by The Spectator, 13 January 2024 Monetarism, with which his name is associated, has long defined economic policy. But what would Friedman have made of the banking collapse, so soon after his death in 2006? The Keynesian economist Nicholas Kaldor called Milton Friedman one of the two most evil men of the 20th century. (Friedman was in distinguished company.) The ‘scourge’ he inflicted on the world was monetarism, a product of what Kaldor called Friedman’s Big Lie – of which more later. Moral judgments aside, how does Friedman rank in the world of 20th-century economists? By common consent, he stands with Friedrich Hayek and John Maynard Keynes at the apex of his profession. All wrestled with the defining problem of their age: the radical economic and political instability of the
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The Spectator, 13 January 2024
Monetarism, with which his name is associated, has long defined economic policy. But what would Friedman have made of the banking collapse, so soon after his death in 2006?
The Keynesian economist Nicholas Kaldor called Milton Friedman one of the two most evil men of the 20th century. (Friedman was in distinguished company.) The ‘scourge’ he inflicted on the world was monetarism, a product of what Kaldor called Friedman’s Big Lie – of which more later. Moral judgments aside, how does Friedman rank in the world of 20th-century economists? By common consent, he stands with Friedrich Hayek and John Maynard Keynes at the apex of his profession. All wrestled with the defining problem of their age: the radical economic and political instability of the 1920s and 1930s.
Their responses reflected their national situations. Keynes, economically secure and confident in Britain’s political aristocracy, turned to the state to provide the stability lacking in markets. Hayek, fleeing the hyperinflation of central Europe, saw the state as the cause, not healer, of economic disasters. Friedman, the aspiring son of Jewish immigrants, put his faith in the ‘land of opportunity, in which anything is possible’. Keynes, I think, was the greatest of the three because he invented a new branch of economics – macroeconomics – to explain how markets might fail spontaneously, whereas Friedman and Hayek simply added refinements to the story of how government interference could wreck spontaneously perfect markets.
Friedman’s genius was to repackage classical economics for conservative political use. His was a ‘creative conservatism’, writes Jennifer Burns, in the ‘first full-length biography of Friedman based upon archival research’. His 1956 essay ‘The Quantity Theory of Money – A Restatement’ is a good example of this. His economic work consisted of a series of fertile restatements of the core ideas of classical economics assembled as artillery against the assault of Keynesians and planners.
He conducted the war with such panache that monetarism has defined the economic policy of the past 40 years, just as Keynesian economics defined that of the previous 40. Like all counter-revolutions, Friedman’s was not a simple going back. He understood that there were new facts on the ground, which is why the doctrine of monetarism with which his name is associated came to define the post-Keynesian, not pre-Keynesian, world. The measure of his success is that whereas after the war the ideas of the right were shaped by the left, after Friedman the ideas of the left were shaped by the right.
In 1976 he won the Nobel prize for his achievements in the ‘field of consumption analysis, monetary history and theory and stabilisation policy’. As the story of the counter-revolution has been exceptionally well told in Daniel Stedman Jones’s Masters of the Universe: Hayek, Friedman, and the Birth of Neoliberal Politics (2012), one looks to a new biography of Friedman for added value.
For almost a decade Burns, a history professor at Stanford University, has immersed herself in more than ‘200 paper-stuffed boxes’ of Friedman material, though this treasure trove does not include the letters between Milton and his widow Rose, who had burnt them. Burns’s book is ostentatiously an insider’s job, the inside being Stanford University’s Hoover Institution, which houses Friedman’s archive.
