The legacy of Milton Friedman

Milton Friedman died recently at the age of 94. What were his central ideas and how did he change the way economies are run? Simon Wilson explains.

Why was Milton Friedman important?

He was one of a tiny handful of economic thinkers who have combined outstanding academic achievement (Friedman headed the influential Chicago School of Economists and was awarded the Nobel prize in 1976) with a popular following, including among the world's most powerful policy-makers. In Friedman's case, his espousal of individual freedom, small government, and monetarism' make him the major economist of the past half century. The only other 20th-century economists who can be placed in the same bracket are (certainly) John Maynard Keynes the great Cambridge economist of the generation before Friedman and (more arguably) JK Galbraith, Friedman's contemporary and bitter economic foe.

What were Friedman's main ideas?

There are three key areas. First, the permanent income' hypothesis, set out in 1957's Theory of the Consumption Function. Here, Friedman showed that household spending is not determined by short-run fluctuations in income, but on long-run expectations of permanent income. This helped to pull the rug out from under the prevailing economic orthodoxy of the mid-century, Keynesianism, since it radically undermines the case for using fiscal policy (ie, taxes and spending) to manage demand. It also helped open up a whole new area of study consumption as a legitimate subject for economics. Second is the idea of the natural rate' of unemployment. Before Friedman, it was widely accepted by economists that there exists a natural trade-off between inflation and unemployment; that governments could choose a slightly higher inflation rate for a slightly lower rate of unemployment. Friedman's counter-argument, set out in 1967, that trying to hold unemployment at unrealistically low levels would produce ever-higher levels of inflation, was spectacularly borne out by events in the 1970s. Friedman believed the best way to beat unemployment is to keep inflation low and then tackle supply-side' issues, such as flexibility in the labour market. The idea of the natural rate, is related to his third major idea: monetarism.

What is monetarism?

As formulated by Friedman between 1956 and 1963, it is the argument that the expansion of the money supply is inherently inflationary, and that governments should take as their macroeconomic task simply the maintenance of price stability (by controlling the money supply). The main work on this is A Monetary History of the United States, 1867-1960.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

In it, Friedman looked in minute detail at the relationship between the money supply and prices a rise in the first leads to a rise in the second and concluded that inflation can be controlled by adjusting the money supply through changes in interest rates.

Is monetarism right wing'?

Yes and no. It is true that, in practice, monetarism has been most closely associated with conservative economists and politics. Friedman himself was a great admirer of president Ronald Reagan, who in turn was a big fan of the economist.

In Britain, Friedman is often cited as the inspiration behind Thatcherite economics and the harsh, but ultimately necessary, reforms of the 1980s, when monetarist' became a little-understood catch-all term of abuse for right-wing' economic thinking. Certainly, Friedman was a major influence on Tory policymakers, although Thatcher's own inspiration was the Austrian Friedrich Hayek, an earlier prophet of economic and political liberty. Yet it would be a mistake to think that all conservatives are monetarists, or all monetarists conservatives.

Why's that?

In the 1970s, disillusionment with Keynesian demand-management (it was unable to meet the challenges of stagflation') was far from restricted to the political right. In the US, it was a Democrat president, Jimmy Carter, who appointed the monetarist economist Paul Volcker as the chairman of the Federal Reserve, and left him free to tame inflation by restricting the money supply. In Britain, the Labour prime minister James Callaghan (possibly influenced by his then son-in-law Peter Jay, The Times's Friedmanite economics editor) shocked his party's 1976 conference with a Friedmanite analysis of the UK's economic crisis three years before Thatcher took power.

So we all agree now?

Up to a point, yes. Gordon Brown's first act as Britain's first Labour chancellor in two decades handing the Bank of England the freedom to set UK rates was unashamedly Friedmanite: the Bank's task is to use monetary policy to target a given level of inflation. Even so, few claim that Friedman got everything right. Central bankers might all be monetarists, in that they believe in the efficacy of monetary policy and inflation-targeting but few regard specifically Friedmanite policy prescriptions as practical.

Friedman's libertarianism

The many lengthy obituaries published last week make it clear that Milton Friedman, who was barely five feet tall, was of a pugnacious disposition. A master of lucid analysis and the pithy putdown, Friedman clearly relished the cut and thrust of debate, and was famous for sticking to his principles. For example, Friedman's pro-market philosophy made him a hero of conservatives, but his libertarian ideas frequently guided him into positions that placed him squarely at odds with fellow Republicans. Friedman advocated a free market in prostitution and narcotics and campaigned (with success) against conscription during the Vietnam war this last, he told one interviewer, was his greatest achievement of all.

Simon Wilson’s first career was in book publishing, as an economics editor at Routledge, and as a publisher of non-fiction at Random House, specialising in popular business and management books. While there, he published, a bestselling classic of the early days of e-commerce, and The Money or Your Life: Reuniting Work and Joy, an inspirational book that helped inspire its publisher towards a post-corporate, portfolio life.   

Since 2001, he has been a writer for MoneyWeek, a financial copywriter, and a long-time contributing editor at The Week. Simon also works as an actor and corporate trainer; current and past clients include investment banks, the Bank of England, the UK government, several Magic Circle law firms and all of the Big Four accountancy firms. He has a degree in languages (German and Spanish) and social and political sciences from the University of Cambridge.