Transcript Milton Friedman and Monetarism

Milton Friedman, 1912 – 2006
• Born in Brooklyn, 1912
– Immigrant parents
• BA, Rutgers, 1932
– Arthur F. Burns, Homer Jones
• MA, Chicago, 1933
– Viner, Knight, Simons
• Columbia: Statistics
• Washington/Treasury
– Keynesian taxes to combat inflation
• There’s no such
thing as a free
lunch.
• NBER/Kuznets
– Consumer Budgets
– Professional Income
• War Research: constrained
optimization
– Anti-aircraft missile
– Sequential Sampling
– Proximity fuse
• PhD, Columbia, 1946
• U. of Chicago, 1946–1977
– Clark Medal, 1951
– Nobel Memorial Prize, 1976
• Hoover Institution, 1977-2006
Milton Friedman (1912 - 2006): Major Works
People tend to attribute to me a long-term plan…I did no planning.
Things just happened in the order in which they happened to happen.
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"Professor Pigou's Method for Measuring Elasticities of Demand From Budgetary Data"
Quarterly Journal of Economics Vol. 50, No. 1 (Nov., 1935), pp. 151-163
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A Monetary and Fiscal Framework for Economic Stability, American
Economic Review, June 1948
Utility Analysis of Choices Involving Risk" with Leonard Savage, 1948,
Journal of Political Economy Vol. 56, No. 4 (Aug., 1948)
"The Expected-Utility Hypothesis and the Measurability of Utility", with
Leonard Savage, 1952, Journal of Political Economy (Dec., 1952)
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The Methodology of Positive Economics (1953)
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Essays in Positive Economics (1953)
"The Quantity Theory of Money: A restatement", 1956, in
Friedman, editor, Studies in the Quantity Theory of Money.
A Theory of the Consumption Function (1957)
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Permanent income hypothesis
A Program for Monetary Stability (Fordham University Press, 1960)
Price Theory (1962),
• A Monetary History of the United States, 1867-1960,
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with Anna J. Schwartz, 1963. Part 3, The Great Contraction
The Relative Stability of Monetary Velocity and the Investment
Multiplier in the United States, 1897-1958, Commission on Money
and Credit, 1963, with David Meiselman
The Role of Monetary Policy, American Economic Review,
(Mar., 1968)
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Expectations augmented Phillips Curve/natural rate of unemployment
The Optimum Quantity of Money And Other Essays (1976)
Milton Friedman's Monetary Framework: A Debate with His
Critics (1975)
Inflation and Unemployment: Nobel lecture, 1977, Journal of
Political Economy. Vol. 85, pp. 451-72.
Monetary Trends in the United States and the United Kingdom: Their
relations to income, prices and interest rates, 1876-1975. with Anna J.
Schwartz, 1982
Quantity Theory of Money, in J. Eatwell, M. Milgate, P. Newman, eds.,
The New Palgrave (1987)
"Franklin D. Roosevelt, Silver, and China," Journal of Political
Economy Vol. 100, No. 1 (Feb., 1992), pp. 62-83
The Chicago School: Price Theory Rules
• Frank Knight—foundations of price theory:
logic, not quantification
– Antipathy to monopolistic competition and
Keynesian intervention muddying competitive
market ideal
• Henry Simons—supported intervention in
imperfect markets & progressive income tax
– Stabilize price level!
• 100% reserve banking
• Rules not discretion
• Oskar Lange—a market socialist
– Rebuilt department shook up by WWII
– Left to serve communist Poland: ambassador to UN
Positive economics: focus on relative prices
Empirical Emphasis
Logical emphasis
Friedman/Stigler
Coase/Buchanan
Extension of economics: Disciplinary Imperialism
• Becker: Discrimination, time, home economics
• Posner: Law and economics
• Stigler/Buchanan: Public choice (political mkts)
• Modigliani-Merton Miller: Efficient markets
Ideas of Milton Friedman
• Positive economics is in principle independent
of any particular ethical position or normative
judgments … it deals with “what is,” not with “what
ought to be.”
• The ultimate goal of a positive science is … a theory
or hypothesis that yields valid and meaningful
predictions about phenomena not yet observed …
[T]heory is to be judged for its predictive power ...
The choice among alternative hypotheses equally
consistent with the available evidence … [is]
suggested by the criteria of “simplicity” and
“fruitfulness”… within a given field of
phenomena.
