Milton Friedman was a pivotal figure in 20th-century economics. His ideas challenged Keynesian theory, advocating for free markets and limited . Friedman's work on and the quantity theory of money reshaped economic thinking.
Friedman's influence extended beyond academia into public policy. His views on monetary policy, unemployment, and consumer behavior continue to impact economic discussions today. Friedman's legacy as a champion of free-market capitalism remains both celebrated and debated.
Life and career of Milton Friedman
Early life and education
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Born in 1912 in Brooklyn, New York to Jewish immigrants from Hungary
Attended Rutgers University, where he earned a Bachelor's degree in economics and mathematics in 1932
Pursued graduate studies at the University of Chicago, earning a Master's degree in economics in 1933
Completed his Ph.D. in economics at Columbia University in 1946, focusing on income and consumption
Academic positions held
Served as a professor of economics at the University of Chicago from 1946 to 1976
Played a key role in establishing the
Held a position as a research associate at the National Bureau of Economic Research from 1937 to 1981
Served as a visiting professor at various institutions, including the University of Wisconsin, University of Minnesota, and Hoover Institution at Stanford University
Influential publications and books
Published his first major work, "Essays in Positive Economics," in 1953, which emphasized the importance of empirical evidence in economic analysis
Co-authored ", 1867-1960" with Anna Schwartz in 1963, arguing that changes in the significantly influenced economic activity
Wrote the influential book "" in 1962, advocating for free markets and limited government intervention in the economy
Published "Free to Choose" in 1980, a popular book that promoted the benefits of a free market economy and individual liberty
Key economic theories of Friedman
Monetarism vs Keynesian economics
Friedman challenged the dominant Keynesian view that government intervention and fiscal policy were necessary to stabilize the economy
Argued that the primary driver of economic fluctuations was changes in the money supply, not government spending or taxation
Believed that monetary policy, controlled by central banks, was a more effective tool for managing the economy than fiscal policy
Quantity theory of money
Friedman revived and modernized the quantity theory of money, which states that the price level is directly proportional to the money supply
Proposed that the demand for money is stable and predictable, and that changes in the money supply lead to proportional changes in nominal income and prices
Emphasized the importance of a steady, predictable growth rate of the money supply to maintain price stability and avoid economic disturbances
Natural rate of unemployment
Introduced the concept of the , also known as the non-accelerating inflation rate of unemployment (NAIRU)
Argued that attempts to push unemployment below the natural rate through expansionary policies would lead to accelerating inflation
Believed that the natural rate of unemployment is determined by structural factors in the economy, such as labor market regulations and the efficiency of job search and matching
Permanent income hypothesis
Developed the , which states that consumers' spending decisions are based on their long-term expected income rather than current income
Argued that temporary changes in income have little effect on consumption, as people tend to smooth their consumption over time
Suggested that policies aimed at boosting short-term income, such as temporary tax cuts, would have limited impact on consumer spending
Friedman rule for optimal monetary policy
Proposed the , which states that the optimal monetary policy is to set the nominal interest rate equal to zero
Argued that a zero nominal interest rate would minimize the opportunity cost of holding money and maximize social welfare
Believed that the Friedman rule could be achieved by setting the money supply growth rate equal to the real interest rate
Friedman's views on economic policy
Advocacy for free markets and capitalism
Friedman was a strong proponent of free markets and capitalism, arguing that they are the most effective means of allocating resources and promoting economic growth
Believed that the role of government in the economy should be limited to protecting property rights, enforcing contracts, and providing a stable monetary framework
Argued that free markets and economic freedom are essential for political freedom and individual liberty
Criticism of government intervention
Friedman criticized various forms of government intervention in the economy, such as price controls, subsidies, and regulations
Argued that government intervention often leads to unintended consequences and distorts market incentives
Believed that the government should not try to redistribute income or protect specific industries from competition
Monetary policy recommendations
Friedman advocated for a rules-based monetary policy, where the central bank would commit to a steady, predictable growth rate of the money supply
Argued that discretionary monetary policy, where the central bank actively adjusts interest rates and the money supply in response to economic conditions, can be destabilizing and lead to inflation
Believed that a stable monetary policy would provide a foundation for long-term economic growth and price stability
Fiscal policy perspectives
Friedman was skeptical of the effectiveness of fiscal policy, such as government spending and taxation, in stabilizing the economy
Argued that fiscal policy is often subject to political pressures and can be slow to implement and adjust
Believed that the government should focus on maintaining a balanced budget over the long run and avoid excessive deficits and debt
Friedman's influence on economic thought
Chicago School of Economics
Friedman was a leading figure in the Chicago School of Economics, which emphasized the importance of free markets, monetary theory, and empirical analysis
The Chicago School challenged the dominant Keynesian view of the time and had a significant impact on economic policy and research
