output. Friedman's work busted the classical Keynesian dichotomy on inflation, which asserted that prices rose from either "cost-push" or "demand-pull" sources. It also put monetary policy on the same level as fiscal policy.

His final major book 'Free to Choose: A Personal Statement', co-authored with his wife Rose Friedman, is said to be a response to John Kenneth Galbraith's book and TV series 'The Age of Uncertainty'. This book reiterated the core beliefs of Friedman, namely laissez-faire economic policies and a criticism of the government's intervention in the economic sphere. The book also argues against protectionism, high taxes and regulation. The book gives examples of 19th century Britain and the USA before the Great Depression as role models of a minimalist economic policy and cite the economic stagnation of India after independence as resulting from centralised planning and too much government intervention. It is further argued that the American public wrongly perceived the Depression to be a result of the failure of capitalism rather than the government and that the Depression allowed the Federal Reserve to centralise its control of the monetary system.

Friedman's Works and Public Policy

Friedman's work has found an echo in many areas of public policy across the world. Thatcher and Reagan were inspired by the laissez-faire prescription of Friedman and this was reflected in the many policies of deregulation and disinvestment of government enterprises in these countries. Friedman himself was active in advising governments across the world in economic policy management. He actively advised the Chilean Government to follow free-market policies when Pinochet was ruling. This became controversial at the time of Friedman getting the Nobel Prize even though Friedman never explicitly supported Pinochet's dictatorial regime.

Friedman's work has had important implications in a wide variety of areas, including in the functioning of central banks. He once famously remarked that if central banks continued to work in the way they do, they could be replaced by computers geared to provide a steady rate of growth in the quantity of money.

As noted above, Friedman believed that policies should be judged by their outcomes rather than their intentions. It was this belief that led him to oppose the minimum wage because he believed that the outcome of this policy was that low-skilled and African Americans were discriminated against, even though it was not intentional. Similarly, he opposed tariffs and subsidies because they unintentionally harmed domestic consumers.

Friedman also wrote a column in 'Newsweek' in the later part of his career. He commented on a variety of policy issues in this column. In 1980, he once wrote, "If you put the federal government in charge of the Sahara Desert, in five years there'd be a shortage of sand", basically suggesting that government intervention was inefficient. He believed that government failures often lead to regulatory capture and can be worse than market failures.


That Friedman was an intellectual giant of the 20th century is accepted by economists, social scientists and policymakers. His ideas on monetary economics still guide central banks and his views on a minimum role for the government find an echo in many of the policies the world over. While the period from the 1930s to the 1960s was intellectually dominated by Keynes and his ideas of an active role for the government, Friedman successfully challenged this established wisdom. Friedman took a contrarian view to Keynes and suggested that the Great Depression was a result of poor monetary policy. In short, Friedman established the importance of monetary policy in economic policy management. It helped many countries in the 1970s that were facing the twin challenges of high unemployment and high inflation (or stagflation), in the face of which the Keynesian prescription of higher government spending was bound to fail. All in all, Friedman has left us with a rich legacy and more economic policy tools in the hands of governments and central banks.

The writer is an IAS officer, working as Principal Resident Commissioner, Government of West Bengal. Views expressed are personal

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