Milton Friedman

Milton Friedman Plot Summary

Introduction

In the tumultuous economic landscape of the 1970s, as inflation soared to double digits and unemployment reached painful heights, a fundamental shift in economic thinking was underway. This transformation had its roots decades earlier in the classrooms of the University of Chicago, where a brilliant economist named Milton Friedman began challenging the dominant Keynesian orthodoxy that had guided economic policy since the Great Depression. The story of how monetarism—the theory that changes in the money supply primarily determine economic fluctuations—rose from academic heresy to global policy framework represents one of the most significant intellectual revolutions of the twentieth century. This intellectual journey takes us from the Great Depression through the stagflation crisis of the 1970s to the dramatic policy shifts under Federal Reserve Chairman Paul Volcker and political leaders like Margaret Thatcher and Ronald Reagan. Along the way, we witness how ideas developed in academic settings transformed central banking practices worldwide, reshaped international financial institutions, and influenced economic reforms from Chile to China. For anyone seeking to understand modern economic debates about inflation, central bank independence, or the proper role of monetary policy, this historical narrative provides essential context for appreciating how today's economic consensus emerged from yesterday's intellectual battlegrounds.

Chapter 1: The Chicago Foundations: Intellectual Roots in the Depression Era (1932-1946)

The Great Depression of the 1930s created a crucible for economic thinking, challenging existing theories and opening space for new approaches. At the University of Chicago, a distinctive school of thought began taking shape that would eventually transform global economic policy. The economics department, led by figures like Frank Knight and Henry Simons, developed a perspective that differed markedly from the emerging Keynesian consensus. While most economists blamed the Depression on market failures requiring government intervention, Chicago economists focused on monetary factors and the role of the Federal Reserve. Milton Friedman arrived at Chicago as a graduate student in 1932, when the American economy was at its lowest point. The banking system was collapsing, unemployment had reached 25 percent, and faith in capitalism itself was wavering. In this environment, Friedman encountered mentors who encouraged rigorous thinking about monetary theory. Frank Knight taught him to question conventional wisdom, while Henry Simons introduced him to the quantity theory of money—the idea that changes in money supply directly influence price levels. These intellectual foundations would shape Friedman's thinking for decades to come. The "Chicago Plan" developed during this period represented an early attempt to address monetary instability. Simons, Lloyd Mints, and other Chicago economists proposed a radical restructuring of the banking system, advocating for 100 percent reserve requirements to prevent the credit expansion and contraction that had contributed to the Depression. While never implemented, this plan demonstrated the Chicago School's focus on monetary factors rather than fiscal stimulus as the key to economic stability. Friedman would later modify these ideas but maintain their essential insight about the centrality of money. During World War II, Friedman gained practical experience working at the Treasury Department, where he helped design tax policies to prevent wartime inflation. This experience gave him firsthand insight into how monetary forces shaped economic outcomes. Meanwhile, John Maynard Keynes's "General Theory," published in 1936, was rapidly gaining influence. Keynesian economics, with its emphasis on government spending to maintain full employment, aligned perfectly with the expanding administrative state and seemed validated by wartime economic management. By 1946, as Friedman returned to Chicago as a professor, the intellectual battle lines were drawn. Keynesian economics dominated policy circles and academic departments, while the Chicago tradition remained a minority view. The Employment Act of 1946 institutionalized the government's responsibility for maintaining full employment, reflecting the Keynesian belief that markets alone could not ensure prosperity. Against this tide, Friedman began developing the monetary approach that would eventually challenge and transform economic orthodoxy. The seeds of the monetarist revolution had been planted, though they would take decades to fully bloom.

Chapter 2: Challenging Keynesianism: Monetarism's Theoretical Development (1946-1963)