Other notable economists associated with the Chicago School include George Stigler, , and Robert Lucas
Impact on monetary policy worldwide
Friedman's ideas on monetarism and the importance of the money supply had a significant influence on central banking and monetary policy around the world
Many central banks adopted and rules-based monetary policy frameworks, inspired by Friedman's insights
The Federal Reserve and other central banks began to place greater emphasis on price stability and the control of inflation
Contributions to methodology of economics
Friedman was a strong advocate for the use of empirical evidence and statistical analysis in economics
He emphasized the importance of testing economic theories against real-world data and using positive economics to understand how the economy actually works
His methodological approach influenced the development of econometrics and the increasing use of data-driven analysis in economics
Political philosophy and activism
Classical liberalism and libertarianism
Friedman's political philosophy was rooted in classical liberalism and libertarianism, which emphasize individual liberty, limited government, and free markets
He believed that economic freedom is a necessary condition for political freedom and that the role of government should be limited to protecting individual rights
Friedman's ideas influenced the development of the libertarian movement in the United States and around the world
Involvement in public policy debates
Friedman actively participated in public policy debates throughout his career, advocating for free-market solutions to various economic and social issues
He argued against the draft during the Vietnam War, supported school choice and voucher programs, and criticized the war on drugs
Friedman's public engagement helped to popularize his ideas and bring economic concepts to a wider audience
Advising governments and politicians
Friedman served as an advisor to several governments and politicians, both in the United States and abroad
He was a member of President Reagan's Economic Policy Advisory Board and provided advice on issues such as taxation and monetary policy
Friedman also advised leaders in countries such as Chile, Iceland, and Estonia on economic reforms and the transition to free-market systems
Friedman's legacy and controversies
Friedman's ideas and influence have left a lasting impact on economics, public policy, and political discourse
His advocacy for free markets and limited government has been celebrated by proponents of economic liberty and criticized by those who favor a larger role for the state in the economy
Some of Friedman's policy recommendations, such as his support for and his advisory role in Chile during the Pinochet regime, have been the subject of controversy and debate
Despite these controversies, Friedman remains one of the most influential and widely-cited economists of the 20th century, and his ideas continue to shape economic thinking and policy discussions to this day
Key Terms to Review (21)
A Monetary History of the United States: A Monetary History of the United States is a comprehensive examination of the evolution of money, banking, and monetary policy in the United States from its inception to modern times. It highlights significant events, changes in policy, and their impacts on the economy, revealing how monetary decisions shape economic outcomes and influence overall financial stability.
Capitalism and Freedom: Capitalism and Freedom is a concept that highlights the relationship between economic systems, specifically capitalism, and individual liberties. It argues that economic freedom, through the mechanisms of a capitalist economy, is essential for fostering personal freedoms and political democracy. This idea posits that a society allowing free markets and private enterprise is better equipped to ensure liberty for its citizens.
Cato Institute: The Cato Institute is a public policy research organization based in Washington, D.C., that promotes libertarian principles and ideas. Founded in 1977, the institute advocates for limited government, individual liberty, free markets, and peace. Its work aligns closely with the ideas of Milton Friedman, especially in promoting free-market policies and criticizing government intervention in the economy.
Chicago School of Economics: The Chicago School of Economics is a neoclassical school of economic thought that originated at the University of Chicago in the early 20th century. It emphasizes free-market principles, minimal government intervention, and the importance of individual choice in economic decision-making. The ideas promoted by this school have significantly influenced modern economic policies and have been particularly associated with Milton Friedman, a key figure in this movement.
Deregulation: Deregulation refers to the process of removing government restrictions and regulations from an industry to promote competition and efficiency. This shift often aims to foster innovation, lower prices, and enhance consumer choice, as it encourages businesses to operate with greater freedom. The concept is closely tied to various economic theories and policies, influencing market structures, the role of privatization, and the enforcement of antitrust laws.
Free Market Capitalism: Free market capitalism is an economic system where prices for goods and services are determined by unrestricted competition between privately owned businesses. This system emphasizes minimal government intervention, allowing supply and demand to dictate market dynamics, which ideally leads to efficient resource allocation and innovation. In free market capitalism, the role of government is primarily limited to protecting property rights and maintaining the rule of law, promoting a climate where businesses can thrive based on consumer choice and entrepreneurial initiative.
Friedman Rule: The Friedman Rule is an economic principle proposed by Milton Friedman that suggests the optimal monetary policy involves setting the nominal interest rate to zero. This rule emphasizes that when the cost of holding money is zero, it encourages economic efficiency and maximizes welfare by minimizing the opportunity cost of holding cash.
