Economic
SYNOPSES
short essays and reports on the economic issues of the day
2007
I
Number 1
T
he death of Milton Friedman on November 16, 2006,
led Federal Reserve Chairman Ben Bernanke to
remark that the “direct and indirect influences of
his thinking on contemporary monetary economics would
be difficult to overstate” and President Bush to note that
“his writings laid the groundwork that transformed many
of the world’s central banks.” Undoubtedly a major factor
underpinning these assessments is the overwhelming
influence that Friedman’s work has had on the way that
economists and policymakers look at inflation.
As Friedman emphasized, “Inflation is an old, old disease.
We’ve had thousands of years of experience of it. There is
nothing simpler than stopping an inflation—from the
technical point of view.”
1
That remedy took a specific form: “The only cure for
inflation is to reduce the rate at which total spending is
growing.” This cure involved a temporary side effect, as
Friedman noted: “There is no way of slowing down inflation
that will not involve a transitory increase in unemployment,
and a transitory reduction in the rate of growth of output.
But these costs will be far less than the costs that will be
incurred by permitting the disease of inflation to rage
unchecked.”
On the issue of how economic policy should manage
total spending, Friedman led the profession away from the
weight it gave to fiscal policy. His work was important in
forming the consensus that monetary actions have more
sizable and reliable effects on aggregate spending than fiscal
actions. In fact, Friedman offered the judgment, “I don’t
think monetary policy has to be backed up by fiscal policy
at all. I think monetary policy can curb inflation.” His rea-
soning behind this was straightforward: “A budget deficit
is inflationary if, and only if, it is financed in considerable
part by printing money”—that is, only if fiscal actions are
accommodated by the monetary authorities. In light of the
importance of monetary policy for aggregate spending
behavior, and of total spending for inflation, Friedman
stated the policy implication: “[M]onetary policy is an
appropriate and proper tool [when] directed at achieving
price stability or a desired rate of price change.” This prin-
ciple underlies the monetary policy framework of major
economies today.
Friedman was particularly scathing about “cost-push”
theories, prevalent in the 1960s and 1970s, that attributed
high inflation to autonomous increases in costs rather than
to excess demand. As he observed, “To each businessman
separately it looks as if he has to raise prices because costs
have gone up. But then, we must ask, ‘Why did his costs go
up? Why is it that [for example] from 1960 to 1964 he didn’t
find that he had to pay so much more for labor he had to
raise prices, but that suddenly from 1964 to 1969 he did?’
The answer is, because, in the second period, total demand
all over was increasing.” Friedman’s monetary view of the
inflation process led him to dismiss “incomes policy”—
i.e., direct controls on wages and prices—as an alternative
or supplement to monetary policy in fighting inflation.
Asked in 1974, “Do you think an incomes policy is an
essential adjunct of a strict monetary policy?” Friedman
replied simply, “Not at all.” Consistent with this judgment,
many countries that once assigned an important role to
incomes policy now rely on monetary policy to control
inflation.
Policymakers in the 1970s saw that inflation was costly,
but failed to grasp that to get inflation under control, they
needed to use monetary policy, and
only needed to use
monetary policy. The fact that today’s policymakers do
understand this reflects the profound impact of Milton
Friedman on monetary economics.
I
1
A list of sources for the quotations from Friedman used here is available at
http://research.stlouisfed.org/publications/mt/Jan2007MT_Milton_Friedman_
on_inflation-SourcesWeb.pdf.
Milton Friedman on Inflation
Edward Nelson
research.stlouisfed.org
Views expressed do not necessarily reflect official positions of the Federal Reserve System.