The post-war period witnessed Milton Friedman's emergence as the leading critic of Keynesian economics. Returning to the University of Chicago in 1946, he found himself in an academic environment increasingly dominated by mathematical models and Keynesian theory. The Cowles Commission, housed at Chicago, represented the cutting edge of mathematical economics, developing complex models based on Keynesian principles. Friedman's methodological approach stood in stark contrast to this trend. In his influential 1953 essay "The Methodology of Positive Economics," he argued that economic theories should be judged not by the realism of their assumptions but by the accuracy of their predictions—a pragmatic stance that would guide his work. Friedman's first major theoretical breakthrough came with his 1957 book on the consumption function. Keynes had posited that people's consumption depended primarily on their current income, a relationship that justified government intervention during downturns. Friedman challenged this view with his "permanent income hypothesis," arguing that people base their spending not on what they earn today but on what they expect to earn over their lifetime. This insight explained why consumption remained relatively stable despite short-term income fluctuations, undermining a key pillar of Keynesian theory and suggesting that temporary tax cuts or spending increases would have limited effects on consumer behavior. During this period, Friedman also began his monumental collaboration with Anna Schwartz at the National Bureau of Economic Research. Together they embarked on a massive empirical study of monetary history, meticulously gathering and analyzing data on money supply, prices, and economic activity dating back to the 1860s. This painstaking work would eventually produce their magnum opus, "A Monetary History of the United States," though it wouldn't be published until 1963. Their research methodology involved tracing the relationship between changes in the money supply and subsequent economic fluctuations, establishing patterns that contradicted Keynesian explanations of business cycles. By the mid-1950s, Friedman had begun developing a coherent alternative to Keynesian macroeconomics. He revived the quantity theory of money, arguing that changes in the money supply were the primary determinant of economic fluctuations. In his 1956 volume "Studies in the Quantity Theory of Money," Friedman presented a "restatement" of the theory that emphasized the demand for money as a stable function of a few key variables. This work laid the groundwork for his later claim that inflation was "always and everywhere a monetary phenomenon" resulting from excessive growth in the money supply relative to economic output. The intellectual battle between Friedman and the Keynesian establishment intensified throughout the 1950s. At a 1951 conference on inflation, Friedman's argument that monetary policy alone could control inflation was dismissed as nonsensical by mainstream economists. The conflict at Chicago became so severe that by 1954, the Cowles Commission departed for Yale, leaving Friedman ascendant. Through his Money and Banking Workshop, Friedman trained a generation of students in monetarist principles, creating what one observer called an "aberrant tradition" of Chicago monetary economics. By the early 1960s, monetarism had emerged as a coherent theoretical challenge to the Keynesian consensus, though its influence on policy remained limited. As the 1960s began, Friedman's position remained distinctly minority, even heretical. When he testified before Congress in 1952, advocating the abolition of the Federal Reserve in its current form, Paul Samuelson dismissed his views as "almost completely fallacious." Federal Reserve Chairman William McChesney Martin continued to "lean against the wind" of inflation or deflation, maintaining discretionary policy rather than following Friedman's proposed rules. Yet the groundwork had been laid for monetarism's eventual triumph, as economic events would soon put Keynesian prescriptions to the test and create an opening for Friedman's alternative vision.

Chapter 3: The Great Inflation: Vindication of Monetarist Predictions (1964-1976)

The mid-1960s marked a turning point in American economic policy and in Friedman's influence on economic thought. As President Lyndon Johnson simultaneously pursued his ambitious Great Society programs and escalated the Vietnam War, the stage was set for a dramatic economic experiment that would ultimately vindicate many of Friedman's warnings. Johnson's administration, guided by Keynesian advisers, believed they could have both "guns and butter" without triggering significant inflation. The Council of Economic Advisers confidently declared that 4 percent unemployment represented "full employment" and that any resulting inflation could be managed through "voluntary wage and price guideposts." Friedman's counternarrative gained momentum through his growing public platform. In 1966, he began writing a regular column for Newsweek, alternating with Paul Samuelson, which gave him unprecedented reach beyond academic circles. His 1967 presidential address to the American Economic Association delivered a frontal assault on the Phillips curve—the supposed trade-off between inflation and unemployment that underpinned much of Keynesian policy. Friedman argued that this trade-off was temporary at best: "There is always a temporary trade-off between inflation and unemployment; there is no permanent trade-off." He introduced the concept of the "natural rate of unemployment" and predicted that attempts to push unemployment below this rate would lead only to accelerating inflation. Events soon vindicated Friedman's analysis. By 1970, inflation had reached 5.4 percent, while unemployment jumped to 5.8 percent—the dreaded combination of "stagflation" that Keynesian theory had deemed impossible. Robert Gordon, initially skeptical of Friedman's critique, found that his econometric models no longer worked with post-1968 data. "Any attempt to reduce the rate of unemployment below its natural rate causes inflation to increase," Gordon concluded. The Phillips curve did not disappear but was transformed into an "expectations-augmented" version that incorporated Friedman's insights about inflation expectations. As one economist noted, Friedman's timing had been "impeccable and even uncanny." The Nixon administration's economic policies further tested Friedman's theories. Nixon appointed Arthur Burns, Friedman's former mentor, as Federal Reserve chairman in 1970. Initially, Friedman was delighted, believing Burns would implement monetary restraint. Instead, Burns pursued an expansionary policy ahead of the 1972 election, while advocating wage and price controls to suppress the resulting inflation. Nixon's dramatic New Economic Policy of August 1971, which imposed a wage-price freeze and ended dollar convertibility to gold, represented a profound rejection of Friedman's approach. Friedman condemned the controls as "likely to do immense harm" and warned they would lead to "more inflationary pressure, not less." The collapse of the Bretton Woods system of fixed exchange rates in the early 1970s represented another vindication of Friedman's long-standing advocacy for floating exchange rates. Working through his former student George Shultz, who became Treasury Secretary in 1972, Friedman helped shape the transition to a new international monetary order. Although the initial "Smithsonian Agreement" attempted to preserve fixed exchange rates, the system ultimately gave way to the floating regime Friedman had long advocated. This shift fundamentally transformed the global financial system, making currencies themselves subject to market forces and compelling nations to compete for capital through sound economic policies. By 1976, when Friedman received the Nobel Prize in Economics, inflation in the United States had reached 11 percent, with unemployment remaining stubbornly high. The Great Inflation had discredited the Keynesian fine-tuning approach and elevated Friedman's monetarist alternative. Even Franco Modigliani, a leading Keynesian, conceded in his 1976 presidential address to the American Economic Association: "We are all monetarists now." The economic experiment of the 1960s and 1970s had transformed Friedman from an academic outsider to the most influential economist of his generation, fundamentally reshaping how economists and policymakers thought about inflation, unemployment, and the limits of government intervention in the economy.