Keynes country and even Hayek country are foreign to her. Her prose is serviceable (though too full of acronyms and American slang for my liking) and her economics sound. She adds to our understanding of Friedman’s economics in four ways: by relating his ideas to the circumstances of his life; by highlighting his critique of mainstream methodology; by drawing attention to the coterie of women economists ‘critical to every stage of his career’; and by relating his influence to the global dominance of the United States in the second half of the 20th century. As American power, hard and soft, replaced Britain’s, so Friedman’s ideas replaced Keynes’s. Burns offers a history of ideas situated in a peculiarly American milieu.
he British Labour politician Denis Healey once called Friedman ‘a Jewish leprechaun’ – a reference to both his ethnicity and his height (5ft). Burns shows how these traits shaped Friedman’s pugnacious style and university career. They gave him the chutzpah to challenge his elders, and pushed his university life westwards. When his academic career started in the early 1930s, East Coast Ivy League universities still shielded themselves from clever Jews by not appointing them to faculty positions. Chicago, being more meritocratic, was more hospitable. From 1934 it became Friedman’s academic base, where till the 1970s he ‘schlumped around in ill-fitting suits… a short Jewish guy who talked too fast’.
Jewish émigrés from Tsarist and Nazi persecutions greatly influenced the development of 20th-century American economics in two different directions. On the one hand, they saw a land of unlimited opportunity; on the other, precious protection against tyranny. Friedman fell into the first, conservative camp. He was attracted by the chance American life afforded to anyone of ability and enterprise to rise to the top, not by its guarantees of human and political rights. On the other side, for economists like Paul Samuelson, one huge attraction of an American Keynesianism was that it promised policy antidotes to European fascism and communism. For Friedman, economic freedom was sufficient antidote.
He soon fell under the spell of what Burns calls ‘Chicago price theory’, and its main expositor, Frank Knight. This intransigent version of traditional microeconomics held that all social problems would yield to competitive prices. Knight’s special contribution was to hook the defence of the price system to uncertainty. The willingness to act despite uncertainty was the source and justification of profit. Chicago’s social and cultural isolation from the East Coast universities gave its price doctrine an extremist character. Burns emphasises its religious hold on all those who passed through the sacred portals of Room 7, where Knight held court, supported by the praetorian guard of Henry Simons and Aaron Director, the brother of Rose Director, whom Friedman married in 1935.
Burns sees Room 7 as the seedbed of modern conservative economics. The aim of turning society into an auction market would give Friedman’s life its political direction. He and Rose had their writing paper embossed with an elementary supply and demand diagram representing the perfect equilibrium not just of a single market but of market society. In 1951, Jacob Viner talked of a ‘Chicago School’ engaged in an organised battle for laissez-faire and the ‘quantity theory of money’ vs ‘imperfect competition theorising and Keynesianism’.
Chicago price theory might be the ‘untouchable core of economics’, but more than its passionate iteration was needed in the early 1930s as the United States led the world into the greatest economic depression in modern times. Unlike the Hayekians, who saw the depression as nature’s way of liquidating unsound investments, Chicago professors urged ‘generous federal expenditures’ to check severe depression and deflation. This was admittedly ambulance work. The deeper problem was to explain how the emergency had arisen and prevent recurrences of the same disease. The quantity theory of money provided Chicago with the answer, and at the same time its answer to Keynes.
Keynes had posited insufficient aggregate spending power as the cause of economic slump, and ‘autonomous expenditure’ by government as the preventative and cure. It was natural enough for Friedman, a brilliant young scholar in search of an identity, to join battle with the Master. His course may have been set when his mentor, Arthur Burns, suggested he study the role of money in business cycles, and assigned a young statistician, Anna Schwartz, to the project. Monetary theory, then a backwater, gave Friedman his niche, and then his fame. He quickly understood that the quantity theory of money could provide both an explanation of economic instability and an inoculation against the fiscal activism advocated by the Keynesians.
In their massive A Monetary History of the United States, 1867-1960, Friedman and Schwartz showed people’s demand for money (or velocity of circulation) to have been remarkably stable over time. The main periods of economic instability coincided with, and were caused by, erratic movements in the supply of money. This was especially true of the great depression. In his famous address to the American Economic Association in 1967 Friedman said:
“The quantity of money in the United States fell by one third in the course of the contraction [of 1929-33]. And it fell not because there were no willing borrowers… It fell because the Federal Reserve System forced or permitted a sharp reduction in the monetary base.“
This is where Kaldor’s assertion of the Big Lie comes in. Kaldor pointed out that Friedman’s own published data in A Monetary History showed a continued increase in the monetary base (high-powered money) between 1930 and 1933, together with a steep contraction of ‘broad money’, which includes bank credit. In other words, it was the shortage of borrowers not the shortage of money which had caused the decline in bank lending. Money passively reflected the state of confidence, as Keynes had claimed. There was much subsequent argument about Friedman’s data, and the problem of causation between money, prices and real activity remains unresolved.
