Milton Friedman, 1912 – 2006

1. There’s no such thing as a free lunch. Born in Brooklyn, 1912 Immigrant parents BA, Rutgers, 1932 Arthur F. Burns, Homer Jones MA, Chicago, 1933 Viner, Knight, Simons Columbia: Statistics Washington/Treasury Keynesian taxes to combat inflation NBER/Kuznets Consumer Budgets Professional Income War Research: constrained optimization Anti-aircraft missile Sequential Sampling Proximity fuse PhD, Columbia, 1946 U. of Chicago, 1946–1977 Clark Medal, 1951 Nobel Memorial Prize, 1976 Hoover Institution, 1977-2006 Milton Friedman, 1912 – 2006

2. Milton Friedman (1912 - 2006): Major Works People tend to attribute to me a long-term plan…I did no planning. Things just happened in the order in which they happened to happen. • "Professor Pigou's Method for Measuring Elasticities of Demand From Budgetary Data" Quarterly Journal of Economics Vol. 50, No. 1 (Nov., 1935), pp. 151-163: • A Monetary and Fiscal Framework for Economic Stability, American Economic Review, June 1948 • Utility Analysis of Choices Involving Risk" with Leonard Savage, 1948, Journal of Political Economy Vol. 56, No. 4 (Aug., 1948) • "The Expected-Utility Hypothesis and the Measurability of Utility", with Leonard Savage, 1952, Journal of Political Economy (Dec., 1952) • The Methodology of Positive Economics (1953) • Essays in Positive Economics (1953) • "The Quantity Theory of Money: A restatement", 1956, in Friedman, editor, Studies in the Quantity Theory of Money. • A Theory of the Consumption Function (1957) • Permanent income hypothesis • A Program for Monetary Stability (Fordham University Press, 1960) • Price Theory (1962), • A Monetary History of the United States, 1867-1960, with Anna J. Schwartz, 1963. Part 3, The Great Contraction • The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897-1958, Commission on Money and Credit, 1963, with David Meiselman • The Role of Monetary Policy,American Economic Review, (Mar., 1968) • Expectations augmented Phillips Curve/natural rate of unemployment • The Optimum Quantity of Money And Other Essays (1976) • Milton Friedman's Monetary Framework: A Debate with His Critics (1975) • Inflation and Unemployment: Nobel lecture, 1977, Journal of Political Economy. Vol. 85, pp. 451-72. • Monetary Trends in the United States and the United Kingdom: Their relations to income, prices and interest rates, 1876-1975. with Anna J. Schwartz, 1982 • Quantity Theory of Money, in J. Eatwell, M. Milgate, P. Newman, eds., The New Palgrave (1987) • "Franklin D. Roosevelt, Silver, and China," Journal of Political Economy Vol. 100, No. 1 (Feb., 1992), pp. 62-83

3. The Chicago School: Price Theory Rules • Frank Knight—foundations of price theory: logic, not quantification • Antipathy to monopolistic competition and Keynesian intervention muddying competitive market ideal • Henry Simons—supported intervention in imperfect markets & progressive income tax • Stabilize price level! • 100% reserve banking • Rules not discretion • Oskar Lange—a market socialist • Rebuilt department shook up by WWII • Left to serve communist Poland: ambassador to UN Positive economics: focus on relative prices Empirical Emphasis Logical emphasis Friedman/Stigler Coase/Buchanan Extension of economics: Disciplinary Imperialism • Becker: Discrimination, time, home economics • Posner: Law and economics • Stigler/Buchanan: Public choice (political mkts) • Modigliani-Merton Miller: Efficient markets

4. Ideas of Milton Friedman • Positive economics is in principle independent of any particular ethical position or normative judgments … it deals with “what is,” not with “what ought to be.” • The ultimate goal of a positive science is … a theory or hypothesis that yields valid and meaningful predictions about phenomena not yet observed … [T]heory is to be judged for its predictive power ... The choice among alternative hypotheses equally consistent with the available evidence … [is] suggested by the criteria of “simplicity” and “fruitfulness”… within a given field of phenomena. • Truly important and significant hypotheses will have “assumptions” that are wildly inaccurate descriptive representations of reality … A hypothesis is important if it “explains” much by little … [T]he relevant question is not whether [“assumptions”] are descriptively realistic … but whether they are sufficiently good approximations for the purpose in hand. • Economics is a “dismal” science because it assumes man to be selfish and money-grubbing … it assumes markets to be perfect, competition to be pure, and commodities, labor, and capital to be homogeneous … [C]riticism of this type is largely beside the point unless supplemented by evidence that a [different] hypothesis yields better predictions.

