Milton Friedman\'s Theoretical Contributions

At the time of Milton Friedman's death, I knew him only as a public intellectual---one whose contributions consisted primarily of educating the public and policy makers on economic issues. I was vaguely aware that he had won the Nobel Prize, but for some reason I never thought to ask for what. So I was somewhat surprised to read on the occasion of his death references to his many theoretical contributions to the science of economics. Following is a summary of what I've learned since then about the highlights of his theoretical contributions.

What I find most striking about some of Friedman's ideas is how obvious they seem now, despite the fact that many of them ran directly contrary to accepted wisdom less than fifty years ago. As Ben Bernanke said in a 2003 speech on Friedman's legacy:

Friedman's monetary framework has been so influential that, in its broad outlines at least, it has nearly become identical with modern monetary theory and practice. I am reminded of the student first exposed to Shakespeare who complained to the professor: "I don't see what's so great about him. He was hardly original at all. All he did was string together a bunch of well-known quotations." The same issue arises when one assesses Friedman's contributions. His thinking has so permeated modern macroeconomics that the worst pitfall in reading him today is to fail to appreciate the originality and even revolutionary character of his ideas, in relation to the dominant views at the time that he formulated them.

Monetarism
Friedman was perhaps best known for his work in resurrecting and refining the monetarist school of macroeconomic thought. One of the core tenets of monetarism is that the root cause of inflation is an increase in the money supply---as Friedman famously stated, that inflation is always and everywhere a monetary phenomenon. Another is that manipulation of the money supply can affect real economic performance in the short run, but that in the long run growth can come only from increases in productivity. Friedman was also one of the first to advance the now widely-accepted hypothesis that the Great Depression was caused by the Federal Reserve rather than by the inherent weaknesses of capitalism. See the aforementioned speech by Ben Bernanke for more details. It seems to me that Ludwig von Mises and others preceded Friedman in much of this; I suspect that Friedman gets the credit largely because he did the empirical work necessary to convince others.

The Limits of the Phillips Curve
Prior to the '70s, it was generally believed that there was a more or less fixed trade-off between unemployment and inflation, as illustrated by the Phillips Curve, and that the government could move along this curve through the judicious use of fiscal policy. Friedman argued that the relationship held only in the short run. Workers would initially be willing to accept falling real wages, but would demand higher pay once they realized that inflation was eroding the value of their wages. Keeping unemployment low, therefore, would require not only high inflation, but constantly accelerating inflation. Friedman was largely vindicated by the stagflation of the '70s, and it was on his advice that Paul Volcker tightened the money supply in the early '80s, bringing inflation under control.

Licensing and Cartelization
Friedman's first major contribution was a theory with which most libertarians are now quite familiar. In Income from Independent Professional Practice, a book he co-authored with Simon Kuznets, he demonstrated that professional licensing requirements limit the supply of medical and legal practitioners, allowing them to charge higher rates than the market would bear under a system of free competition.

The Permanent Income Hypothesis
Friedman developed the Permanent Income Hypothesis, which states that people tend to base their consumption decisions not on current income but on their expectations about their long-term average incomes. The primary significance of this, I gather, is that it complicates attempts to manage the economy with macroeconomic policies---for example, people believing that an increase in their income is only temporary may respond by saving rather than consuming.


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