Chapter 4: Policy Revolution: Volcker, Thatcher, and Monetarist Practice (1976-1985)

By the late 1970s, the persistent failure of conventional approaches to tame inflation set the stage for a dramatic policy revolution. When Paul Volcker became Federal Reserve Chairman in August 1979, inflation in the United States had reached 11 percent and was accelerating. Volcker, who had served as undersecretary of the Treasury during the Nixon administration, had witnessed firsthand the consequences of accommodative monetary policy. In October 1979, he announced a fundamental shift in the Fed's approach: instead of targeting interest rates, the central bank would focus on controlling monetary aggregates, allowing interest rates to find their market level. This "monetarist experiment" represented the practical application of Friedman's ideas about monetary policy. The immediate results were dramatic and painful. Interest rates soared to unprecedented levels—the prime rate reached 21.5 percent in December 1980—and economic activity contracted sharply. Unemployment peaked at 10.8 percent in November 1982, the highest level since the Great Depression. Farmers protested in Washington, automobile dealers sent Volcker coffins filled with car keys, and construction workers mailed pieces of lumber to the Fed. Yet Volcker persisted, believing that only a credible commitment to monetary restraint could break the inflationary psychology that had become embedded in the economy. Across the Atlantic, Margaret Thatcher's election as British Prime Minister in 1979 brought monetarism to the heart of government policy. Thatcher had absorbed Friedman's ideas through her economic adviser, Alan Walters, and made controlling inflation her top priority. "Inflation is the parent of unemployment," she declared, directly challenging the Keynesian view that fighting inflation would increase joblessness. Like Volcker, she was willing to accept the pain of recession to break the inflationary cycle. The British economy suffered severely, with unemployment exceeding 3 million by 1982, but inflation fell from over 20 percent to around 5 percent by 1983. The implementation of monetarism proved more complex than the theory suggested. Deregulation of the financial system in both countries made monetary aggregates increasingly difficult to measure and control. M1, M2, and other measures of money supply behaved erratically, forcing central bankers to adapt their approaches. Volcker eventually abandoned strict monetarist targeting in 1982, though he maintained the focus on controlling inflation. This pragmatic adaptation reflected a broader pattern: while pure monetarism—with its emphasis on steady money growth—was not fully implemented, Friedman's core insights about inflation, expectations, and the limits of discretionary policy became part of the mainstream consensus. By 1984-85, the policy revolution had largely succeeded in its primary goal. Inflation in the United States had fallen to around 4 percent, and a sustained economic expansion was underway. The recession, though severe, had been relatively short-lived, and the economy rebounded strongly once inflation expectations had been reset. The Volcker disinflation vindicated Friedman's core insights: that inflation was fundamentally a monetary phenomenon, that expectations played a crucial role in price dynamics, and that there was no permanent trade-off between inflation and unemployment. The painful transition confirmed Friedman's warning that once inflation became embedded in expectations, reducing it would require a period of higher unemployment. The policy revolution of 1979-85 transformed central banking around the world. Price stability became the primary objective of monetary policy, and central bank independence gained new importance. The age of fine-tuning had given way to the age of rules, frameworks, and transparency. As former Fed Chairman Alan Greenspan later observed, "The central bank's job is to worry about inflation. Milton Friedman made that point. We all understand that." This transformation in monetary thinking represented one of the most significant paradigm shifts in economic policy of the 20th century, and its effects continue to shape central banking practices today.

