The Measure Of Milton

Milton Friedman (1912-2006) contributed to economic analysis but was also an important economic philosopher.

 Listener: 24 February, 2007.

Keywords: Macroeconomics & Money;

When Friedman visited New Zealand in 1981 he was interviewed for the Listener. Told that money supply (in this case Reserve Bank-issued currency plus trading bank lending, what economists call “M1”) had increased by 164.5 percent between 1971 and 1979, he pointed out that consumer prices had risen by 158 percent over the same period. “That’s not a bad correlation is it? … I’ll guarantee you, if you make this calculation for any country you want, given a reasonable time span … you’ll get the same result.”

Since 1979 M1 has increased 11.1 times, while consumer prices have risen only 4.2 times. Hardly a good correlation. So much for Friedman’s guarantee.

Central banks soon learnt that Friedman’s “monetarist” prescription of controlling money supply to control inflation did not work. New Zealand’s Reserve Bank tried it for a short while in 1985, but gave up in frustration. No central bank in the world is “monetarist” today. In that sense, Friedman’s monetary economics is obsolete.

So why the generous tributes when he died in November? Friedman challenged economists to think more carefully about the role of money in the economy. There had been a tendency to say “money doesn’t matter”.

That was not Maynard Keynes’s view. But some of his followers oversimplified Keynes’s subtlety. At the other extreme, Friedman proclaimed that only money matters. Today, most economists would say money matters to some extent. The Reserve Bank looks at changes in money supply when it assesses the state of the economy.

Friedman was also smarter than most of his followers. He said “substantial inflation is always and everywhere a monetary phenomenon”. Notice the adjective “substantial”, which his acolytes usually leave out. There can be no doubt that high inflation is associated with substantial rises in the quantity of money. That correlation may not be true when inflation is low. Was 2002 a year of inflation since consumer prices rose 2.7 percent, or of deflation since producer prices (measured by the GDP deflator) fell 1.4 percent? Did the money supply go up or down? Friedman’s money supply (M1) rose 6.4 percent, but by a wider, more often used definition (M3) it fell 2.5 percent. When inflation is insubstantial the theory does not work very well at all.

The most lavish obituary tributes to Friedman reflected his contribution to economic ideology. He vigorously argued for the supremacy of choice and freedom, and the excellence of the “free” market in delivering them. Free to Choose, which he wrote with his wife Rose, will be read long after his contributions to economic analysis are relegated to the history of ideas.

The Friedmans tried to bolster their economic ideology – a value judgment with which one may agree or disagree – with the empirical claim that “a society that puts freedom first will … end up with both greater freedom and greater equality”. In which case societies with less inequality would have greater freedom. Northern Europe and Australasia have less unequal income distributions than the US. Does that mean New Zealand gives a higher priority to freedom than the US? Even the Friedmans would find that surprising. Inequality has been rising over the past two decades. Did our commitment to freedom diminish under Rogernomics?

Choice may not produce happiness. As the Economist editorialised: “To find the market system wanting because it does not bring joy as well as growth is to place too heavy a burden on it. Capitalism can make you well off. And it also leaves you free to be as unhappy as you choose. To ask any more of it would be asking too much” (December 23, 2006).

Friedman alerts us to the importance of choice and the market’s role in delivering it. But we need to define choice carefully. I follow Indian economist Amartya Sen’s view that life’s possibilities are crucial. Can you choose to be a tailor, nurse or mechanic irrespective of your gender, ethnicity or social origin? In comparison, the number of types of jam on your supermarket shelf seems trivial. But as Friedman reminds us, that is not a reason to restrict them.