Friedman wrote in 1982:
“Only a crisis – actual or perceived – produces real change. When the crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.“
It was the stagflation of the 1970s, not the great depression, which brought monetarism to power by seeming to offer a double confirmation that erratic money causes an erratic economy.
Just as the depression of the 1930s was caused by the Federal Reserve Board printing too little money, so the inflation of the 1970s was caused by the Fed printing too much, at the behest of a government committed to an unrealistic level of full employment. Once more Friedman took on the Keynesians, who this time had no explanation for the simultaneous explosion of unemployment and inflation. Against their contention that the inflation was a ‘cost-push’ phenomenon caused by overpowerful trade unions, Friedman insisted that inflation was ‘always and everywhere a monetary phenomenon’. He developed his theory of ‘adaptive expectations’ to show the futility of governments trying to push unemployment below its ‘natural rate’ – the rate which would prevail if prices were stable. All that would do would be to stoke inflation without reducing unemployment.
The need was for a policy rule, enforced by an independent central bank, to stop governments from inflating the money supply. Stable money meant stable prices. Stable prices meant stable business expectations, and stable business expectations meant a stable economy. The only planning of capitalism was the planning of money: everything else would thrive unplanned.
Monetarism was Friedman’s main contribution to economic theory and policy. He pioneered other initiatives supportive of market-based conservatism: the ‘permanent income hypothesis’ which suggested that economies were more cyclically stable than Keynes had supposed; ‘helicopter money’ in the form of a negative income tax to provide welfare for the poor without a state bureaucracy to administer it. Floating exchange rates, to replace the collapsed Bretton Woods system of fixed exchange rates, was a further extension of Chicago price theory.
His economics was also conservative in method. Running through the book, but difficult to summarise, is the story of his battles against the strong current of American institutionalism which stood for a ‘realistic’ economics. Like Keynes and Hayek, Friedman defended ‘unrealism of assumptions’ as the only way of making safe generalisations in economics. The test of a good theory is whether it produces good results, not on whether it mimics reality. In 1945 he got fiercely embroiled with the Cowles Commission for Economic Research, newly housed in Chicago University and funded by a wealthy investor, to develop a science of picking stocks. Friedman attacked its belief that good enough market simulations would open the way for the omniscient planner, making actual markets superfluous. He stood apart from the rational expectations revolution developed by his Chicago disciple Robert Lucas for exactly this reason: if the future was ergodic (i.e. probabilistic) there would be no need for markets.
Friedman died in 2006, aged 94. It would have been good to know how he would have explained the banking collapse of 2007-8, and the efforts of his admirer Ben Bernanke to avoid the mistakes of the Fed of 1930, both of which suggested that something more than money supply was involved in the good functioning of economies. Burns is sympathetic to Friedman; but to understand all does not mean to forgive all. Among his ‘blind spots and imperfections’ were his negative attitude to human rights, his lovefest with Barry Goldwater, his opposition to the 1964 Civil Rights Act and his engagement with the Pinochet dictatorship in the 1970s.
Burns argues that Friedman didn’t so much endorse Pinochet as attack his predecessor as threatening to bring left-wing totalitarianism to Chile. The economic market was more democratic than the political market. She recognises that this view became increasingly ‘unfashionable’ in the dawning era of human rights, defined by sanctions, boycotts, and de-investments, through which activists ‘found power in purity’. Nor could the ‘land of opportunity’ of which Friedman wrote so lovingly as a youngster have survived the culture wars which erupted in his last years.’ The Last Conservative’ sounds right.