The Nobel Prize

Milton Friedman (1912–2006)

Milton Friedman was born in Brooklyn, New York, USA in 1912. The son of working-class Jewish immigrants from Central Europe, he studied mathematics and economics at Rutgers University, from where he graduated with a BA in 1932. Upon receipt of a scholarship, Friedman commenced graduate studies at the University of Chicago where he was awarded an MA in 1933. After a year of further graduate work at Columbia University, he returned to Chicago as a research assistant. From 1935 to 1937 he was employed as an economist at the National Resources Committee in Washington, DC, investigating consumer expenditures in the United States. In 1937 he accepted a post at Columbia University as a part-time lecturer and in the same year joined the research staff at the National Bureau of Economic Research (NBER). At the NBER, Friedman assisted Simon Kuznets (see entry in this volume) in his studies of the incomes of professionals (Kuznets and Friedman, 1945). This work formed the basis of Friedman’s doctoral dissertation and he was subsequently awarded a PhD from Columbia University in 1946. During the Second World War, Friedman worked first at the US Treasury Department on wartime tax policy from 1941 to 1943, and then from 1943 to 1945 as associate director of the Statistical Research Group of the Division of War Research at Columbia University. In 1945, following the end of the war, he joined the University of Minnesota as an associate professor. After one year at Minnesota he accepted the post of associate professor at the University of Chicago in 1946, where he was subsequently promoted to a full professorship in 1948. Apart from visiting posts at Cambridge University (1953–54), Columbia University (1964–65), the University of California, Los Angeles (1967) and the University of Hawaii (1972), Friedman remained at Chicago before retiring from active teaching in 1977. Since then he has been a senior research fellow at the Hoover Institution at Stanford University. In addition to his posts at Chicago, Friedman also worked as a member of the research staff at the NBER for a second period from 1948 to 1981.

Friedman’s many offices and honours have included: the award of the John Bates Clark Medal of the American Economic Association in 1951 and the National Medal of Science in 1988; serving as president of the American Economic Association in 1967 and the Mont Pelerin Society from 1970 to 1972; and the award of honorary degrees from numerous universities around the world. In 1976 he was awarded the Nobel Memorial Prize in Economics ‘for his achievements in the fields of consumption analysis, monetary history and theory, and for his demonstration of the complexity of stabilization policy’ (Nobel Foundation, 2004).

Friedman is best known as the founding father and leading exponent of the monetarist school of macroeconomic thought, and for championing the case for the efficacy of free markets in a wide variety of contexts. Over the course of his long and distinguished career he has made contributions to many areas including: methodology; consumer behaviour; international economics; monetary theory, history and policy; and the causes of business cycles and inflation. In attempting to survey his most important works in these areas we begin with what Friedman believes to be his best scientific work, namely his 1957 book, A Theory of the Consumption Function. In this work he put forward his permanent income hypothesis, whereby consumption is held to depend upon expected long-run average or lifetime income, rather than current disposable income as in Keynesian analysis. In doing so Friedman was able to reconcile the seemingly conflicting evidence from cross-section and time-series studies of the consumption–income relationship. One implication of the hypothesis is that if individuals believe that a specific income change is only temporary, then it will have only a small effect on their permanent income and, in consequence, a small effect on their consumption. As such, an economist who believes that consumption is a function of permanent income is likely to be more sceptical about the usefulness of a tax change for stabilisation purposes than one who believes that consumption depends on current disposable income. Friedman’s permanent income hypothesis, together with the life-cycle hypothesis associated with the work of Franco Modigliani (see entry in this volume) and Richard Brumberg, has had a profound and lasting influence on the direction of research in the area of consumer behaviour.

