Echoing Karl Marx’s dictum, the great Chicago economist George Stigler once said of his friend and colleague Milton Friedman that while Stigler only wanted to understand the world, Friedman wanted to change it. It’s a remark pertinent to the legacy of Friedman, whose attempts to change our world, successful and otherwise, are the theme of his latest biographer, Jennifer Burns, in Milton Friedman: The Last Conservative.
Witty, smart, zealous for intellectual combat, Friedman enjoyed the University of Chicago classroom but reached well beyond it. Born in 1912, he was already a prominent economist by his early thirties. He won the Nobel Prize for economics in 1976, and continued to advocate his views until his death thirty years later. Through his Newsweek columns, television appearances, relentless cultivation of powerful friends, and frequent travel, he magnified the considerable influence he earned as an economic thinker. It was actually Stigler who came up with the line that “if you have never missed a flight you have wasted a lot of time at airports” but it was Friedman who most strikingly embodied the idea. Gifted with immense energy and verve, he hustled.
Readily conceding some of his big ideas didn’t work, Burns argues Friedman was nonetheless responsible for much of the shape of the world today. He created, she argues, modern central banking, floating exchange rates, and the “Washington consensus” on a universally applicable model of market economies. If she is right it was a considerable achievement for an economist who never ran a government department or held political office, and whose central theory, like that of Karl Marx, turned out to be just plain wrong.
And wrong it was. His big theory was that the rate of inflation — or more broadly nominal income — is always related to the rate of growth of the money supply. It was a claim with important implications. For Friedman, it meant a market economy was inherently stable except for variations in the money supply. If the money supply contracted it could cause a depression. If it expanded too quickly, it could cause inflation. Since the money supply could be controlled by government, it was government that was responsible for inflationary booms and deflationary busts. A capitalist economy would be stable if the money supply grew at a steady rate consistent with low inflation and reasonable output growth.
Friedman’s conviction was sustained by his 1963 finding, with Anna Schwartz, that the US money stock had plummeted during the great depression of the 1930s. Their observation stimulated debate, though it didn’t prove that a fall in the money stock caused the depression. After all, 9000 US banks had failed during the Depression, and the biggest component of money measures is bank deposits. It’s hardly surprising the quantity of money declined.
Put to the test by Federal Reserve chairman Paul Volcker in 1979, Friedman’s theory turned out to be wrong. To quell inflation, the Federal Reserve announced money growth targets aligned with Friedman’s rule. The targets proved very difficult to achieve. The US central bank did succeed in forcing up interest rates, however, creating back-to-back recessions and dramatically reducing inflation. Meanwhile the money supply continued to increase at much the same rate as before. Contradicting Friedman, interest rates mattered in controlling inflation; the money supply did not.
Though some have concluded that the swift rise in the money supply and the subsequent increase in inflation during the Covid epidemic bore out Friedman’s prediction, it didn’t. The episode was an even more telling repudiation. From 2020 to 2023 the US money supply (measured as M1, which is mainly bank transaction deposits) rose by 400 per cent, the result of the Federal Reserve creating cash to buy bonds and lend freely to banks and business. Over the same period US prices rose by 18 per cent, or less than one twentieth of the increase in the money stock.
(It is true, as Friedman maintained, that inflation is always and everywhere a monetary phenomenon. In a certain sense this must be true, since inflation is by definition about changes in the value of money. But changes in the quantity of money need not and evidently do not result in equivalent changes in inflation or nominal income.)
Once followed with eager interest by economists and market analysts, the money supply numbers these days are rarely mentioned. Friedman’s conception of the relationship with inflation survives in elderly conservative haunts (including the pages of Australia’s Quadrant magazine) and among some financial markets people.
It was still a widely discussed variable when I was working on a doctorate in economics in the US in the early eighties. Yet in later years on the Reserve Bank board I can’t recall the money supply being seriously mentioned, ever. Nor in an earlier four years as an economist in the office of the treasurer and then the prime minister. Nor yet was it taken seriously when I was working subsequently as an economist in financial markets. Though dutifully published by central banks, the money supply numbers contain no information useful for predicting inflation or nominal income growth.