Gary Becker: Gary Becker was an influential American economist known for his work in the field of human capital and the application of economic theory to social issues. His research expanded the scope of economics beyond traditional boundaries, incorporating elements such as family dynamics, education, and crime into economic analysis. Becker's groundbreaking approach contributed to a greater understanding of how economic principles can be applied to various aspects of human behavior and social policy.
Government intervention: Government intervention refers to the active involvement of the government in the economy, aimed at regulating or influencing economic activities. This can include a variety of actions such as creating laws, imposing regulations, and providing subsidies to protect or stimulate specific sectors. The goal of such interventions is often to address market failures, promote social welfare, and ensure economic stability.
Great Depression: The Great Depression was a severe worldwide economic downturn that lasted from 1929 to the late 1930s, characterized by massive unemployment, declining production, and significant deflation. It had profound effects on global economies and led to major changes in economic theories and policies, particularly influencing the perspectives of various economists on the role of government in stabilizing the economy.
Inflation Targeting: Inflation targeting is a monetary policy strategy used by central banks to maintain price stability by targeting a specific inflation rate. This approach involves setting an explicit target for the inflation rate and using various tools, such as interest rate adjustments, to steer actual inflation toward that target. It aims to enhance transparency and accountability in monetary policy while promoting economic stability and growth.
Monetarism: Monetarism is an economic theory that emphasizes the role of governments in controlling the amount of money in circulation. It posits that changes in the money supply have major influences on national output in the short run and the price level over longer periods. This theory was notably popularized by Milton Friedman, who argued that variations in the money supply are the primary cause of economic fluctuations, making it essential for central banks to regulate the money supply to ensure economic stability.
Money supply: The money supply refers to the total amount of monetary assets available in an economy at a specific time, including cash, coins, and balances held in checking and savings accounts. This concept is crucial for understanding economic activity, as it influences inflation, interest rates, and overall economic growth. Central banks often manipulate the money supply to achieve desired economic outcomes, making it a key focus of monetary policy.
Natural Rate of Unemployment: The natural rate of unemployment is the level of unemployment that exists when the economy is at full employment, reflecting the normal turnover in the labor market. It includes frictional unemployment, which occurs as workers transition between jobs, and structural unemployment, which arises from mismatches between skills and job requirements. This rate does not account for cyclical unemployment, which fluctuates due to economic downturns or booms.
Negative income tax: A negative income tax is a system where individuals or families earning below a certain income level receive supplemental pay from the government instead of paying taxes. This approach aims to provide a safety net for low-income earners while also encouraging them to work, as they can still receive benefits even when they earn income. It combines elements of direct financial assistance with incentives to remain in the labor market.
Permanent Income Hypothesis: The permanent income hypothesis is an economic theory proposed by Milton Friedman that suggests individuals base their consumption choices on their expected long-term average income rather than their current income. This theory emphasizes that people will smooth their consumption over time, planning for future income changes while reacting less to temporary fluctuations in income. It has important implications for understanding consumer behavior, savings, and economic policies.
Privatization: Privatization refers to the process of transferring ownership and control of a public service or asset to private individuals or organizations. This shift is often driven by the belief that private entities can operate more efficiently and effectively than the government, leading to improved services and reduced costs. The concept is connected to various economic theories and practices, including market-oriented reforms, the management of public goods, and debates around the welfare state.
School vouchers: School vouchers are government-funded scholarships that allow students to attend a school of their choice, typically outside their assigned public school. This concept promotes school choice and competition among schools, aiming to improve educational quality by giving families the option to choose better-performing institutions, whether public or private. Advocates argue that vouchers empower parents, while critics express concerns over funding and educational equity.
Stagflation: Stagflation refers to an economic situation characterized by stagnant economic growth, high unemployment, and high inflation occurring simultaneously. This condition poses a significant challenge for policymakers, as traditional methods to combat inflation can exacerbate unemployment and slow down growth further.
Thomas Sowell: Thomas Sowell is an American economist and political commentator known for his work on economic theory, social policy, and the critique of government intervention in markets. His ideas often emphasize the importance of free markets and the consequences of various social policies, making him a significant figure in contemporary economic thought, especially in discussions surrounding Milton Friedman and his advocacy for free-market capitalism.
Velocity of money: The velocity of money refers to the rate at which money is exchanged in an economy over a given period. It is a key concept in understanding how active the economy is, as it indicates how often a unit of currency is used to purchase goods and services. A higher velocity suggests a more active economy, while a lower velocity may indicate sluggish economic activity.