Milton Friedman

Milton Friedman

Chicago School of Economics
Birth	31 July 1912 Brooklyn, New York
Death	16 November 2006 San Francisco, California
Nationality	American
Institution	Hoover Institution (1977-2006) University of Chicago (1946-77) Columbia University (1937-41, 1943-45) National Bureau of Economic Research (1937-40)
Field	Economics
Alma mater	Columbia University (Ph.D., 1946), University of Chicago (M.A., 1933), Rutgers University (B.A., 1932)
Opposed	John Maynard Keynes, John Kenneth Galbraith
Influences	Frank Knight, Jacob Viner, Irving Fisher, Arthur Burns, Henry Simons
Influenced	Anna J. Schwartz, Gary Becker, Thomas Sowell, David D. Friedman
Contributions	Price theory, monetarism, permanent income hypothesis, natural rate of unemployment, floating exchange rates
Awards	John Bates Clark Medal (1951) Nobel Memorial Prize in Economics (1976) Presidential Medal of Freedom (1988)

Milton Friedman (1912-2006) was the most publicly effective advocate of free markets of the twentieth century, and the economist Austrians argue with most. The argument is not about his conclusions, most of which Austrians share, but about his method and his monetary theory, and it is sharper for the agreement rather than in spite of it.

Career

Friedman grew up in Rahway, New Jersey, took a scholarship to Rutgers and graduated in 1932 having studied mathematics and economics, then went to Chicago for a master's degree in 1933 and to Columbia for a doctorate awarded in 1946. At Chicago he took Jacob Viner's price theory course and met Rose Director, whom he married and with whom he later wrote.

The doctoral work, done at the National Bureau of Economic Research with Simon Kuznets, produced the finding that most interests libertarians: entry barriers maintained by the American Medical Association accounted for a large part of the gap between physicians' incomes and those of comparable professionals. Publication was delayed and the result was contested, which is itself a fair illustration of the point.

During the Second World War he worked in the Treasury's Division of Tax Research, where he took part in designing wartime payroll withholding. He defended the measure as a wartime necessity and regretted its consequences, having supplied the fiscal machinery that made a large permanent income tax administratively possible.

He joined the University of Chicago economics department in 1946 and stayed thirty years, founding the Money and Banking Workshop in 1953. He attended the first meeting of the Mont Pelerin Society in 1947 at Friedrich Hayek's invitation, later calling it the beginning of his active involvement in politics. He wrote a Newsweek column from 1966 to 1984, received the Nobel Memorial Prize in 1976, moved to the Hoover Institution in 1977, and reached his largest audience with Free to Choose, a book and 1980 television series written with Rose.

Contributions

Three pieces of work carried his professional reputation.

The permanent income hypothesis, set out in A Theory of the Consumption Function (1957), holds that households base consumption on the income they expect to persist rather than on current receipts. It explained anomalies in the consumption data and had a policy edge: a tax change understood to be temporary is absorbed by saving and does not move consumption, which undercuts activist fiscal fine-tuning on its own terms.

A Monetary History of the United States, 1867-1960 (1963), with Anna Schwartz, argued that the Great Depression was made into a catastrophe by Federal Reserve failure rather than by any instability inherent in capitalism. Whatever one makes of the thesis, the book removed the Depression from the list of things markets are held to have done to themselves.

The natural rate hypothesis, delivered as his 1967 presidential address to the American Economic Association, attacked the Phillips curve. Friedman argued that any inflation-unemployment trade-off depends on workers mistaking a nominal wage rise for a real one, so it survives only while inflation is unanticipated; holding unemployment below its natural rate therefore requires not high inflation but continuously accelerating inflation. The stagflation of the 1970s, which the simple Keynesian model did not permit, was widely read as confirmation.

Where Austrians agree

The list is long and is worth stating before the disagreements, because the disagreements are often mistaken for opposition.

Friedman argued against the minimum wage, rent control, tariffs, conscription and occupational licensing, and for drug legalisation and school choice. Walter Block's obituary called him a beacon on the minimum wage, free trade and rent control, and singled out the 1989 open letter to drug czar William Bennett calling for legalisation, which cost him support among conservatives, and the attack on the American Medical Association's restriction of entry to medicine in Capitalism and Freedom.

His work on health care is a further point of agreement. A 1992 Hoover Institution study, "Input and Output in Health Care", recorded that 56 percent of American hospitals were private and for-profit in 1910 and about 10 percent by the 1970s, after decades of subsidy to government-run institutions, and that between 1965 and 1989 medical expenditure rose 224 percent while hospital beds per thousand population fell 44 percent.

He read this through Max Gammon's finding, which he called Gammon's law: in a bureaucratic system an increase in expenditure will be matched by a fall in production, so that such systems behave like black holes, sucking in resources while shrinking in emitted production. He added that the law had impressed him most in American schooling, where input on every measure had risen for decades while output, whether counted as students, schools or quality, had gone down.

Where Austrians disagree

Method

The deepest split is methodological and predates every policy question. In "The Methodology of Positive Economics" (1953) Friedman argued that a theory is to be judged by the accuracy of its predictions and not by the realism of its assumptions, and that demanding realistic assumptions is a confusion about what a theory is for.