Friedman’s most influential book, A Monetary History of the United States, 1867–1960 (which he co-authored with Anna Schwartz), was published in 1963 (Friedman and Schwartz, 1963a). In their monumental study, Friedman and Schwartz presented persuasive evidence to support the monetarist belief that changes in the stock of money play a largely independent role in cyclical fluctuations. Particularly controversial is their interpretation that the Great Depression resulted from the failure of the Federal Reserve to prevent the US money stock from falling by about a third between October 1929 and June 1933. Subsequent research with Anna Schwartz at the NBER resulted in the publication of Monetary Statistics of the United States (1970) and Monetary Trends in the United States and the United Kingdom (1982).

This series of volumes for the NBER can be seen as part of a much wider body of work undertaken by Friedman from the late 1940s/ early 1950s onwards which has sought to re-establish the quantity theory of money approach to macroeconomic analysis. According to adherents of this approach, changes in the money supply are the predominant, though not the only, factor explaining changes in money income. In his famous essay ‘The Quantity Theory of Money – A Restatement’, Friedman (1956, pp. 3–21) put forward a theory of the demand for money asserting that the demand for money is a stable function of a limited number of variables. If the demand for money function is stable, then velocity will also be stable and will change in a predictable manner if any of the limited number of variables in the demand for money function should change. Friedman’s restatement of the quantity theory as, in the first instance, a theory of the demand for money, acted as a catalyst for many subsequent empirical studies on which variables influence the demand for money and whether the relationship between the demand for money and these variables is stable over time.

Another theme of Friedman’s research on the importance of money involves his work examining the timing of the relationship between changes in money and money income (for example, Friedman, 1958; 1961; Friedman and Schwartz, 1963a; 1963b). One of the most influential of his findings is that the outside lag associated with monetary policy is both long and variable. In discussing ‘The Role of Monetary Policy’ in his 1967 presidential address to the American Economic Association, Friedman (1968) introduced the concept of a natural rate of unemployment, which he argued is determined by the structure of the labour and goods markets, including market imperfections. By augmenting the Phillips curve with the expected rate of inflation as an additional variable that determines the rate of change of money wages, he was able to demonstrate that a trade-off between inflation and unemployment only exists in the short run, and that in the long run the Phillips curve is vertical at the natural rate of unemployment. Furthermore, any attempt to maintain unemployment below the natural rate will lead to accelerating inflation. In his Nobel Memorial Lecture, Friedman (1977) offered an explanation of the existence of a positively-sloped Phillips curve for a period of several years, which is compatible with a vertical long-run Phillips curve at the natural rate of unemployment.
This body of interrelated work helped to forge Friedman’s views on the role and conduct of stabilisation policy. Given the numerous problems associated with stabilisation policy, including time lags (most notably the length of the inside lag associated with fiscal policy in the United States and the length and variability of the outside lag associated with monetary policy), and the inflationary consequences of reducing unemployment below the natural rate (the precise value of which is uncertain), discretionary policy activism could turn out to be destabilising. Since the late 1940s Friedman has addressed the issue of an appropriate ‘Monetary and Fiscal Framework for Economic Stability’ (Friedman, 1948). He has been particularly vociferous in advocating that the authorities should follow a stable rate of monetary growth in line with the trend/longrun growth rate of the economy (see, for example, Friedman, 1968); the famous ‘k’ per cent monetary rule.
While many of these ideas were particularly controversial at the time Friedman first presented them, over the years a number of his key insights have been absorbed into mainstream macroeconomics. Most notably, the views that the long-run Phillips curve is vertical, and that money is neutral in the long run, are now widely accepted and form part of the modern mainstream consensus. Furthermore, Friedman has convinced a majority of economists and policy makers that sustained inflation is not possible without excessive monetary growth and that the potential of activist discretionary fiscal and monetary policy is much more limited than conceived prior to the monetarist counter-revolution.

