Milton Friedman, undead

Friedman is dead but continues to wield influence from beyond the grave. Here is a story on Mike Harris and Preston Manning’s commentary that the Harper government is not right-wing enough and laying out their Friedman-esque version of Canada:

”Excessive government taxation and spending limit the economic freedom of individuals and businesses by reducing their incomes and transferring economic decision-making powers into the hands of the politicians and bureaucrats,” write Harris and Manning.

… Harris and Manning also take aim at government regulations, which they say prevent individuals and businesses from ”freely making decisions or entering into agreements they otherwise would.”

On that front, governments should hold regular ”delegislation/deregulation” sessions to strike obsolete and overly restrictive laws and regulations from the books. There should also be new ”sunset clauses” incorporated into regulations so they automatically expire after five years unless they are renewed.

Their major proposals include:

– Reducing the size of governments in Canada over six years so that spending represents 20 to 25 per cent of the economy, rather than the current 39 per cent.
– Restraining government spending increases to .9 per cent annually over the next five years.
– Accelerating the elimination of all corporate capital taxes.
– Advising Ottawa to reduce the corporate tax rate to 12 per cent from the current 21 over the next five years and provinces to cut the rate by at least 30 per cent, with a target of eight per cent.
– Eliminating the capital gains tax.
– Introducing tax-exempt, pre-paid savings accounts, which would be essentially the reverse of RRSP’s. The earnings and withdrawals would be tax exempt.
– Eliminating interprovincial trade barriers because they cost the economy billions per year.

These are moral judgements with little or no empirical basis as guides for economic policy (the only “evidence” in the list is a bogus claim on interprovincial trade barriers). It is the same righteous moral stance that drove Friedman’s hatred for government intervention and that is blind to existing inequalities and externalities.

With that in mind let’s review some more perspectives on Friedman. First, here’s Dean Baker:

First, I would take issue with claims about him being proven right on macroeconomic questions. Milton Friedman was the author and main promulgator of the money growth rule. His gospel was that we did not need the Fed, we just needed a computer that would increase the money supply by 3 percent annually. While central banks did experiment with this approach (including the Volcker Fed), I don’t think that anyone in the world (not even Milton Freidman at the time of his death) still believes that this is a good way to manage monetary policy.

One can view the current inflation targeting fad as a variant of the money rule, but even here there are few advocates of a strict target. Most proponents of inflation targetting support targetting with a human face, which is little different than monetary policy with a goal of maintaining low rates of inflation.

His natural rate of unemployment hypothesis also ran into serious trouble in the late nineties. I won’t repeat my diatribes following the awarding of the Nobel Prize to Edmund Phelps, but a “natural rate” of unemployment that seems to move around frequently and unpredictably (and possibly in response to actual rates of unemployment), is not very natural.

I will give Friedman more credit on the political economy front. His views here certainly did have a huge influence on the world and I would agree that we should all think long and hard about a situation in which we are going to have the government tell people that they can’t engage in some economic transaction in the manner in which they choose.

Having said that, I think he and his followers are far too willing to accept government interventions that have the effect of shifting income upwards as just the natural working of the market. … The natural workings of the market don’t give us patent and copyright protection — that comes from the government: Bill Gates owes his good fortune at least as much to the government as his talent and hard work.

Corporations are also creations of the government. It is the rules created by the government that make it easy for CEOs and other top management to rip off shareholders and other stakeholders, not the market. Similarly, the Wall Street folks get rich because they can use their political power to ensure that they are allowed to run gambling casinos without paying any taxes. (Imagine a Las Vegas casino that didn’t have to pay the Nevada state gambling tax.) And of course, doctors, lawyers and other highly paid professionals earn so much more than dishwashers and custodians because of government protection (actually Friedman agrees with me on this one).

I would also note that in my “free market” utopia, workers have the right to organize unions and bargain collectively. This right is absent in Mr. Friedman’s world, hence his association with Chilean dictator Augusto Pinochet, who imprisoned tortured and killed people for union activity.