But then some of Marx’s central ideas were also wrong. Demand hasn’t proved always to be less than supply, workers haven’t become increasingly poor, and the labour theory of value, which he adopted, has long been superseded by better ways of explaining prices. Yet Marx undoubtedly exerted great influence on the world. While conceding he was wrong on the central point of the “monetarism” he espoused, Burns argues that Friedman was similarly influential.
By 1979, when the central monetarist idea began to fail, Friedman had already given his famous 1967 presidential address to the American Economic Association in which he challenged many of his colleagues’ focus on a short-run trade-off between inflation and unemployment. He succeeded in reorienting economic thinking back to a long run in which there was no trade-off and therefore not much room for stabilising the economy with government spending.
More than monetarism, that address changed scholarly economic thinking. The short-run trade-off survives today in economics teaching, but coupled now with a long-run story in which there is a certain minimum unemployment rate — often disputed — consistent with stable inflation.
Intelligent, well-researched, scrupulous, balanced and clearly written, Burns’s is an excellent biography. Her archival work on Friedman’s relationships with Chicago colleagues, Federal Reserve governors, presidential candidates and presidents is thorough, fresh and deeply interesting. Even so it credits Friedman with more than seems to me reasonable.
Much of Friedman’s reputation was based on a wonderful stroke of professional luck in the late 1960s. As Burns tells it, he observed an increase in the rate of growth of the US money supply and predicted an increase in inflation. In his 1967 address he argued there was no stable relationship between inflation and employment. When people observed that inflation was rising they would increase their wage demands and businesses would increase prices, taking inflation higher. When inflation took off in the late 1960s Friedman claimed to be vindicated. When unemployment also rose in response to a slowing economy, Friedman was doubly vindicated. He had predicted both rising inflation, and unemployment, and by the early seventies both were apparent.
It was also true, however, that the Johnston Administration was financing both the war in Vietnam and its ambitious Great Society program of social spending and infrastructure. Federal spending rose from 16 per cent of GDP in 1965 to 19 per cent in 1968, with almost all of the increase funded by an increased deficit. Inflation rose from 1.6 per cent in 1965 to 5.5 per cent in 1969. During the next decade, helped along by a tenfold increase in oil prices, inflation and unemployment would increase very much more. Even so, the increase at the end of the sixties was a disorienting shock, one that burnished Friedman’s repute as an economic seer. Through the seventies, a decade of high inflation and an intermittently rising unemployment rate, Friedman’s reputation grew.
They were his best years. By the early eighties, with Volcker’s disinflation efforts demonstrating that a money supply target was a lot harder to achieve than Friedman supposed — and unnecessary to combat inflation — his professional reputation lost some of it shine. Even at Chicago, a new school of “rational expectations” pioneered by younger economists was displacing Friedman at the centre of classical economic thinking. At the same time, though, his public reputation became more lustrous with popular books and a television series lauding capitalism, markets and the freedom Friedman argued capitalism encouraged.
Friedman could claim some singular successes, as Burns points out. He was an advocate of floating exchange rates at a time when orthodoxy predicted global chaos if exchange rates were not fixed against each other and the price of gold. When the big market economies were forced to move to floating rates from the end of the 1960s, Friedman was proved right. Markets adjusted, and more importantly monetary policy could refocus on targeting inflation rather than the exchange rate.
Friedman could claim considerable credit not only for arguing in favour of floating exchange rates, which have become nearly universal in major economies, but also for several proposals that for one reason or another were not widely adopted. One is school vouchers, a government payment which would allow parents to choose their children’s school. Another is the negative income tax, which in Friedman’s version would replace other welfare payments with a single payment.