Chapter 5: Global Impact: From Chile to the Washington Consensus (1975-1995)

The influence of monetarist ideas extended far beyond the United States and Britain during the 1970s and 1980s, reshaping economic policies across the globe. Perhaps no international case proved more contentious than Chile, where monetarist principles were applied under the authoritarian regime of General Augusto Pinochet. Following the 1973 military coup that overthrew socialist president Salvador Allende, Chile faced economic chaos with inflation exceeding 300 percent. In March 1975, Friedman visited Santiago for six days, meeting with Pinochet and delivering lectures on inflation. His prescription of "shock treatment" to end inflation—sharp reductions in government spending and a credible commitment to stop printing money—aligned with a reform plan already developed by Chilean economists known as the "Chicago Boys." These Chicago Boys—Chilean economists who had studied at the University of Chicago under Friedman and his colleague Arnold Harberger—implemented a comprehensive program of economic liberalization. They slashed government spending, eliminated price controls, privatized state enterprises, and opened the economy to international trade. The results were initially painful—GDP fell by 12.9 percent in 1975, and unemployment reached 20 percent. But inflation began to decline, and by the late 1970s, Chile was experiencing what some called an "economic miracle," with growth rates averaging 7 percent between 1976 and 1981. This dramatic turnaround made Chile a showcase for market-oriented reforms, though the association with Pinochet's repressive regime remained deeply controversial. The Chilean experience became a template for economic reforms across Latin America. Countries like Argentina, Bolivia, and Mexico, facing debt crises and hyperinflation in the 1980s, turned to similar policies of monetary restraint, fiscal discipline, privatization, and trade liberalization. These reforms, often implemented under pressure from international financial institutions, became known as the "Washington Consensus"—a term coined by economist John Williamson in 1989 to describe the standard policy prescriptions advocated by the IMF, World Bank, and U.S. Treasury Department. While not purely monetarist, these policies reflected Friedman's emphasis on stable money, limited government intervention, and free markets. The collapse of communism in Eastern Europe and the Soviet Union created another arena for the spread of market-oriented reforms. Countries transitioning from centrally planned to market economies sought new economic models, and many turned to policies influenced by Chicago School thinking. In Poland, Finance Minister Leszek Balcerowicz implemented a "shock therapy" program in 1990 that bore striking similarities to the Chilean approach. Similar reforms were attempted in Russia, though with less success due to institutional weaknesses and political resistance. The transition experiences varied widely, but the intellectual framework guiding these reforms often drew on monetarist principles about the importance of price stability and market mechanisms. International financial institutions became key vehicles for spreading these ideas globally. The International Monetary Fund increasingly made loans conditional on adopting Washington Consensus policies, requiring borrowing countries to implement monetary restraint, fiscal discipline, and structural reforms. This approach was particularly influential during the debt crises that plagued developing countries in the 1980s and 1990s. Critics argued this represented a form of economic imperialism, imposing a one-size-fits-all model without sufficient attention to local conditions. Supporters countered that these policies addressed fundamental economic imbalances and created conditions for sustainable growth. By the mid-1990s, the global impact of monetarist-influenced policies was evident across continents. Central banks from New Zealand to Israel had adopted inflation targeting frameworks, which combined Friedman's emphasis on price stability with greater transparency about policy goals. Financial markets had been liberalized in countries at all levels of development, creating more integrated global capital markets. State-owned enterprises had been privatized on a massive scale, reducing government's direct role in economic activity. While these changes produced genuine economic gains—particularly in controlling inflation—they also generated new inequalities and vulnerabilities that would eventually prompt reassessment of the monetarist legacy. The Asian financial crisis of 1997-98 and later the global financial crisis of 2008 would raise questions about whether the pendulum had swung too far toward market fundamentalism.

