The Friedman legacy

Milton Friedman, the 1976 Nobel laureate in economics, passed away last week at the age of 94. He will be remembered as the progenitor of the monetarist school of macro-economics, which can simplistically be characterised by the proposition that the supply of money is the dominant driver of inflation. The proposition itself dated back several centuries in the form of the quantity theory of money, but Prof. Friedman can be credited with reviving and placing it in the context of policy debates taking place in the market economies during the 1950s and 1960s. Macro-economic thinking at the time was dominated by the Keynesian paradigm, which received credit for explaining and providing policy solutions for the Great Depression. After World War II, the Keynesian prescription was enshrined in the Radcliffe Report, a policy document prepared by the UK government. It asserted that the way to sustain full employment was a combination of high government spending and low interest rates. This became the conventional wisdom in both the UK and the US, where it was personified in the actions and statements of W Arthur Burns, chairman of the US Federal Reserve Board from the late 1960s until the end of the 1970s.

Prof. Friedman became the most prominent challenger of the Keynesian explanation of the Depression and the policy positions it implied. In the 1950s, in a co-authored book analysing the monetary history of the US, he argued that the Depression was induced by the Federal Reserve's actions in tightening liquidity and not by the spontaneous changes in consumer and investor behaviour that Lord Keynes would have people believe. In his 1956 article restating the quantity theory of money, he provided the analytical foundations for a comprehensive, dynamic explanation for the linkages between money, growth and inflation. This thought process culminated in his 1968 presidential address to the American Economic Association, in which he demonstrated that the Keynesian way of sustaining low unemployment would, eventually and inevitably, result in accelerating inflation. At a time when the US itself was facing inflationary pressure as a consequence of the Fed's accommodation of government borrowing requirements induced by the Vietnam war and expanding domestic social programmes, his analysis struck a massive chord. Mr Burns' successor, Paul Volcker, implemented an essentially Friedmanite recommendation to shift from keeping interest rates low to maintaining tight, transparent and predictable control over the money supply. The crux of Prof. Friedman's thoughts is now firmly embedded in the approach and rhetoric of central bankers around the world. His emphasis on credible commitments and a rule-based approach to monetary policy has found expression in the inflation-targeting approach that is being followed by many countries, including the UK and the eurozone.

At a broader level, Prof. Friedman was a leading figure of the "Chicago school", economists at the University of Chicago who contributed to strengthening the analytical foundations of the conservative policy agenda. That placed him squarely in the policy spotlight on many issues. Among other modes of public engagement, he wrote a regular column for a popular American newsmagazine for several years, trading views with his contemporary and fellow Nobel laureate Paul Samuelson. These contributed significantly to widening the understanding of somewhat arcane issues and, very likely, to more informed and better policy making. There is no doubt that Prof. Friedman stands tall among the leading economists of the last century, while also being one of the few whose name acquired household recognition.