Milton Friedman

Milton Friedman challenged Keynesian orthodoxy by arguing that money, not government spending, was the key to managing the economy — a theory that reshaped central banking and economic policy globally.

The Chicago school and early work

Friedman was educated at Rutgers and the University of Chicago, where he developed a distinctive approach to economics based on empirical analysis and skepticism toward government intervention. After working briefly for the government during World War II, he joined the University of Chicago faculty in 1946, where he remained for decades.

At Chicago, Friedman led a school of economic thought that emphasized markets, individual choice, and skepticism toward government planning. He was fiercely intellectual, willing to debate with leading economists and to defend his views rigorously.

The monetary theory revolution

Friedman’s major intellectual contribution was the revival and development of monetary theory. He argued that the money supply was the dominant factor determining the price level and inflation, as well as short-run fluctuations in output and employment.

This contrasted with Keynesian orthodoxy, which emphasized fiscal policy (government spending) as the primary tool for managing the economy. Friedman contended that Keynes and his followers had underestimated the role of money and that Keynesian policies would inevitably lead to inflation if pursued without restraint.

A Monetary History of the United States

In 1963, Friedman and Anna Schwartz published A Monetary History of the United States, 1867-1960, which became a landmark study. The book traced the history of money in America and argued that monetary policy — particularly the Federal Reserve’s decision to contract the money supply in the early 1930s — had transformed the 1929 stock market crash into the Great Depression.

This revisionist history suggested that the Great Depression could have been prevented with better monetary policy. The implication was that central banks, by managing the money supply, could prevent catastrophic economic downturns.

Monetary policy rules

Friedman advocated for the Federal Reserve to adopt a simple rule: expand the money supply at a constant rate, roughly equal to the long-term growth rate of the economy. This “monetarist rule” would prevent the Fed from causing inflation or recession through its discretionary decisions.

He was skeptical of discretionary monetary policy, arguing that lags and uncertainty meant that the Fed often tightened when it should loosen and vice versa. A fixed rule would be better than human discretion, even if imperfect.

The natural rate of unemployment

Friedman introduced the concept of the “natural rate of unemployment” — the rate below which trying to push unemployment would only cause inflation. This concept suggested that there was a limit to how much the Fed (or government) could reduce unemployment without triggering inflation.

This theory was controversial and was tested during the inflation of the 1970s. When both inflation and unemployment rose simultaneously — a phenomenon called “stagflation” — some economists cited Friedman’s work to explain how expansionary policy had caused the problem.

Political economy and Capitalism and Freedom

Beyond technical economic theory, Friedman was also a public intellectual and libertarian. His book Capitalism and Freedom, published in 1962, argued for minimal government intervention and maximum individual choice. He advocated for school vouchers, flat taxes, and the elimination of many government programs.

This political philosophy was inseparable from his economics. He believed that free markets were not just efficient but also compatible with freedom, and that government intervention, however well-intentioned, ultimately restricted liberty.

The influence on monetary policy

Friedman’s monetarist ideas influenced central banks globally. By the 1980s, central banks in the US, UK, and elsewhere began to adopt monetarist principles, targeting money supply growth and rejecting the idea that they could permanently trade off inflation for lower unemployment.

The Federal Reserve under Paul Volcker adopted monetarist ideas in combating the inflation of the 1970s and early 1980s. This period demonstrated that controlling the money supply was indeed a powerful tool for controlling inflation.

The later years and legacy

Friedman remained active as a public intellectual into his nineties, continuing to argue for free markets and against government intervention. He won the Nobel Prize in Economics in 1976 for his contributions to monetary theory.

His influence on economics is profound. While pure monetarism has waned and economists have adopted more nuanced frameworks, the understanding that money matters is Friedman’s enduring legacy. Central banks globally now focus on monetary policy as a primary tool for managing the business cycle.

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