When Milton Friedman, an American economist, began his career as professor at Chicago University during the 1950s and 1960s, Keynesian ideas were the dominant force in macroeconomic analysis. In the years following, the World War II Western governments, with the depression of 1930s still fresh in their minds, began to move away from the laissez-faire approach to economic management that had until then been the dominant force in most capitalist states. But by 1976, the year Freidman collected his Nobel Prize, Keynes’ hegemony in economics had, for a while it seemed, been overthrown with monetarism firmly established as the new orthodoxy.
Inflation: it’s the money supply
Friedman’s economic theories led to many important developments in the 20th Century – however, it was his restating of the quantity of money theory that cemented his reputation as a leading economist and earned him the Nobel Prize.
In the late 1950s, a New Zealand-born economist A.W. Phillips gained recognition for his observation of a historical correlation between unemployment and inflation. Periods of high unemployment were often accompanied by periods of low inflation, and vice versa. However, governments, mistakenly, came to believe this historical correlation suggested a permanent trade-off between inflation and unemployment. If a government wanted to stimulate employment, then that increase could, in a sense be bought, at the expense of higher inflation.
Friedman pointed out that the relationship between the two may hold – up to a point – but there could be no permanent trade-off. Inflation might lead to higher levels of employment because it becomes increasingly profitable to hire workers if prices rise faster than wages. However, if high levels of inflation continue for a sustained period then workers, understanding that their purchasing power is being diminished, will begin to bargain for higher wages in advance. Eventually, wages will to rise again in line with inflation and higher unemployment will inevitably result, whatever adjustments governments make.
“During the 1950s and 1960s, it looked as if Keynesian interpretation was right,” Friedman would later recall. “After all we had relatively prosperous countries, relatively stable prices as well as relatively low interest rates – it was a golden era.”
But this ‘golden era’ proved to be very short-lived. In 1973, an oil embargo declared by the Arab members states of OPEC knocked the wind out of the global economy and, as inflation and unemployment soared, helped to trigger a crisis of faith in the Keynesian paradigm. According to Friedman, “during the 1970s, you had a combination that under Keynesian analysis could not exist. You had high inflation and high unemployment at the same time – something named ‘stagflation’. It was that experience, more than anything, that led to a change in public and intellectual attitudes towards money.”
Under the strain of the 1973 Oil Crisis, the historical correlation between the rate of inflation and unemployment broke down – as Freidman had foreseen five years earlier. Predicting the occurrence of stagflation cemented Friedman’s status as one of the leading economic thinkers of the day with both his peers and the wider public. His insight also prompted a paradigm shift in the political economy of the day; helping to smash the Keynesian consensus by providing intellectual backbone to the neoliberal reforms enacted when Ronald Reagan and Margaret Thatcher came to power in the late 1970s and early 1980s.
Monetarism, the economic school of thought promoted by Friedman as an alternative, contended that since inflation was a problem of “too much money chasing too few goods”, limiting the growth of the money supply would be the most effective solution to the problem of stagflation. To keep inflation in check, he recommended that central banks should be tasked with increasing the money supply at a steady, low rate of 2%-3% from which they would not be permitted to deviate, regardless of how the economy is performing. His instinctive distrust of central bankers even led him to propose a more radical, although perhaps less realistic, remedy – getting rid of them altogether. “I’ve always been in favour of abolishing the Federal Reserve and substituting it for a machine programme that will keep the quantity of money going up at a steady rate,” he once said.
A free market ideologue
Friedman did not spend his entire career as a public intellectual working to produce largely apolitical analyses of economic phenomena such as inflation. There was also another side – Friedman, the free market ideologue.
Using a range of media platforms, such as his weekly column in Newsweek and his TV series ‘Free to Choose’, he persistently endeavoured to spread the gospel of free markets. On this principle, he saw no room for compromise. Whatever the issue was – healthcare, education, even the global trade in recreational drugs – he favoured free market solutions and steadfastly opposed any call for government intervention.
His tireless efforts appeared to be rewarded. In the 1980s, Western economies began to shift back to the same laissez-faire approach to economic management that had prevailed prior to the Keynesian revolution. Protectionist trade policies began to be reversed, regulation was loosened and the public sector beat a hasty retreat from many areas of national economies. Today, most economic historians acknowledge that Friedman’s free market activism was a factor in the speed of this ideological reversal, even if the economic mess of the late 1960s and 1970s had made the return to liberal economics almost inevitable.
Monetarism – a flawed idea?