• Truly important and significant hypotheses will have
“assumptions” that are wildly inaccurate descriptive
representations of reality … A hypothesis is
important if it “explains” much by little …
[T]he relevant question is not whether
[“assumptions”] are descriptively realistic … but
whether they are sufficiently good approximations
for the purpose in hand.
• Economics is a “dismal” science because it
assumes man to be selfish and money-grubbing …
it assumes markets to be perfect, competition to be
pure, and commodities, labor, and capital to be
homogeneous … [C]riticism of this type is largely
beside the point unless supplemented by evidence
that a [different] hypothesis yields better
predictions.
More Ideas of Milton Friedman
“ I never reached a judgment about monetary or fiscal
policy because of my belief in free markets. ”
• A Monetary and Fiscal Framework for Economic
Stability, AER 1948
– Eliminate private creation of money and discretionary
control of Ms by central bank 100% reserve banking
– Base G on community’s desire, need, and willingness
to pay for public services
– A predetermined program of transfer payments
– A progressive personal income tax system
 Rely on automatic stabilizers
… countercyclical action … [can] do too much as well as
too little. (1951)
• The Case for Flexible Exchange Rates (1950)
• Instability of exchange rates is a symptom of instability
in the underlying economic structure. Elimination of this
symptom by administrative freezing cures none of the
underlying difficulties and only makes adjustment to
them more painful.
• Studies in the Quantity Theory of Money (1956)
– The Quantity Theory of Money: A Restatement
• There is perhaps no other empirical relation in
economics that has been observed to recur so uniformly
under so wide a variety of circumstances as the relation
between substantial changes over short periods in the
stock of money and in prices …
– Phillip Cagan, Monetary Dynamics of Hyperinflation
• Adaptive expectations and stable money demand
– John Klein, German Money and Prices, l932-44
– Eugene Lerner, Inflation in the Confederacy, 1861-65
– Richard Seldon, Velocity in the United States
Yet More Ideas of Milton Friedman
• A Theory of the Consumption Function (1957)
– “Errors” are in income, not in consumption
Permanent income hypothesis
• A Monetary History of the United States (1963)
• … inflation is always and everywhere a monetary
phenomenon.
• …small events at times have large consequences. A
liquidity crisis in a fractional reserve banking system is
precisely the kind of event that can trigger – and often
has triggered – a chain reaction. And economic collapse
often has the character of a cumulative process. Let it
go beyond a certain point, and it will tend for a time to
gain strength from its own development as its effects
spread and return to intensify the process of collapse.
Because no great strength would be required to hold
back the rock that starts a landslide, it does not follow
that the landslide will not be of major proportions.
• The Role of Monetary Policy (1968)
– Adaptive Expectations
Vertical Long-run Phillips Curve
 Accelerationist Hypothesis
• Capitalism and Freedom (1962)
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Money growth rule (3 – 5% per year)
Floating exchange rates
Negative income tax
School vouchers
End occupational licensure
“Why Not a Volunteer Army?” (1967) / Gates
Commission (1968)
Paul Samuelson on Naïve Monetarism
• The pity increases for one who adopts a
simple theory of positivism that exonerates a
nominated theory (the quantity theory), even if
its premises are unrealistic, so long as it
seems to describe with approximate accuracy
some facts. Particularly vulnerable is the
scholar who tries to test competing theories
by submitting them to simplistic linear
regressions with no sophisticated calculations
of Granger causality, cointegration,
collinearities…
• The proof of the pudding is in the eating.
There was a widespread myth of the 1970s…
A new paradigm, monistic monetarism, gave a
better fit. King Keynes is dead! Long live King
Milton! [But] contemplate the true facts…In
terms of accuracy…never did post-1950
monetarism score well.
Empirical Defense of Monetarism
• Phillip Cagan (1965)
Correlation between M and Y & P runs mostly
from M  Y & P
• Andersen and Jordan (1968)
$Y = f(Lagged 𝜟M, lagged ΔG)
The gospel according to St. Louis
• Brunner and Meltzer (1976)
Financing deficit with Money vs. Bonds
M  $Y  Y (first) & P
 $Wealth  C  Y
Bonds  Wealth  C  Y
So Money matters most
• Christina and David Romer (2004)
“Intended” fed funds rates inferred from
statements made around FOMC meetings
purged of information in Fed’s Green Book
 policy shocks—moves by the Fed
independent of economic conditions.
They find that [monetary] policy has large,
relatively rapid, and statistically significant
effects on both output and inflation.