Second, Richard Posner:

I think his belief in the superior efficiency of free markets to government as a means of resource allocation, though fruitful and largely correct, was embraced by him as an article of faith and not merely as a hypothesis. I think he considered it almost a personal affront that the Scandinavian nations, particularly Sweden, could achieve and maintain very high levels of economic output despite very high rates of taxation, an enormous public sector, and extensive wealth redistribution resulting in much greater economic equality than in the United States. I don’t think his analytic apparatus could explain such an anomaly.

I also think that Friedman, again more as a matter of faith than of science, exaggerated the correlation between economic and political freedom. A country can be highly productive though it has an authoritarian political system, as in China, or democratic and impoverished, as was true for the first half century or so of India’s democracy and remains true to a considerable extent, since India remains extremely poor though it has a large and thriving middle class–an expanding island in the sea of misery. What is true is that commercial values are in tension with aristocratic and militaristic values that support authoritarian government, and also that as people become economically independent they are less subservient, and so less willing to submit to control by politicians; and also that they become more concerned with the protection of property rights, which authoritarian government threatens. But Friedman seemed to share Friedrich Hayek’s extreme and inaccurate view that socialism of the sort that Britain embraced under the old Labour Party was incompatible with democracy, and I don’t think that there is a good theoretical or empirical basis for that view. The Road to Serfdom flunks the test of accuracy of prediction!

I imagine that without the element of faith that I have been stressing, Friedman might have lacked the moral courage to propound his libertarian views in the chilly intellectual and political climate in which he first advanced them.

Next, James Galbraith, anticipating Friedman’s death back in 1996:

The Surrender of Economic Policy

There is a common ground on economic policy that now stretches, with differences only of degree… Across the spectrum, all declare that the main job of government is to help markets work well. On the supply side, government can help, up to a point, by providing education, training, infrastructure, and scientific research – all public goods that markets undervalue. But when it comes to macro economic policy, government should do nothing except pursue budget balance, and leave the Federal Reserve alone.

To accept a balanced budget and the unchallenged monetary judgment of the Federal Reserve is, by definition, to remove macroeconomics from the political sphere. … Even if there were substantial gains to be made by public investments on the supply side, the conservative fiscal consensus precludes them by denying the resources.

We have now seen two Democratic presidents – Carter and Clinton – deeply damaged because they did not dispute this orthodoxy in good time and therefore could not control the levers of macro policy. Macroeconomics, not microeconomics, is the active center of power. Practical conservatives understand this. It is no accident that conservatives always seek to control the high ground of deficit and interest rate policy, nor any surprise that liberals defeat themselves from the beginning when they concede it.

Yet, the economics behind this consensus is both reactionary and deeply implausible. It springs from a never-never-land of abstract theory concocted over 25 years by the disciples of Milton Friedman and purveyed through them to the whole profession. Liberals – and anyone else concerned with economic prosperity – should now reject this way of looking at the world.

… The conservative macroeconomic creed is built on three basic elements. They are, first, monetarism – the idea that the Federal Reserve’s monetary policy controls inflation, but has little effect on output and employment except perhaps in the very short run. Second, there is rational expectations, which is the idea … that individual economic agents are so clever, so well informed, and so well educated in economics that they do not make systematic errors in their economic decisions, especially the all-important choices of labor supply. And third, there is market clearing: the idea that all transactions, including the hiring and firing of workers, occur at prices that equate the elemental forces of supply and demand.

Taken together, these assumptions conjure an efficient labor market that yields appropriate levels of employment and wages. The employment level generated by this abstraction is the core policy concept of mainstream macroeconomics, known as the natural rate of unemployment. If unemployment is above the natural rate, the theory dictates that prices and wages will fall. If unemployment is below the natural rate, the theory dictates that inflation will rise. Sustainable, noninflationary employment growth occurs only at the natural rate.

Among most economists these ideas are amazingly noncontroversial. The only dispute is over a narrow point of policy – whether there is any value in attempts to steer the economy toward the natural rate if it happens to be, for a time, either above or below it. To the strictest natural-raters, doing nothing is always and everywhere the right prescription, because the economy will always return to the natural rate on its own. Policy cannot help, and the very instruments of macro policy should be abandoned.