5. More Ideas of Milton Friedman “ I never reached a judgment about monetary or fiscal policy because of my belief in free markets. ” • A Monetary and Fiscal Framework for Economic Stability, AER 1948 • Eliminate private creation of money and discretionary control of Ms by central bank 100% reserve banking • Base G on community’s desire, need, and willingness to pay for public services • A predetermined program of transfer payments • A progressive personal income tax system  Rely on automatic stabilizers … countercyclical action … [can] do too much as well as too little. (1951) • The Case for Flexible Exchange Rates (1950) • Instability of exchange rates is a symptom of instability in the underlying economic structure. Elimination of this symptom by administrative freezing cures none of the underlying difficulties and only makes adjustment to them more painful. • Studies in the Quantity Theory of Money (1956) • The Quantity Theory of Money: A Restatement • There is perhaps no other empirical relation in economics that has been observed to recur so uniformly under so wide a variety of circumstances as the relation between substantial changes over short periods in the stock of money and in prices … • Phillip Cagan, Monetary Dynamics of Hyperinflation • Adaptive expectations and stable money demand • John Klein, German Money and Prices, l932-44 • Eugene Lerner, Inflation in the Confederacy, 1861-65 • Richard Seldon, Velocity in the United States

6. Yet More Ideas of Milton Friedman • A Theory of the Consumption Function (1957) • “Errors” are in income, not in consumption Permanent income hypothesis • A Monetary History of the United States (1963) • … inflation is always and everywhere a monetary phenomenon. • …small events at times have large consequences. A liquidity crisis in a fractional reserve banking system is precisely the kind of event that can trigger – and often has triggered – a chain reaction. And economic collapse often has the character of a cumulative process. Let it go beyond a certain point, and it will tend for a time to gain strength from its own development as its effects spread and return to intensify the process of collapse. Because no great strength would be required to hold back the rock that starts a landslide, it does not follow that the landslide will not be of major proportions. • The Role of Monetary Policy (1968) • Adaptive Expectations Vertical Long-run Phillips Curve  Accelerationist Hypothesis • Capitalism and Freedom (1962) • Money growth rule (3 – 5% per year) • Floating exchange rates • Negative income tax • School vouchers • End occupational licensure • “Why Not a Volunteer Army?” (1967) / Gates Commission (1968)

7. Paul Samuelson on Naïve Monetarism • The pity increases for one who adopts a simple theory of positivism that exonerates a nominated theory (the quantity theory), even if its premises are unrealistic, so long as it seems to describe with approximate accuracy some facts. Particularly vulnerable is the scholar who tries to test competing theories by submitting them to simplistic linear regressions with no sophisticated calculations of Granger causality, cointegration, collinearities… • The proof of the pudding is in the eating. There was a widespread myth of the 1970s… A new paradigm, monistic monetarism, gave a better fit. King Keynes is dead! Long live King Milton! [But] contemplate the true facts…In terms of accuracy…never did post-1950 monetarism score well.

8. Empirical Defense of Monetarism • Phillip Cagan(1965) Correlation between M and Y & P runs mostly from M  Y & P • Andersen and Jordan (1968) $Y = f(Lagged M, lagged ΔG) The gospel according to St. Louis • Brunner and Meltzer (1976) Financing deficit with Money vs. Bonds M  $Y  Y (first) & P  $Wealth  C  Y Bonds  Wealth  C  Y So Money matters most • Christina and David Romer(2004) “Intended” fed funds rates inferred from statements made around FOMC meetings purged of information in Fed’s Green Book  policy shocks—moves by the Fed independent of economic conditions. They find that [monetary] policy has large, relatively rapid, and statistically significant effects on both output and inflation.

