Milton Friedman

Definition

Milton Friedman was an American economist who was a prominent advocate of free-market capitalism and monetarist economic policies. His ideas and theories had a significant impact on the field of economics, particularly in the context of shifts in aggregate demand and the Phillips Curve.

5 Must Know Facts For Your Next Test

1. Friedman argued that expansionary monetary policy could not permanently reduce unemployment below its natural rate, a concept known as the natural rate hypothesis.
2. Friedman's critique of the Phillips Curve challenged the idea that there was a stable trade-off between inflation and unemployment, leading to the understanding of the short-run and long-run Phillips Curves.
3. Friedman's monetarist theory emphasized the importance of controlling the money supply to stabilize the economy and combat inflation, in contrast to Keynesian policies that focused on fiscal stimulus.
4. Friedman's Permanent Income Hypothesis suggested that consumers base their spending on their long-term expected income rather than their current income, which has implications for the effectiveness of fiscal policy.
5. Friedman's advocacy of free-market capitalism and limited government intervention influenced the economic policies of many governments, including the Reagan administration in the United States and the Thatcher government in the United Kingdom.

Review Questions

• Explain how Milton Friedman's views on the Phillips Curve challenged the conventional understanding of the relationship between inflation and unemployment.
  • Milton Friedman's critique of the Phillips Curve argued that the trade-off between inflation and unemployment was not stable or permanent. He proposed the concept of the natural rate of unemployment, which is the level of unemployment that exists due to normal market functions, even when the economy is in equilibrium. Friedman argued that expansionary monetary policy could not permanently reduce unemployment below this natural rate, as it would only lead to higher inflation. This challenged the conventional view that policymakers could use the Phillips Curve to fine-tune the economy by managing the inflation-unemployment trade-off.
• Describe how Friedman's monetarist theory differed from Keynesian policies in terms of the role of the money supply and fiscal stimulus.
  • Friedman's monetarist theory emphasized the importance of controlling the money supply as the primary means of influencing economic activity and combating inflation. This contrasted with Keynesian policies, which focused more on the use of fiscal stimulus, such as government spending and tax cuts, to stabilize the economy. Friedman believed that the money supply was the key driver of economic fluctuations and that the central bank should adopt a rule-based approach to monetary policy, rather than relying on discretionary fiscal interventions. This led to a shift away from Keynesian demand management policies towards a greater emphasis on monetary policy and the control of the money supply.
• Analyze how Friedman's Permanent Income Hypothesis and its implications for the effectiveness of fiscal policy relate to the concept of shifts in aggregate demand.
  • Friedman's Permanent Income Hypothesis suggested that consumers base their spending decisions on their long-term expected income rather than their current income. This has important implications for the effectiveness of fiscal policy, such as tax cuts or government spending, in shifting aggregate demand. If consumers view these fiscal interventions as temporary and not affecting their permanent income, they may not significantly increase their spending, limiting the impact on aggregate demand. This contrasts with the Keynesian view that fiscal policy can be an effective tool for stabilizing the economy by directly influencing consumer spending and aggregate demand. Friedman's theory highlighted the importance of considering consumer expectations and the distinction between temporary and permanent income changes when analyzing the effects of fiscal policy on aggregate demand.

Related terms

Monetarism:

An economic theory that focuses on the control of the money supply as the primary means of influencing economic activity and inflation.

Friedman's Permanent Income Hypothesis: The theory that individuals base their consumption not on their current income, but on their expected long-term, or 'permanent,' income.

Natural Rate of Unemployment:

The level of unemployment that exists in an economy due to normal market functions, even when the economy is in equilibrium.