… Alas, the location of the natural rate is not actually observed. Worse, the damn thing will not sit still. It is not only invisible, it moves! This is no problem for the never-do-anything crowd. But it poses painful difficulties for would-be intervenors, those few voices in the administration who call, from time to time, for summer jobs, public works programs, and lower interest rates. How can one justify a dash to the goalposts, if you don’t know where they are?

… Conservatives employ the myth of the market to oppose political solutions to distributive problems. But to leave things to the market is no less a political choice than any other.

Suppose the concept of an aggregate labor market and the associated metaphor of a natural rate of unemployment could be wiped away with a stroke from the professional consciousness (as it deserves to be). The policy notion that controlling the reduction of unemployment is the principal means of fighting inflation would lose its power. It would then become intellectually possible to revive the idea of giving a job to everybody who wants one. The issue becomes not how many jobs but rather who to employ and on what terms?

Investment and Consumption

Creating jobs is a matter of finding things for people to do. Investment of all kinds creates jobs, and stabilization of private investment demand is the traditional macroeconomic issue. Low and stable interest rates are essential here-more on that later. Public investment can step in where private investment will not go, and should be designed and pursued for its direct benefits, not its imaginary indirect ones. But consumption is also an important and much maligned policy objective. People should have the incomes they need to be well fed, housed, and clothed – and also to enjoy life. Public services can help: day care, education, public health, culture, and the arts all deserve far more support than they are getting.


Technological renewal should be understood as part of a strategy of maintaining investment demand. It makes sense progressively to shut down the back end of the capital stock, for environmental, safety, energy efficiency, and competitive reasons. Properly designed regulation can help, and this will open up investment opportunities for new technologies. At the same time, a flatter wage structure and bigger safety net, including retraining but also more generous early retirement for older displaced workers, would reduce the cost of job loss and the resistance from affected workers. Again, this is an adjunct of high-growth macro policy, not a substitute for it.


Inflation policy would not go away. But the pursuit of relative price stability, rather than being the result of sluggish growth and tight money, would become concerned with the management of particular elements of cost, as the economy got closer to full employment. This includes wage pressures, and also materials prices, rent, and interest. Management of aggregate demand – an undoubted force on nonwage prices – could operate through channels with less effect on employment (a variable tax on excess profits, for example). Since wages are a major element in costs, inflation policy would be concerned with the institutional mechanisms of wage bargaining.


This exercise returns us to the real, inevitably political questions obscured by technical mumbo jumbo about natural unemployment rates: our overall structure of incomes and opportunities. What should be the distribution of incomes? How much range, between the bottom and the top? Between capital and labor? Between skilled and not? In my view, the present course of rising inequality must be reversed, and liberals should frankly support the political steps required for this purpose. Trade unions should be strengthened and the aggressive new organizing campaigns of the AFL-CIO strongly supported. Minimum wages should be raised. And liberals should strongly defend the progressive income tax, as well as support proposals for wealth taxation.

Once the basic distribution of income has been set right, further gains in real wages can only happen, on average, at the rate of productivity growth. But to keep the distribution from getting worse again, these gains should be broadly distributed, substantially social and only slightly industrial or individual. In other words, we need to return to the principle of solidarity -that the whole society advances together.

Higher minimum wages are especially important for this purpose. In their book, Myth and Measurement, David Card and Alan Krueger argue that raising the minimum wage within a reasonable range would not cost jobs. In fact, higher minimum wages may increase employment by reducing job turnover. This is a doubly important work, once for its direct policy relevance and again because it flatly contradicts, and deeply undercuts, standard models of the aggregate labor market.

Interest Rates

Low and stable has to be the watchword. Interest rates should lose their present macroeconomic function, which has been to guarantee stagnation. They should serve instead to arbitrate the distribution of income between debtors and creditors, financial capital and entrepreneurship. As a first approximation, real rates of return on short-term money should be zero. And there is no reason why long-term rates of interest in real terms should exceed the long-term real growth rate of the economy. Indeed they should lie below this value, effecting a gradual redistribution of wealth away from the creditor and toward the debtor class and a long-term stabilization of household and company balance sheets. Speculation in asset markets should be heavily taxed.


Ironically, the budget deficit hardly comes up in this discussion. During the postwar boom, we were a high-employment, low-inflation, low-interest-rate society with a progressive tax structure. Such societies do not have structural-deficit problems. A peacetime military budget would also greatly help. At any rate, the present fixation on balancing the budget is nonsense, as all serious economists should loudly declare.