Chapter 6: Legacy and Evolution: Monetarism's Influence on Modern Central Banking

The legacy of monetarism continues to shape economic policy and debate well into the 21st century. While pure monetarism—with its emphasis on targeting monetary aggregates—has largely been abandoned, its core insights about inflation, central bank independence, and the importance of monetary stability have become embedded in modern economic practice around the world. Perhaps the most enduring institutional legacy is the transformation of central banking. Before the monetarist revolution, central banks often operated as extensions of government finance ministries, frequently accommodating fiscal needs at the expense of price stability. Today, central bank independence is considered essential in advanced economies, with price stability typically enshrined as the primary mandate. Inflation targeting, first adopted by New Zealand in 1990 and subsequently by dozens of countries, represents a compromise between rigid monetarist rules and unfettered discretion. By committing to a specific inflation target but retaining flexibility in how to achieve it, central banks created a framework that provided both accountability and adaptability. As former Federal Reserve Chairman Ben Bernanke noted, inflation targeting was "not an ironclad rule" but rather "a framework for making monetary policy decisions in a complex, uncertain economic environment." This approach incorporated Friedman's emphasis on rules and predictability while acknowledging the practical difficulties of implementing strict monetarist prescriptions in a dynamic financial system. The 2008 Global Financial Crisis presented a significant challenge to the post-monetarist consensus. When conventional monetary policy reached the "zero lower bound" of interest rates, central banks turned to unconventional measures like quantitative easing—massive asset purchases designed to inject liquidity into financial markets. Friedman had actually anticipated such measures in a 1969 paper discussing monetary policy in deflationary conditions, though the specific implementation differed from his conception. The crisis also revived debates about financial regulation that echoed earlier Chicago School discussions. Critics argued that excessive deregulation, influenced by free-market thinking, had created vulnerabilities that amplified the crisis. The COVID-19 pandemic triggered another round of monetary innovation, with central banks deploying unprecedented stimulus measures while governments implemented massive fiscal responses. The resulting surge in money supply growth without immediate inflation puzzled many observers and sparked renewed debate about monetary theory. When inflation did emerge in 2021-22, reaching levels not seen since the early 1980s, it reignited interest in monetarist explanations. Some economists pointed to the dramatic expansion of money supply during the pandemic as a key factor, echoing Friedman's dictum that "inflation is always and everywhere a monetary phenomenon." Friedman's intellectual legacy extends beyond monetary policy to broader questions about the role of markets and government. His advocacy for school choice through educational vouchers has influenced education reform debates for decades. His proposal for a negative income tax as an alternative to complex welfare programs anticipated later discussions about universal basic income. Even economists who reject his political philosophy acknowledge his methodological contributions and empirical insights. As Nobel laureate Robert Solow, often a critic of Friedman, conceded: "Everything reminds Milton of the money supply. Well, everything reminds me of sex, but I keep it out of my papers." Today, central banks around the world operate within frameworks that bear Friedman's intellectual imprint, even as they have moved beyond strict monetarism. The Federal Reserve's dual mandate of price stability and maximum employment reflects his insight that monetary policy cannot permanently reduce unemployment but can maintain stable prices. The European Central Bank's primary focus on price stability embodies his emphasis on controlling inflation as the foundation for sustainable growth. The global norm of floating exchange rates, which Friedman advocated when fixed rates were still orthodox, has transformed international finance. While debates continue about the proper conduct of monetary policy, the revolution Friedman helped launch has fundamentally and permanently altered how we think about money, inflation, and central banking.

Summary

The monetarist revolution represents one of the most significant transformations in economic thinking of the twentieth century. At its core, this story reveals how ideas developed in academic settings can reshape the world when historical circumstances create openings for new approaches. Friedman's challenge to Keynesian orthodoxy succeeded not just because of the intellectual rigor of his arguments, but because stagflation in the 1970s created a crisis that conventional wisdom could not explain or solve. The painful but ultimately successful disinflation of the early 1980s vindicated key monetarist insights: that inflation is fundamentally a monetary phenomenon, that expectations play a crucial role in economic behavior, and that there are limits to government's ability to fine-tune the economy. For contemporary policymakers, the monetarist legacy offers several enduring lessons. First, price stability provides the foundation for sustainable economic growth—when inflation becomes entrenched, restoring stability requires difficult choices and often significant economic pain. Second, institutional frameworks matter—independent central banks with clear mandates are better positioned to maintain monetary stability than those subject to short-term political pressures. Finally, economic theories must be judged by their predictive power and practical applicability, not by their mathematical elegance or ideological appeal. As central banks navigate new challenges from digital currencies to climate change, these lessons from the monetarist revolution remain relevant. The story of how a small group of economists transformed global economic policy reminds us that ideas matter, especially when they offer solutions to problems that existing frameworks cannot address.

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Jennifer Burns

Jennifer Burns is Associate Professor of History at Stanford University and a Research Fellow at Stanford’s Hoover Institution on War, Revolution, and Peace. A nationally recognized authority on Rand and conservative thought, she has discussed her work on The Daily Show and Book TV and has been interviewed on numerous radio programs.

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