It is harder to praise Friedman alone for widely shared ideas that also proved useful. For example, Burns credits Friedman for insisting on the role of prices as the central mechanism in a market economy. But in this respect he was by no means unique. He deployed a style of economic analysis that Adam Smith called the invisible hand and was most coherently developed by the British economist Alfred Marshall in the 1890s. The technique was used by Marshall’s pupil Keynes and taught at Harvard in much the same form as at Chicago. It is still taught today and remains one of the most powerful tools in economics. Friedman was good at it, but not as good as his contemporaries and colleagues, Stigler and Gary Becker, or many other microeconomists of his era.
Friedman did successfully contest the supremacy of fiscal policy over monetary policy, a lingering legacy of Keynes’s advice for dealing with deep slumps such as the Great Depression. The fiscal emphasis was rooted in Keynes’s notion that the circumstances of the Depression and the fear it engendered meant lower interest rates would not make much difference to spending. It was the “liquidity trap” in which people conserved cash rather than buy things or invest. Direct government spending was a better option to sustain demand and jobs. This aspect of Keynes’s thinking dominated economic thought in the United States, particularly among supporters of Roosevelt’s New Deal. Friedman insisted on the important role of central banks, a reorientation that remains.
Friedman’s enduring contribution, Burns argues, was to remind the economics profession that money matters. She is certainly right, even if the particular mechanism he had in mind proved to be wrong. Even so I am not at all sure of her argument that Freidman resurrected interest in money among economists, or that it had ever ceased to be of interest. After all, Keynes wrote his Treatise on Money before the General Theory of Employment, Interest and Money, and the General Theory has much to say about money and interest rates. John Hicks’s famous simplification of the General Theory, still taught as the ISLM equations, is all about interest rates, the public penchant to hold money, and the quantity of money. Friedman himself acknowledged the contributions of an earlier American monetary theorist, Irving Fisher.
Burns also credits Friedman with an important role in creating the “Washington consensus,” the nineteen nineties notion that began as a description of a widespread change of economic policies in South America away from import replacement. Friedman made some contribution, though not as important as that of his trade theory colleagues. Japan, then Korea, then Taiwan, then most of Southeast Asia had in any case focused on export strategies decades before Chicago economists, including Friedman, advised Pinochet regime in Chile to adopt one.
Generalised with Thomas L. Friedman’s The World is Flat into a view that democracy, capitalism and economic globalisation had become the more or less universally agreed elements of human societies, it moved well beyond Friedman’s scope. Friedman certainly welcomed it, but did he create it? A world of liberal market economies had, after all, been an American foreign policy ideal since the end of the second world war. The creation of the modern global economy rested on successive GATT trade rounds, the European common market, the reconstruction of Japan and Germany and other changes Friedman may have applauded but had nothing to do with him. He welcomed China’s accession to World Trade Organization in 2001 but was not an important player in removing the US veto. China’s economic success with considerable state ownership and direction ran opposite to Friedman’s prescriptions. On the Washington consensus, there is anyway today no consensus.
As he became more involved in Republican politics, Friedman’s moral compass became unreliable. Supporting Barry Goldwater’s campaign for the presidency, Friedman opposed the 1964 Civil Rights Act. His argument, according to Burns, was that people have a right to racially discriminate if they wish. With economics, you need to know when to stop.
His fans claim Friedman’s ideas also had a big impact on Australia. According to economist Peter Swan, speaking at a Friedman tribute in Sydney in 2007, Friedman’s ideas arguably spurred not only “the demolition of the Berlin Wall, the demise of the Soviet Union and of communism [and] the rise of Maggie Thatcher in the UK” but also the “magnificent success of the early Hawke–Keating government,” which “freed up the financial system, floated the dollar, and deregulated and privatised much of the economy. And Friedman’s ideas surely laid the foundations for the great prosperity enjoyed by Australians under the Howard government.”
Putting aside his suggestions about the Berlin Wall and the demise the Soviet Union, Swan’s attribution of the success of the Hawke and Keating governments to Friedman is hard to see. Writing about those governments, researching the archive of Keating’s files, I cannot recall coming across Friedman’s name once.