The above, all taken together, would be a macroeconomic policy to fight for! The liberal microeconomic supply-siders can do some useful things – or think they can – by getting a little money into education, training, infrastructure. But the point is to raise living standards, to increase security and leisure, and to provide jobs that are worth having. And that requires us to reclaim macroeconomics as a major policy tool.

A final thought from Harvard’s Niall Ferguson in The Telegraph:

It wasn’t just that Friedman rehabilitated the quantity theory of money. It was his emphasis on people’s expectations that was the key; for that was what translated monetary expansion into higher prices (with positive effects on employment and incomes lasting only as long as it took people to wise up). In this, as in all his work, Friedman combined scepticism towards government with faith in individual rationality and therefore freedom.

The list of libertarian reforms he urged is an impressive one: the abolition of the draft; the abolition of fixed exchange rates; vouchers to allow parental choice in education; tax credits instead of government handouts. Nevertheless, it will be for monetarism — the principle that inflation could be defeated only by targeting the growth of the money supply and thereby changing expectations — that Friedman will be best remembered.

Why then has this, his most important idea, ceased to be honoured, even in the breach? Friedman outlived Keynes by half a century. But the same cannot be said for their respective theories. Keynesianism survived its inventor for at least three decades. Monetarism, by contrast, predeceased Milton Friedman by nearly two.

The death of monetarism is usually explained as follows. In the course of the 1980s, pragmatic politicians and clever central bankers came to realise that it was difficult to target the growth of the money supply. As Chancellor of the Exchequer, Geoffrey Howe preferred to raise interest rates and reduce public sector borrowing. His successor Nigel Lawson targeted the exchange rate of the pound against the deutschmark.

At the Federal Reserve, too, Friedman’s rules, once zealously applied by Paul Volcker, gradually gave way to Alan Greenspan’s discretion. And, for all the praise he heaped on Friedman last week, Greenspan’s successor Ben Bernanke is dismissive of monetarism. Earlier this year the Fed ceased to track and publish M3 (the broadest monetary aggregate). It is the inflation rate that today’s central bankers want to target, not money (though the President of the European Central Bank, Jean-Claude Trichet, recently came out as a neo-monetarist).

Anti-monetarists point out that the relationship between monetary growth and inflation has simply broken down. Inflation is low nearly everywhere. The latest figure for the annual growth in American core consumer prices is just 2.3 per cent, down from 3.8 per cent in May. Yet the annual growth rate of M3, which diehard monetarists have continued to track unofficially, is just under 10 per cent. Last year, according to the IMF, M2 increased by nearly 13 per cent in the UK. In some emerging markets the figure was higher. Russia’s money supply grew 25 per cent.

Yet simply because consumer price inflation has remained low, money has not become irrelevant. On the contrary: it is the key to understanding the world economy today. For there is nothing in Friedman’s work that states that monetary expansion is always and everywhere a consumer price phenomenon.

In our time, unlike in the 1970s, oil price pressures have been countered by the entry of low-cost Asian labour into the global workforce. Not only are the things Asians make cheap and getting cheaper, competition from Asia also means that Western labour has lost the bargaining power it had 30 years ago. Stuff is cheap. Wages are pretty flat.

As a result, monetary expansion in our time does not translate into significantly higher prices in shopping malls. We don’t expect it to. Rather, it translates into significantly higher prices for capital assets, particularly real estate and equities. The people who find it easiest to borrow money these days are hedge funds and private equity firms. Through leveraged buy outs, the latter can easily acquire companies and, by improving their cashflow, boost their valuations. These guys then buy houses in Chelsea with the millions they make.

It makes sense. Consumer goods are plentiful: the supply of computing power has grown even faster than the supply of credit to consumers. But shares in Chinese banks and houses with Chelsea postcodes are scarce, while the supply of credit to their potential purchasers seems almost infinite.

No one can say for sure what the consequences will be of this new variety of inflation. For the winners, one asset bubble leads merrily to another; the key is to know when to switch from real estate to paintings by Gustav Klimt. For the losers, there is the compensation of cheap electronics.


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