Through his work on prices, Friedman had correctly identified the in-built weaknesses of the Keynesian approach to economics that had brought about stagflation in a number of capitalist nations in the 1970s. However, some economists today continue to dispute whether the solution he prescribed, monetarism, achieved its objectives when put into practice. In the early 1980s, both the US and UK experimented with monetarist policies, attempting to control inflation by limiting the growth of the money supply. The results were mixed.
In the US, unemployment soared and the experiment was quickly abandoned. Meanwhile, under the rule of Friedman’s loyal disciple Margaret Thatcher, the UK persisted with monetarist policy. Inflation was successfully brought under control, reduced to 4.3% by 1983, down from an astronomical rate of 27% in the mid-1970s.
Since then, central banks in Western economies have adopted a much more flexible approach than the one Friedman advocated. The US Federal Reserve, for instance, responded to recession in 2001 by slashing interest rates and allowing the money supply to inflate. Then, once the return to growth was assured, interest rates were raised and growth of the money supply dropped to zero. And all this, it should be noted, took place even under the supervision of the self-proclaimed monetarist Alan Greenspan.
Paul Krugman, the Economist and New York Times columnist, is one of the most high profile critics of monetarist theory. Writing in 2007 an essay for the New York Review of Books, he contended that modern central banks were remarkably successful in their application of the “discretionary fine-tuning that Friedman decried”. Inflation, he wrote, by and large remained at acceptable levels throughout the 1990s and early 2000s, and recessions, when they occurred, tended to be briefer and shallower compared to downturns in the previous decades – this, of course, was written prior to the cataclysmic events that unfolded in the autumn of 2008.
But if the experiences of Western economies in the past two decades raise questions on the practical applicability of monetarism, the story of China’s stratospheric ascent during the post-Mao years offers some evidence to the contrary. In 1988, authorities in Beijing, troubled by double-digit inflation, turned to Friedman for guidance. As expected, Friedman advised the Chinese leadership to rein in growth of the money supply – the alternatives, price controls or rationing would only serve to exacerbate the problem, he argued. China took Friedman’s advice and inflation returned to acceptable levels where it has since remained.
The ‘miracle of Chile’
Friedman’s role in the supposed ‘miracle of Chile’ is undoubtedly the most contentious facet of his legacy. In the early 1970s, Chile suffered a severe economic crisis followed by a social and political crisis. The outcome, the overthrow of the democratically-elected government of socialist President Salvador Allende in a coup d’état by General Augusto Pinochet, proved to be the watershed moment – not only in the history of Chile, but also in the Cold War.
After seizing power, Pinochet and his military junta, acted on the advice of Friedman and the ‘Chicago Boys’ and quickly set about undoing the economic and public policies of his predecessor. State enterprises were auctioned off, financial and trade regulations were abolished and the countries nascent welfare state dismantled.
The fact that Chile now stands as one the strongest economies in the Americas is, Friedman’s acolytes argue, a testament to the value of economic liberalism. Others, including Krugman and Indian economist Amartya Sen, insist that sustained economic growth was only truly realised until the late 1980s, by which time Pinochet’s hard-line free market policies had been considerably softened.
But whatever view one takes on the economics, Friedman’s association with a regime which violently disposed of an elected government and crushed dissent from left-wing activists and union members with torture and murder is undeniably a blemish on his reputation. Friedman was once reported to have said that, “history suggests that capitalism is a necessary pre-condition for political freedom.” But the history of Chile in the latter part of the 20th Century seems to suggest something entirely different.
The return of Keynes?
Today, history seems to have come full circle. Following a financial crisis that has been widely described as the worst since the 1930s, it seems only natural that governments across the world once again turned to the ideas of Keynes.
In the immediate aftermath of the 2008 crisis, governments in the US and Europe proceeded to enact large fiscal stimulus packages; borrowing and spending to offset falling demand in the private sector. It was precisely the solution Keynes would have prescribed, and precisely the sort of move Friedman would have opposed.
But those who argued that the financial crisis spelled the end of Friedman’s contemporary relevance were perhaps guilty of speaking too soon. For one thing, the austerity measures enacted in the UK and Europe over the past few years appear to be straight out of the Friedman textbook. He would have certainly approved of the logic, frequently espoused by the governments of the UK and Germany, which says that nations cannot address a budget deficit by spending money. However, he would have set delimited time periods to quantitative easing (QE), as he did during Japan’s deflationary crisis in the 1990s when he advocated “until the high powered money starts getting the economy in an expansion”.