The Hawke and Keating governments were indeed adherents of what was then broadly known as economic rationalism, but it is fanciful to credit Friedman. It was just regular economics. The Hawke government put in place an Accord with the trade unions which, with the cooperation of the wage arbitration tribunal, restrained the growth of wages. That idea was anathema to Friedman. The Hawke and Keating governments legislated tariff cuts, long advocated by Australian economists and drawn from mainstream economic thinking that long preceded Friedman. (Influenced by Bert Kelly, Whitlam had also been a tariff reformer.) Friedman was an advocate of the sort of privatisations effected by the Hawke and Keating governments, but so were many other prominent economists.
There is perhaps more of a Friedmanite influence in financial deregulation. Australia’s efforts were in some respects more thoroughgoing than in the United States, but somewhat later — as was the float of the currency. In Australia, as in Britain and the United States, deregulation was prompted by the increasing success of unregulated financial businesses, cross-border competition and the opportunities offered by computing and communications technologies. Friedman advocated financial deregulation but, again, so did others.
And while Australia’s Reserve Bank continued with monetary targets until 1985 the operating instrument and the real focus of policy was always the short-term interest rate. The bank anyway had no more success than other central banks in meeting its money targets. The targets were seen as aspirational projections rather than outcomes that had to be attained. Not long after the float of the Australian dollar, the bank (and the government) dropped what had by then become fictional monetary targets. As the bank’s then deputy governor, Stephen Grenville, pointed out in a canonical 1997 paper, by the late eighties it was widely recognised that the relationship between money and nominal income had broken down. He approvingly quoted a remark of the Bank of Canada governor: “We didn’t abandon monetary targets, they abandoned us.”
For all that, Burns rightly points out that Friedman could claim a good deal of the credit for many of the characteristics of contemporary central banking. One is explicit targets, though now expressed as an inflation range rather than a rate of growth of money. Another is openness, expressed as public information about the monetary policy decisions of the central bank, and its economic forecasts. A third might be the greater independence of central banks from the rest of the government. In the United States all three were in varying degrees absent from the Fed when Friedman began drawing attention to the role of money and monetary policy from the later 1950s onward. He could claim to have had a big influence on central banking, and for the better.
Freidman’s most thorough intellectual biography is the magnificent two volume study by Edward Nelson, an Australian economist working at the Federal Reserve in Washington. At over 1300 pages Nelson’s Milton Friedman and Economic Debate in the United States 1932-1972 (University of Chicago Press, 2020) demonstrates in detail the range of Friedman’s professional impact in the long-running disputes between economists broadly aligned with Keynesian views, and those adhering to the Chicago classical tradition.
As Nelson noted in 2011, some of Friedman’s views have been put to unexpected uses. The then Fed chair Ben Bernanke cited Friedman’s criticism of inactivity of the central bank during the Great Depression to justify the large-scale intervention of the Fed in the 2008 financial crisis. But it is also true that the 2008 crisis was caused by a grotesque failure of financial businesses to control risks. Alan Greenspan’s misplaced confidence that financial markets would correctly price the risks of mortgage securitisation, the most expensive error in the history of central banking thus far, had a distinctly Friedmanite or at least Chicago ring.
Perhaps Friedman’s most enduring legacy is his support for the notion that market economies usually work reasonably well. They occasionally crash but by and large the price mechanism, the invisible hand, guides efficient decisions much better than state control of prices, labour and capital. Friedman argued for this view but it was, after all, the fundamental tenet of economic theory as developed in Western Europe and Britain from the eighteenth century onward, and not a view that Friedman either invented or much improved. A brilliant advocate, an important scholar — that should be enough for one very distinguished career in economics, without also being held responsible for the shape of the world in the second half of the twentieth century. •
Milton Friedman: The Last Conservative
By Jennifer Burns | Farrar Straus Giroux | $59.99 | 592 pages
