Economist of the 20th Century
Nov 28, 2006
A hero of mine, a giant amongst economists, passed away on November 16, 2006 at the age of 94.
A hero of mine, a giant amongst economists, passed away on November 16, 2006 at the age of 94.
Milton Friedman, arguably the most influential economist of the past century, was a prime force in the movement of nations toward less government and greater reliance on individual responsibility.
Ugandans should tip their hats to Friedman as they line up to buy shares of Stanbic Bank, withdraw money from ATM machines, freely exchange shillings into dollars and enjoy the comforts of the privately owned Kampala Serena Hotel.
It was Professor Friedman’s research at the University of Chicago that laid the intellectual foundations for the low inflation that we enjoy today. His research earned him the Nobel Prize in Economic Science in 1976.
It was his public advocacy of economic freedoms, private enterprise and other revolutionary ideas in the 1950s that we have to thank for the privatization and flexible exchange rates.
His most famous insight, “Inflation is always and everywhere a monetary phenomenon†is almost a cliché.
It seems pretty obvious now, but it dealt a knock-out blow to the Keynesian orthodoxy that blamed the “usual suspects†– greedy businessmen raising prices, grasping trade unions asking for higher wages, Arab Sheiks increasing the price of oil and even the weather – for inflation.
Friedman had the audacity to show that these “usual suspects†had nothing whatsoever to do with inflation.
He showed that even if there was an increase in the price of a particular good it would not lead to a general increase in the price level.
Friedman made it clear that wage and price increases did not drive inflation; they just reflected it. His insight completely demolished the Keynesian notion of "cost push" inflation.
The stunning implication of his famous insight was that inflation occurs only when the Central Bank prints too much money making the supply of money grow faster than the real economy creates value. Control money and you control inflation.
In a 1970 lecture, “The Counterrevolution in Monetary Theory,†Friedman outlined eleven propositions about how monetary policy affects the economy.
All were wildly controversial, almost disreputable, at the time. Most are accepted today.
The first six propositions described the effects of tightening or loosening the money supply.
Changing the money supply, Friedman argued, raises or lowers nominal national income with a lag of six to nine months.
That change appears initially in output, so an increase in the money supply spurs production. After another six to nine months, however, prices adjust. Real, as opposed to nominal, income does not change. Voila. Money is neutral.
This was another big idea. The proposition that monetary policy can affect real output only in the short run was revolutionary at the time.
The conventional Keynesian view held that monetary policy could be used to affect real outcomes – for example, to lower the rate of unemployment – for an indefinite period.
Friedman went on to advance the idea of a “natural rate of unemploymentâ€, in place of the trade off between inflation and output implied by the then-fashionable “Phillips Curveâ€. This is the contention that, in the long run, unemployment returns to its normal rate regardless of the rate of inflation.
In the short run, there is an inverse relationship between inflation and unemployment because inflation is often unexpected; but in the long run the relationship disappears.
Friedman resurrected the Quantity Theory of Money, the view that a stable relationship exists between money supply and nominal demand.
The stable relationship implied that monetary policy could be used to influence demand conditions and thus stabilize the economy. At that time, the Keynesian view was that stabilizing the economy should be left to fiscal policy—government spending and taxes.
Perhaps Friedman’s greatest achievement was the development of the “permanent income hypothesisâ€.
This is the contention that people adjust their consumption only to changes in their expectations of their long-term or permanent income.
In other words, transitory or temporary changes in income have little effect on consumption spending. If the marginal propensity to consume from transitory income was small then fiscal policy would have a much smaller impact than the Keynesians claimed.
However, the most fundamental policy recommendation put forth by Friedman is the injunction to policy makers to provide a stable monetary background for the economy and avoid inflation or deflation.
This was the policy implication of his magnum opus, “A Monetary History of the United States 1867-1960,’ written with Anna Schwartz in 1963.
