Milton Friedman: The Great Conservative Partisan

Milton Friedman died on November 16, 2006 at the age of 94. Without doubt, Friedman was one of the most influential (perhaps the most influential) economists of the second half of the twentieth century. Not only did he contribute to reviving belief in the economic efficacy of the market system, he also had a profound political impact by linking capitalism with freedom.

Friedman’s treatment of capitalism and freedom colored understandings so that many among America’s elite now see a simplistic identity between the two. However, the reality is a complicated tango whereby free markets promote certain dimensions of freedom but can also bruise others – including democracy, meritocracy, and equality of opportunity. To paraphrase George Orwell, in market systems we are all free but some are (a lot) freer than others.

In 1976 Friedman was awarded the Nobel Prize in economics for his contributions to scientific economics. These contributions are marked by two characteristics. First, they are imbued with an underlying conservative partisanship characterized by profound animus to government. Second, Friedman achieved public standing through his macroeconomic work, much of which has been discredited. In a sense, Friedman is the economist who lost the battle but ended up winning the war, convincing society to adopt his view of the world.

One of Friedman’s most widely recognized contributions is monetarism, which recommends that central banks target money supply growth. Monetarism flourished in the late 1960s and 1970s and was briefly adopted by central banks as a policy framework in the late 1970s and early 1980s. That experiment produced devastating interest rate volatility, prompting central banks to revert to their traditional practice of targeting interest rates.

Monetarism was supported by Friedman’s joint work with Anna Schwartz in which they argued that the Federal Reserve caused the Great Depression through mistaken monetary tightening. This was Friedman’s first major salvo in his crusade against government, implicitly blaming government for the Depression. Friedman’s claim has always smacked of the tail wagging the dog since the Fed’s tightening was modest and brief, suggesting an underlying instability of the 1929 economy. The 1929 stock market was characterized by feverish speculation, and the Fed would indeed have done better to provide easy liquidity when investors rushed to exit. However, that also proves the dangerous instability of financial markets and makes the case for an active government regulatory presence, the very opposite of Friedman’s philosophical perspective.

At the theoretical level, monetarism asserts that central banks control the money supply and should aim for steady money supply growth. Friedman even recommended replacing the Fed with a computer that would mechanically manage the money supply regardless of the economy’s state. Furthermore, he suggested the Fed aim for a zero nominal interest rate. If the equilibrium real interest rate is three percent, that policy implies steady deflation of three percent.

These monetarist propositions reflect a flawed understanding of money. Money is a form of credit - an IOU. If central banks try to control the narrow money supply, the private sector just moves to create other forms of credit. That is why the Fed was unsuccessful in targeting the money supply, and why predicating economic policy on the relationship between the money supply and economic activity is a will o’ the wisp. With regard to deflation, Japan’s recent experience has confirmed the lessons of the Great Depression. In a credit-money economy generalized deflation is catastrophic and should be avoided.

Monetarism’s most famous aphorism is that “inflation is always and everywhere a monetary phenomenon.” This saying reflects Friedman’s polemical powers, capturing for monetarists what all sensible economists already knew. Inflation is about rising prices, and prices are intrinsically a monetary phenomenon since they are denominated in money terms.

Sustained inflation requires that the money supply grow in order to finance transacting at higher prices. For Friedman, this made villainous central banks the exclusive cause of inflation because of his belief that they control the money supply. However, the reality is that the private sector can also inflate the money supply through its own credit creation activities. Additionally, central banks (viz. the Bernanke Fed) may be compelled to temporarily accommodate inflationary private sector pressures to avoid triggering costly recessions. The implication is that inflation can have different causes, something Friedman denied. Sometimes inflation is caused by excessively easy monetary policy or large budget deficits financed by central banks. Other times it is due to private sector forces, including speculative booms and conflicts over income distribution.

Monetarism asserts that monetary policy is all-powerful. Subsequently, Friedman changed his view and argued that monetary policy had no long-run real economic impacts. Friedman cleverly termed his later theory the natural rate of unemployment, thereby enlisting nature on his side.

His new theory supported an extreme conservative policy agenda that still lives. According to the theory, the minimum wage increases unemployment by driving up wages, and should therefore be done away with. The same holds for unions. No consideration is given to the possibility that these institutions create an income distribution that promotes mass consumption and full employment. Finally, since central banks supposedly have no long run effect on unemployment and wages, they are not responsible for labor market outcomes. Natural rate theory thereby allows the Fed and European Central Bank to take full employment policy off the table while protecting them from charges that their policies may contribute to wage suppression.

Close inspection reveals natural rate theory to be akin to a religious doctrine. This is because it is not possible to conceive of a test that can falsify the theory. When predictions of the natural rate turn out wrong (as they repeatedly have), proponents just assert that the natural rate has changed. That has led to the most recent incarnation of the theory in which the natural rate is basically the trend rate of unemployment. Whatever trend is observed is natural – case closed.