Monetarism: Spreading the Word
Shadow Open Market Committee
Journal of Money, Credit and Banking
Carnegie-Rochester Conference
Series on Public Policy
Karl Brunner
1916 – 1989
Journal of Monetary Economics
Allan Meltzer
1928 Meltzer: I was very much a left-wing activist as a student.
Major Works by Meltzer
•Keynes’ Monetary Theory:
A Different Interpretation, 1988.
•A History of the Federal Reserve,
•volume 1, 1913-1951, 2002;
volume 2, 1951 – 1969, 2010.
Early Joint Works: Meltzer with Brunner
"Predicting Velocity: Implications for theory and policy", with K. Brunner, 1963, J of Finance
The Federal Reserve's Attachment to the Free Reserves Concept, with K. Brunner, 1964.
An Alternative Approach to the Monetary Mechanism, with K. Brunner, 1964.
"Some Further Investigations of Demand and Supply Functions for Money", with K. Brunner, 1964, J of Finance
"The Meaning of Monetary Indicators", with K. Brunner, 1967, in Horwich, editor, Monetary Process and Policy.
"Economies of Scale in Cash Balances Reconsidered", with K. Brunner, 1967, QJE.
"Liquidity Traps for Money, Bank Credit, and Interest Rates", with K. Brunner, 1968, JPE
"The Nature of the Policy Problem" with K. Brunner, 1969, in K. Brunner, editor,
Targets and Indicators of Monetary Policy.
"The Uses of Money: Money in the Theory of an Exchange Economy" with K. Brunner, 1971, AER
"Friedman's Monetary Theory" with K. Brunner, 1972, JPE
"Money, Debt and Economic Activity" with K. Brunner, 1972, JPE
"A Monetarist Framework for Aggregative Analysis" with K. Brunner, 1972, Kredit und Kapital
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Later Joint Works
"Strategies and Tactics for Monetary Control", with K. Brunner, 1983, CROCH
"Money and Credit in the Monetary Transmission Process", with K. Brunner,
1988, AER
Money and the Economy: Issues in monetary analysis, with K. Brunner, 1989.
Monetary Economics, with K. Brunner, 1989.
"Money Supply", with K. Brunner, 1990, in Friedman and Hahn, editors,
Handbook of Monetary Economics
Monetarism in Theory and Practice
• Theory: M  P and Y in short – run
M  P in long - run
• Friedman’s restated quantity theory
• Expectations augmented Phillips Curve
 Vertical long – run Phillips Curve
 “Monetary mischief”
• Practice: oppose Keynesian activism
• Monetary vs. fiscal policy: what matters?
• Inherent stability vs. instability of
enterprise economy
• Policy: Long – run vs. short – run focus
• Varying policy lags … “too much too
late”
» Steady money growth as
automatic stabilizer
The Monetarist Mantra
Long-run price and growth stability
• Rules, not discretion
– Steady growth of monetary aggregate: M1, M2, MB
• Automatic stabilizer
• Quantity Theory Framework: Stable (M/P)d
• Classical Dichotomy
• Natural Rate Hypothesis
– Expectations Augmented Phillips Curve
• Vertical Long-Run Phillips Curve
• “Treasury View” – Fiscal Policy Crowded Out
– Andersen & Jordan: The Gospel According to St.L.
• M Impacts > G Impacts
• Flexible Exchange Rates: No Price Controls
– International Monetarism: Johnson & Frenkel
• Monetary Theory of the Balance of Payments
• Monetary Theory of the Exchange Rate
• Control of money supply justified to maintain
price stability—a stable value of money.
The Great Depression: “Holy Grail of
Macroeconomics”
• Lionel Robbins (1934) The Great Depression
• J.K. Galbraith (1955) The Great Crash: 1929
• Friedman and Schwartz (1963) The Great
Contraction
• Murray Rothbard (1963) America’s Great Depression
• Charles Kindleberger (1973) The World in
Depression: 1929 - 1939
• Robert Lucas and Edward Prescott (1970s)
– Real Business Cycle Theory
• Peter Temin (1978) Did Monetary Forces Cause the
Great Depression?
• Hyman Minsky (1982) Can “It” Happen Again?
• Ben Bernanke (1983) Nonmonetary Effects of Financial Crisis in Propagation of the Great Depression
• Peter Temin (1989) Lessons from The Great
Depression
• Barry Eichengreen (1992) Golden Fetters: The Gold
Standard and the Great Depression, 1919-1939
• Edward Prescott (1999) Some observations on the
Great Depression
• Richard Koo (2008) The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession
• C. Reinhart and K. Rogoff (2009) This Time is
Different: Eight Centuries of Financial Folly