Unlike the Keynesians who thought that economic instability could be traced to a lack of aggregate demand or “animal spiritsâ€, Friedman insisted that it could be traced to inept monetary policy.
Uganda provides an excellent example of what inept monetary policy can do to an economy.
Between 1971 and 1992, successive governments continued to pump out money at a faster rate than the economy grew and then repeatedly devalued the shilling in a Quixotic attempt to stabilize the economy.
In mid-1980 the official exchange rate was sh7.30 per dollar.
When the Obote government floated the shilling in mid-1981, it lost 96% of its previous value immediately before settling at sh78 per dollar. However, with the printing presses running full speed the shilling continued its decline hitting sh1,450 to the dollar in 1986.
In May 1987, the NRM government introduced a new shilling, worth 100 old shillings, along with an effective 76 percent devaluation.
But following this devaluation, the money supply continued to grow at an annual rate of 500 percent eroding the value of the new shilling.
In July 1988, the government again devalued the shilling by 60 percent, setting it at sh150 per dollar.
However, by late 1990, the official exchange rate had collapsed to sh510 per dollar. That was if you could get the dollar without going to the “Kibanda boys†where the black market rate was sh700 per dollar.
The government continued to ignore the writing on the wall and tried to curb inflation by bizarre means like increasing disbursements of import-support funds and tightening controls on credit.
These measures helped lower the rate of inflation to 30 percent by mid-1990, but by late 1990, inflation had once again resumed its upward spiral.
By failing to apply Friedman’s monetary framework, the Bank of Uganda and Treasury doomed Uganda to a quarter century of high inflation, a free-falling currency, capital flight, low savings, low investment and grinding poverty.
Inflation was finally tamed in 1992, when Uganda put in place a strict cash budget system. No cash. No government spending. This is a classic monetarist prescription.
A strict cash budget system prohibits the Treasury from borrowing from the Central Bank under any circumstances.
Uganda opted for a weaker version in which only certain Treasury officials were allowed to authorize borrowing.
With smaller budget deficits and reduced monetary financing of government borrowing; inflation dropped to single digits just as Friedman had predicted almost 50 years before.
Milton Friedman, arguably the most influential economist of the past century, was a prime force in the movement of nations toward less government and greater reliance on individual responsibility.
Ugandans should tip their hats to Friedman as they line up to buy shares of Stanbic Bank, withdraw money from ATM machines, freely exchange shillings into dollars and enjoy the comforts of the privately owned Kampala Serena Hotel.
It was Professor Friedman’s research at the University of Chicago that laid the intellectual foundations for the low inflation that we enjoy today. His research earned him the Nobel Prize in Economic Science in 1976.
It was his public advocacy of economic freedoms, private enterprise and other revolutionary ideas in the 1950s that we have to thank for the privatization and flexible exchange rates.
His most famous insight, “Inflation is always and everywhere a monetary phenomenon†is almost a cliché.
It seems pretty obvious now, but it dealt a knock-out blow to the Keynesian orthodoxy that blamed the “usual suspects†– greedy businessmen raising prices, grasping trade unions asking for higher wages, Arab Sheiks increasing the price of oil and even the weather – for inflation.
Friedman had the audacity to show that these “usual suspects†had nothing whatsoever to do with inflation.
He showed that even if there was an increase in the price of a particular good it would not lead to a general increase in the price level.
Friedman made it clear that wage and price increases did not drive inflation; they just reflected it. His insight completely demolished the Keynesian notion of "cost push" inflation.
The stunning implication of his famous insight was that inflation occurs only when the Central Bank prints too much money making the supply of money grow faster than the real economy creates value. Control money and you control inflation.
In a 1970 lecture, “The Counterrevolution in Monetary Theory,†Friedman outlined eleven propositions about how monetary policy affects the economy.
All were wildly controversial, almost disreputable, at the time. Most are accepted today.
The first six propositions described the effects of tightening or loosening the money supply.