9. Shadow Open Market Committee Journal of Money, Credit and Banking Carnegie-Rochester Conference Series on Public Policy Journal of Monetary Economics Karl Brunner 1916 – 1989 Allan Meltzer 1928 - Meltzer: I was very much a left-wing activist as a student. • Major Works by Meltzer • Keynes’ Monetary Theory: • A Different Interpretation, 1988. • A History of the Federal Reserve, • volume 1, 1913-1951, 2002; • volume 2, 1951 – 1969, 2010. Early Joint Works: Meltzer with Brunner "Predicting Velocity: Implications for theory and policy", with K. Brunner, 1963, J of Finance The Federal Reserve's Attachment to the Free Reserves Concept, with K. Brunner, 1964. An Alternative Approach to the Monetary Mechanism, with K. Brunner, 1964. "Some Further Investigations of Demand and Supply Functions for Money", with K. Brunner, 1964, J of Finance "The Meaning of Monetary Indicators", with K. Brunner, 1967, in Horwich, editor, Monetary Process and Policy. "Economies of Scale in Cash Balances Reconsidered", with K. Brunner, 1967, QJE. "Liquidity Traps for Money, Bank Credit, and Interest Rates", with K. Brunner, 1968, JPE "The Nature of the Policy Problem" with K. Brunner, 1969, in K. Brunner, editor, Targets and Indicators of Monetary Policy. "The Uses of Money: Money in the Theory of an Exchange Economy" with K. Brunner, 1971, AER "Friedman's Monetary Theory" with K. Brunner, 1972, JPE "Money, Debt and Economic Activity" with K. Brunner, 1972, JPE "A Monetarist Framework for Aggregative Analysis" with K. Brunner, 1972, Kredit und Kapital Monetarism: Spreading the Word : : Later Joint Works "Strategies and Tactics for Monetary Control", with K. Brunner, 1983, CROCH "Money and Credit in the Monetary Transmission Process", with K. Brunner, 1988, AER Money and the Economy: Issues in monetary analysis, with K. Brunner, 1989. Monetary Economics, with K. Brunner, 1989. "Money Supply", with K. Brunner, 1990, in Friedman and Hahn, editors, Handbook of Monetary Economics

10. Monetarism in Theory and Practice • Theory: M  P and Y in short – run M  P in long - run • Friedman’s restated quantity theory • Expectations augmented Phillips Curve  Vertical long – run Phillips Curve  “Monetary mischief” • Practice: oppose Keynesian activism • Monetary vs. fiscal policy: what matters? • Inherent stability vs. instability of enterprise economy • Policy: Long – run vs. short – run focus • Varying policy lags … “too much too late” • Steady money growth as automatic stabilizer

11. The Monetarist Mantra Long-run price and growth stability • Rules, not discretion • Steady growth of monetary aggregate: M1, M2, MB • Automatic stabilizer • Quantity Theory Framework: Stable (M/P)d • Classical Dichotomy • NaturalRate Hypothesis • Expectations Augmented Phillips Curve • Vertical Long-Run Phillips Curve • “Treasury View” – Fiscal Policy Crowded Out • Andersen & Jordan: The Gospel According to St.L. • M Impacts > G Impacts • Flexible Exchange Rates: No Price Controls • International Monetarism: Johnson & Frenkel • Monetary Theory of the Balance of Payments • Monetary Theory of the Exchange Rate • Control of money supply justified to maintain price stability—a stable value of money.

12. The Great Depression: “Holy Grail of Macroeconomics” • Lionel Robbins (1934) The Great Depression • J.K. Galbraith (1955) The Great Crash: 1929 • Friedman and Schwartz (1963) The Great Contraction • Murray Rothbard (1963) America’s Great Depression • Charles Kindleberger (1973) The World in Depression: 1929 - 1939 • Robert Lucas and Edward Prescott (1970s) • Real Business Cycle Theory • Peter Temin (1978) Did Monetary Forces Cause the Great Depression? • Hyman Minsky (1982) Can “It” Happen Again? • Ben Bernanke (1983) Nonmonetary Effects of Finan-cialCrisis in Propagation of the Great Depression • Peter Temin (1989) Lessons from The Great Depression • Barry Eichengreen (1992) Golden Fetters: The Gold Standard and the Great Depression, 1919-1939 • Edward Prescott (1999) Some observations on the Great Depression • Richard Koo (2008) The Holy Grail of Macro-economics: Lessons from Japan’s Great Recession • C. Reinhart and K. Rogoff (2009) This Time is Different: Eight Centuries of Financial Folly