Austrians reject this at the root. On the Misesian account the propositions of economics are deduced from the fact that human beings act, and their truth does not depend on statistical confirmation, because the historical data are never generated by a controlled experiment and are always the joint product of everything happening at once. On Friedman's criterion a theory known to be false in its premises is acceptable if it predicts well; on the Austrian criterion that is exactly what cannot be tolerated, because without true premises there is no reason to expect the prediction to keep working. Nothing else on this list is as fundamental, and much of the rest follows from it.

The Great Depression

Friedman and Schwartz blame the Federal Reserve for allowing the money stock to contract by about a third between 1929 and 1933. Murray N. Rothbard also blames the Federal Reserve, and for the opposite thing: the credit expansion of the 1920s, which produced the malinvestment that the bust then had to liquidate.

The two diagnoses are not compatible and they prescribe opposite remedies. Friedman's implies the Fed should have inflated harder in 1930; Rothbard's implies it should not have inflated in 1927, and that inflating in 1930 would have postponed the correction at the cost of making it worse. Both books appeared in 1963.

Money

Friedman advocated an irredeemable paper standard governed by a rule requiring the money supply to grow at a constant annual rate, holding this cheaper than a gold standard and less prone to inflationary excess than discretion.

Austrians object that the rule leaves a monopoly issuer in place and merely instructs it, that the aggregate it targets is not a well-defined quantity, and that expanding the money supply at any positive rate still redistributes toward whoever receives the new money first. The disagreement is about whether the problem with central banking is that it is badly run or that it exists. Rothbard's extended critique, published as "Milton Friedman Unravelled", makes the case that Friedman's monetary programme is statist in structure whatever its author's intentions.

Second thoughts on paper money

The most interesting thing about Friedman's monetary position is that he moved a long way from it late in his career, and said so in print.

In his July 1985 presidential address to the Western Economic Association he said his years advocating a monetary rule had been ill-spent, because the argument had been addressed to officials imagined as selflessly devoted to the public interest. We do not think of a businessman that way, he observed, and there is no reason to think of government officials differently; the Federal Reserve concentrates great power in few hands and is so constructed that it has been in their interest to pursue a policy he believed harmful. It was therefore a waste of time to try to persuade them to adopt the rule.

In June 1986 he published "The Resource Cost of Irredeemable Paper Money" in the Journal of Political Economy, retracting a premise rather than a policy. He and other monetary economists had taken it for granted that the real resource cost of producing irredeemable paper money was negligible, amounting to paper and printing. Experience under a universal paper standard, he wrote, makes it crystal clear that the assumption, whatever its truth for the government's own issuing costs, is false for society as a whole.

The costs he identified are the ones a paper standard generates by making the future price level uncertain: the growth of a hard money industry, private hoarding of gold and silver whose resource cost he thought may have equalled or exceeded that of an effective gold standard, and the development of financial and currency futures markets which serve a genuine hedging function but would not have arisen had the paper regime not created the uncertainty they hedge.

The same year he and Schwartz asked "Has Government Any Role in Money?" and answered that in principle it need not have one and historically often had none. Governments entered after the fact, once a community had settled on a unit of account and private producers had supplied media of exchange; many private issuers convertible into specie operated successfully for long periods, though they knew of no example of privately produced inconvertible money. Their conclusion was that leaving monetary and banking arrangements to the market would have produced a more satisfactory outcome than was actually achieved through government involvement.

He never followed this to a gold standard, and was explicit that his paper was not a plea for one, calling a return neither desirable nor feasible except in the event that predictions of hyperinflation proved correct. His reason was political rather than economic: asked in a 1976 Johannesburg lecture why a gold standard was not feasible, he answered that if one could re-establish a world in which government spending was a tenth of national income, laissez-faire reigned and full employment policy had been abandoned, a real gold standard might be restored, but that essentially no government is willing to surrender control over domestic monetary policy.

This is close to the public choice objection Austrians had been making against him for thirty years, arrived at independently and conceded in his own terms.

See also

• Chicago School of economics
• Great Depression
• Austrian Business Cycle Theory
• Gammon's Law
• Federal Reserve System
• Stagflation
• Murray N. Rothbard
• Money supply

Links

• Milton Friedman Unravelled (pdf) by Murray N. Rothbard, Fall 2002
• Milton Friedman RIP by Walter Block, November 2006
• Milton Friedman, 1912-2006 by Hans F. Sennholz, December 2006
• Is Milton Friedman a Keynesian? by Roger W. Garrison
• Can Friedman's Money Rule Stabilize the Economy? by Frank Shostak, November 2008
• Friedman for Government Intervention: The Case of the Great Depression by Mateusz Machaj, January 2007
• The Curse of the Withholding Tax by Laurence M. Vance, April 2005
• Milton Friedman and the Human Good by Tibor R. Machan, June 2010
• Fanatical, Not Reasonable: A Short Correspondence Between Walter Block and Milton Friedman (pdf) by Walter Block, Summer 2006
• Milton Friedman (1912-2006) from The Concise Encyclopedia of Economics
• Milton Friedman at Wikipedia
• Free to Choose, the 1980 television series
• Hayek on Milton Friedman and Monetary Policy (video)