Changing the money supply, Friedman argued, raises or lowers nominal national income with a lag of six to nine months.
That change appears initially in output, so an increase in the money supply spurs production. After another six to nine months, however, prices adjust. Real, as opposed to nominal, income does not change. Voila. Money is neutral.
This was another big idea. The proposition that monetary policy can affect real output only in the short run was revolutionary at the time.
The conventional Keynesian view held that monetary policy could be used to affect real outcomes – for example, to lower the rate of unemployment – for an indefinite period.
Friedman went on to advance the idea of a “natural rate of unemploymentâ€, in place of the trade off between inflation and output implied by the then-fashionable “Phillips Curveâ€. This is the contention that, in the long run, unemployment returns to its normal rate regardless of the rate of inflation.
In the short run, there is an inverse relationship between inflation and unemployment because inflation is often unexpected; but in the long run the relationship disappears.
Friedman resurrected the Quantity Theory of Money, the view that a stable relationship exists between money supply and nominal demand.
The stable relationship implied that monetary policy could be used to influence demand conditions and thus stabilize the economy. At that time, the Keynesian view was that stabilizing the economy should be left to fiscal policy—government spending and taxes.
Perhaps Friedman’s greatest achievement was the development of the “permanent income hypothesisâ€.
This is the contention that people adjust their consumption only to changes in their expectations of their long-term or permanent income.
In other words, transitory or temporary changes in income have little effect on consumption spending. If the marginal propensity to consume from transitory income was small then fiscal policy would have a much smaller impact than the Keynesians claimed.
However, the most fundamental policy recommendation put forth by Friedman is the injunction to policy makers to provide a stable monetary background for the economy and avoid inflation or deflation.
This was the policy implication of his magnum opus, “A Monetary History of the United States 1867-1960,’ written with Anna Schwartz in 1963.
Unlike the Keynesians who thought that economic instability could be traced to a lack of aggregate demand or “animal spiritsâ€, Friedman insisted that it could be traced to inept monetary policy.
Uganda provides an excellent example of what inept monetary policy can do to an economy.
Between 1971 and 1992, successive governments continued to pump out money at a faster rate than the economy grew and then repeatedly devalued the shilling in a Quixotic attempt to stabilize the economy.
In mid-1980 the official exchange rate was sh7.30 per dollar.
When the Obote government floated the shilling in mid-1981, it lost 96% of its previous value immediately before settling at sh78 per dollar. However, with the printing presses running full speed the shilling continued its decline hitting sh1,450 to the dollar in 1986.
In May 1987, the NRM government introduced a new shilling, worth 100 old shillings, along with an effective 76 percent devaluation.
But following this devaluation, the money supply continued to grow at an annual rate of 500 percent eroding the value of the new shilling.
In July 1988, the government again devalued the shilling by 60 percent, setting it at sh150 per dollar.
However, by late 1990, the official exchange rate had collapsed to sh510 per dollar. That was if you could get the dollar without going to the “Kibanda boys†where the black market rate was sh700 per dollar.
The government continued to ignore the writing on the wall and tried to curb inflation by bizarre means like increasing disbursements of import-support funds and tightening controls on credit.
These measures helped lower the rate of inflation to 30 percent by mid-1990, but by late 1990, inflation had once again resumed its upward spiral.
By failing to apply Friedman’s monetary framework, the Bank of Uganda and Treasury doomed Uganda to a quarter century of high inflation, a free-falling currency, capital flight, low savings, low investment and grinding poverty.
Inflation was finally tamed in 1992, when Uganda put in place a strict cash budget system. No cash. No government spending. This is a classic monetarist prescription.
A strict cash budget system prohibits the Treasury from borrowing from the Central Bank under any circumstances.
Uganda opted for a weaker version in which only certain Treasury officials were allowed to authorize borrowing.
With smaller budget deficits and reduced monetary financing of government borrowing; inflation dropped to single digits just as Friedman had predicted almost 50 years before.