In addition to his work on the consumption function, the role of money in the business cycle, and the role and conduct of stabilisation policy, Friedman has also made important contributions to methodology and international economics. Two essays, both of which first appeared in his 1953 book, Essays in Positive Economics, have been particularly influential in each of these fields of study. In his essay ‘The Methodology of Positive Economics’, Friedman argued that the appropriate test of a theory is its ability to yield empirically corroborated predictions, not the realism of its assumptions. Here, the stamp of a fruitful economic theory is its capacity to make accurate predictions. This methodological approach, mirrored throughout his work, has led Friedman to favour small-scale empirical models that are simple to test and that can explain a limited set of phenomena under a wide range of circumstances. In another pioneering essay, ‘The Case for Flexible Exchange Rates’, he argued that such a regime would improve the process of balance of payments adjustment. His anticipation of the breakdown of the Bretton Woods fixed exchange rate system, in an analogous manner to that anticipating accelerating inflation ahead of the events of the 1970s (see Friedman, 1968), lent further weight to his arguments and his favoured methodological approach.

As well as his many scientific contributions, Friedman has sought to communicate his views on a wide range of issues to non-economists. A regular provider of columns for Newsweek over the 1966–84 period, he has also written such worldwide best sellers as Capitalism and Freedom (Friedman, 1962) and Free to Choose (1980, co-written with his wife Rose Friedman). Both books have been translated into more than 15 languages, while Free to Choose, which champions the case for the free market, was made into a ten-part television series shown in many countries. His gift for writing about topics in applied economics, accessible to a mass audience, has established Friedman as one of the most famous contemporary economists. However, above all, his formidable output of technical books and learned journal articles, which has helped shape both modern macroeconomic theory and policy making, has made Friedman one of the most influential and outstanding economists in the history of the discipline.

Main Published Works
(1945), Income from Independent Professional Practice (with S. Kuznets), New York: National Bureau of Economic Research.
(1948), ‘A Monetary and Fiscal Framework for Economic Stability’, American Economic Review, 38, June, pp. 245–64; reprinted in Essays in Positive Economics, Chicago: University of Chicago Press, 1953.
(1953), Essays in Positive Economics, Chicago: University of Chicago Press.
(1956), Studies in the Quantity Theory of Money (ed.), Chicago: University of Chicago Press.
(1957), A Theory of the Consumption Function, Princeton, NJ: Princeton University Press.
(1958), ‘The Supply of Money and Changes in Prices and Output’, in The Relationship of
Prices to Economic Stability and Growth, Washington, DC: Congressional Report, pp. 241– 56; reprinted in The Optimum Quantity of Money and Other Essays, Chicago: Aldine, 1969.
(1961), ‘The Lag in Effect of Monetary Policy’, Journal of Political Economy, 69, October, pp. 447–66; reprinted in The Optimum Quantity of Money and Other Essays, Chicago: Aldine, 1969. (1962), Capitalism and Freedom, Chicago: University of Chicago Press.
(1963a), A Monetary History of the United States, 1867–1960 (with A.J. Schwartz), Princeton, NJ: Princeton University Press.
(1963b), ‘Money and Business Cycles’ (with A.J. Schwartz), Review of Economics and Statistics, 45, February, pp. 32–64; reprinted in The Optimum Quantity of Money and Other Essays, Chicago: Aldine, 1969.
(1968), ‘The Role of Monetary Policy’, American Economic Review, 58, March, pp. 1–17; re
printed in The Optimum Quantity of Money and Other Essays, Chicago: Aldine, 1969.
(1969), The Optimum Quantity of Money and Other Essays, Chicago: Aldine.
(1970), Monetary Statistics of the United States (with A.J. Schwartz), New York: Columbia
University Press.
(1977), ‘Nobel Lecture: Inflation and Unemployment’, Journal of Political Economy, 85, June, pp. 451–72.
(1980), Free to Choose: A Personal Statement (with R. Friedman), New York: Harcourt Brace Jovanovich.
(1982), Monetary Trends in the United States and the United Kingdom: Their Relation to Income, Prices, and Interest Rates, 1867–1975 (with A.J. Schwartz), Chicago: University of Chicago Press.
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