Since natural rate theory cannot be tested, a sensible thing would be to examine its assumptions for plausibility and reasonableness. However, Friedman’s early work on economic methodology blocks this route by asserting that realism and plausibility of assumptions have no place in economics. With most economists blindly accepting this position, the result is a church in which entry is conditional on accepting particular assumptions about the working of markets.

The theory of consumption is another area in which Friedman contributed. His permanent income theory of consumption sensibly argues that household consumption and saving decisions are made on the basis of households’ assessments of their long term sustainable income, and not just on the basis of today’s income. However, Friedman also asserted that all households save the same proportion of their sustainable income. This proposition is manifestly false, as shown by the behavior of the super-paid. It also has clear conservative implications. Since all save the same proportion, transferring income from higher paid to lower paid households generates no economic stimulus. Progressive taxes can still be justified on ethical grounds, but not on economic stimulus grounds.

Lastly, Friedman was an early proponent of flexible exchange rates. Whereas the argument that flexible exchange rates facilitate macroeconomic adjustment has worn well, Friedman’s arguments against the dangers of destabilizing speculation have not. In line with his ideological predisposition for markets and against government intervention, Friedman ruled out destabilizing speculation. His argument was there exists a fundamental equilibrium price, and if prices depart from this speculators see a profit opportunity and drive prices back. However, experience has shown that exchange rates and asset markets are prone to speculative bubbles, and it has been extremely difficult to find a relation between exchange rates and fundamentals – whatever they are.

While such findings do not support fixed exchange rates, they do support a case for sensible exchange rate management by well-informed officials who can do a better job than speculative casino markets. Yet, the triumph of Friedman’s anti-government economics means that this sensible policy approach has been ignored by U.S. policymakers.

In sum, Milton Friedman’s political economy helped provide a corrective to the excessive disregard of markets and the price system engendered by the Great Depression, and his advocacy of the power of economic incentives abides. However, Friedman was not a lone defender of markets. Keynes, himself, always held an enormous regard for the market system – what he termed the Manchester System. Leading American and British Keynesians also shared that regard. However, whereas these Keynesian economists understood the limits of the market and the importance of government in making capitalism work for ordinary people, Friedman did not. By all accounts, Milton Friedman was a considerate and compassionate person, and he was a revered teacher. However, his fame rests on his ideas, and those ideas suffer from an excess of conservative partisanship.

10 Responses to “Milton Friedman: The Great Conservative Partisan”

  1. Friedman as Partisan at super hanc petram Says:

    [...] we have Thomas Palley on Milton Friedman: “However, whereas these Keynesian economists understood the limits of the market and the importance of government in making capitalism work for ordinary people, Friedman did not.” Search [...]

  2. Mike Meeropol Says:

    I find it unbelievable that the main “contribution” of Friedman and Schwartz — namely the idea that the FED caused the Great Depression — has continued to hold sway over journalists and casual observers. Of course the depression was accompanied by a decline in the STOCK of money. However, as Peter Temin so clearly showed in DID MONETARY FORCES CAUSE THE GREAT DEPRESSION? that tells us nothing about whether causation came from the supply side (the Friedman-Schwartz position) or the demand side (a straightforward Keynesian position).

    The evidence is clear that the 1929 stock market crash ushered in a recession that in 1930 became a great depression in the context of a wave of bank failures.

    So the question is — did restrictions on the money supply cause those failures or was there a decline in aggregate demand that caused the bank failures which destroyed a significant part of the stock of money over the next two-three years?

    Temin devised an ingenious test — if the problem first was based on a shortage of supply, there should be an upward blip in interest rates BEFORE the bank failures started — or some other form of credit rationing.

    Temin found NO SUCH EVIDENCE.

    As far as I’m concerned that should kill the Friedman-Schwartz argument but people like Bernanke keep asserting that Friedman “was right” and that the FED “caused” the depression.

    Amazing nonsense!!

  3. Don Richards Says:

    That’s about the size of it, Tom. This to add, however. A couple of years ago Friedman published a column on the op-ed page of the Wall Street Journal in which he noted the comparative stability of the post-war economy, an outcome that he attributed to wise management by the Fed. This floored me! It seemed an explicit reversal of much of what he had advocated during his professional life, at least as far as discretionary monetary policy is concerned.

  4. Gator80 Says:

    I must take issue with two of Mr. Palley’s comments, both under his heading of ‘extreme conservative agenda’ (which gives away the game right there).

    First he refers to the ‘theory’ of minimum wage. That is like talking about the ‘theory’ of gravity. Mr. Palley, an economist, surely understands the LAW of supply and demand! When prices go up, quantity demanded declines. True for labor as much as for anything else. Perhaps someone can point out examples of other commodities where price increases do not lead to reduced consumption.

    Second, in referring to Mr. Friedman’s view on unions, Mr. Palley says that ‘No consideration is given to the possibility…’ This seemingly innocuous comment is actually an outrageous and unfair attack. I presume Mr. Palley has read Mr. Friedman’s work. He may or may not agree with certain conclusions but it is impossible to claim that Mr. Friedman, a true scientist, did not fully contemplate and explore all options and possibilities.

    Mr. Palley would be better served providing evidence in support of his claims rather than attempting to besmirch one of the greatest economists of our time.

  5. Greider and Palley bury Friedman « Relentlessly Progressive Economics Says:

    [...] Thomas Palley and William Greider add two (more critical) obituaries for Milton Friedman. Both make the distinction between Friedman as a professional economist and as a public intellectual: Milton Friedman: The Great Conservative Partisan [...]

  6. Paddy Quick Says:

    Friedman’s monetarism was based on his theoretical analysis — a form of portfolio analysis in which Money was one of a variety of assets, including (physical) capital goods and human capital. His and Anna Schwartz’s Monetary History was an attempt to prove, empirically, that the demand for Money was a more stable function than Keynes’s consumption function. This strange enterprise was singularly unsuccessful, although much ink was spilled by both monetarists and Keynesians on the debate.
    A more interesting issue is Friedman’s understanding of capital, and the anti-Marxist notion that all production must be understood as the product of capital, rather than labor. The notion of human capital, although associated primarily with Gary Becker, is a product of the Chicago school of thought. Thus human beings enter the production function merely as a form of capital. The more recent concept of “social capital” ascribes the increase in labor productivity resulting from the ways in which people organize themselves not to the people themselves but to “capital.” Turning Marxism on its head, they take any flow of production and translate it into its “capital” equivalent.
    Friedman’s other theoretical “contribution” also deserves analysis - namely his early version of Margaret Thatcher’s aphorism that “there is no such thing as society.” The only interactions that he considers to be “free” are those between atomized individuals, so that any collective decision-making (other than through unanimity) is a violation of freedom. His hostility to government is only the most visible form of this extremism, although it is apparent in his rejection of the notion of “corporate responsibility” (even capitalists should not coerce each other!). It reaches its most virulent form, of course, in his anti-communism, since communism is, for him, a rejection of both of his deeply held theoretical beliefs.
    The role of the “Chicago boys” in rushing to the aid of Pinochet shortly after the 1973 coup in Chile must always be remembered — democracy, collective decision-making, is antithetical to Friedman’s concept of “freedom.”

  7. political economist Says:

    Gator80, you must have misread Palley’s comment on the minimum wage. He did not refer to the theory of minimum wage or to a theory of the minimum wage or anything like a minimum wage theory. Please re-read. You will see he was referring to what he called Friedman’s “new theory” [natural rate of unemployment] and its analysis of the effect of a minimum wage.

    Also, I would appreciate it if you would give a citation or citations from Friedman showing that Friedman did “fully contemplate and explore all options and possibilities” concerning the possible positive effects of unions.

    thanks for your help

  8. TOM PALLEY Says:

    Dear Gator80,

    Thanks for your interesting comments.

    (1) Even within standard neo-classical theory (i.e. supply & demand analysis) a minimum wage can raise employment. One case is when employers have monopsony power. A second case is when firms offer jobs that are marked by flexible hours. In that case, a minimum wage raises the hourly wage and firms may then cut back on hours and substitute toward more workers working fewer hours at greater intensity. These issues are examined in two papers of mine in the Eastern Economic Journal (1995 and 2001).

    (2) Of course if wages are determined on non-neo-classical principles the story is even easier to tell.

    (3) Milton Friedman believed in a supply determined world in which demand adjusted to supply, and in which supply was independent of demand. That was a belief and nowhere does he address arguments against that belief.

    Good luck with your studies. Keep an open mind.


    Tom Palley

  9. Gator80 Says:

    Political Economist: Free to Choose, Chapter 8 (”Who Protects the Worker?”).

  10. Gator80 Says:

    I greatly appreciate your response to my post, Dr. Palley.

    Not having a PhD in economics myself I confess I had to run to the dictionary to look up monopsony. I found “monopsony is a state in which demand comes from one source.” So I assume your reference to ‘employers with monopsony power’ refers to cases where certain laborers have only one option for employment. Forgive me, but I fail to see how that increases employment as a result of a minimum wage. I’m trying to visualize such an employer saying, “OK, so they’ve raised the minimum wage? Let’s add some more staff!” Perhaps someone can provide some specific examples.

    I understand the flexible hours example a little better I think. It’s not clear the individual workers come out ahead, though, by working fewer hours at higher wages. And isn’t that the reason more generally why unemployment increases due to minimum wages? Employers try to cut back on labor costs by having fewer workers work “at greater intensity.”

    (It also brings up what I regard as the interesting philosophical question about minimum wages. In cases where employers feel unable to absorb the incremental wages from a minimum wage increase they will often reduce staff to hold total expenses in line. So from the point of view of the workers which is better: 7 employees making $5 per hour or 5 employees making $7 per hour?)

    Lastly, your comment that Professor Friedman believed “demand adjusted to supply and…supply was independent of demand” seems so bizarre that I assume I am misreading it. Are you saying that if demand for, say, yo-yo’s increases for whatever reason, Friedman believed suppliers would not adjust and produce more yo-yo’s?