A Scoreboard for Friedman

Adding to Don’s observations below, here’s a partial list of Friedman’s achievements, with a score out of ten for each.

1. The permanent income hypothesis. This was advanced in A Theory of The Consumption Function (1957). Keynes had argued that household consumption varies with current income in a simple way: if your after-tax income goes up by $100, your consumption increases by about $80, with the remaining $20 being saved. Friedman argued that the increase could be anything from zero to the full hundred, depending on whether the change in income was regarded as permanent or transitory. Together with Modigliani’s ‘life-cycle hypothesis’, this idea greatly enriched the way macroeconomists think about consumption decisions, which are now seen in terms of an unfolding plan shaped by long-term earnings expectations. In empirical terms, it also explained why consumption proved much less volatile than Keynes’ theory leads one to expect. 9/10 for useful theoretical innovation prompted by painstaking analysis of numbers, marred by occasional questionable massaging of the data.
2. The NAIRU hypothesis. Most famously in “The Role of Monetary Policy” his 1968 Presidential Address to the AEA, Friedman developed this idea in parallel with this year’s Nobel laureate Edmund Phelps. As I commented when the prize was announced, there is nothing remarkable in the idea that there is some threshold level of unemployment beyond which the economy becomes inflation-prone. What was new was the idea that, because expectations of inflation are self-confirming, prices will not just rise, but will do so at an accelerating rate. Whether or not this is always and everywhere true, it became the core principle governing central banking. The implication is that if central banks drop their guard and let the economy grow too fast, unemployment will rise above the NAIRU, and the inflation monster will escape from its cage. 8/10 for largely favourable influence on current policies.
3. Popular Polemics. Capitalism and Freedom (1962) and Free to Choose: A personal statement, with Mrs Friedman (1980). How ever you respond to these books, you can’t deny they are well written and very beguiling. A reader predisposed to laisser-faire ideology will be smitten, overjoyed to be handed such an armoury of arguments for privatisation and the user-pays principle, and against regulation and redistribution. A reader who is instinctively repelled by the idea that capitalism is a democracy ruled by ‘dollar votes’, will still find many of the arguments hard to dismiss. 7/10 for raising public understanding of economic issues, too one-sided for my taste.
4. Methodology. “The Methodology of Positive Economics” (1953) became the point of departure for all future discussions of methodology economics. This is partly because at first blush the thesis seemed so outrageous: namely, that it doesn’t matter if the assumptions of a theory are false, as long as it generates accurate predictions. In the underworld of the ‘methodology’ specialist in economics, one can find a spectrum of opinion: at one end Friedman’s article is dismissed as na¯ve, contradictory and meaningless; at the other end it is defended as a respectable and coherent case for ‘instrumentalism’. But in the mainstream it’s Holy Writ, the definitive answer to anyone who objects to what economists do, and a licence for most applied economists to carry on with a clear conscience doing what they do: deriving simple behavioural predictions from optimisation problems, then going ahead to test them against sample data. The key thing here is that you don’t worry whether individuals understand their own behaviour in terms of a mechanical response to material incentives they behave ‘as if’ they were doing so. 6/10 for helping economists to sleep peacefully.
5. Monetarism. This is Friedman’s signature doctrine, expounded in “The Quantity Theory of Money: A restatement” (1956), in the volume he edited entitled Studies in Quantity Theory; and also in Inflation: Causes and consequences, (1963). This was an attempt to modernise the classical quantity theory of money, according to which the value of money depends on the quantity of money in circulation. The implication is that inflation is caused by an excessively rapid increase in the quantity of money. In the eighteenth century when the ‘money supply’ was still a stock of coins, this was self-evidently true. But in a modern system where money is mostly paper credit the money supply is arbitrary, and indeed it becomes impossible to distinguish between demand and supply. The great monetary theorists Thornton and Wicksell, bookends of the nineteenth century, both argued that inflation makes it necessary for firms and households to obtain more deposits, and this increases the money supply. The inflation itself is caused by excessively low interest rates that stimulate business investment beyond what the nation’s resources can accommodate. In attempting to reassert the quantity of money itself as a causal variable, Friedman propelled monetary theory, and the art of central banking, backwards. 3/10 for influence on theory and policy, with mostlly regressive results.
6. General contribution to the history of macroeconomic thought. Friedman’s ability as a theoretician was exceeded by his talent for analysing empirical data, but even the latter was eclipsed by his flair for intellectual demagoguery. This is particularly evident in his dismissive attitude to Keynes and Keynesian ideas. Obviously Friedman’s policy recommendations are very un-Keynesian. But at the same time he made full use of the conceptual apparatus developed by Keynes, and in many ways his research program was compatible with Keynesian one. It became largely possible to represent Keynesian and monetarist positions as special cases of the same general theory (if not Keynes’s General Theory), and macroeconomics in the 1970s consisted largely of empirical investigations designed to adjudicate between Keynesian and monetarist claims about details such as the ‘interest elasticity of money demand’, something that would not have been possible without a common frame of reference. At the end of the day monetarism still attributes macroeconomic fluctuations to variations in demand, unlike the other ‘right wing’ schools of macroeconomic theory the rational expectations and real business cycles schools. Nonetheless Friedman made it his business to promulgate the idea that Keynes had nothing whatever of value to offer. He would not even give Keynes credit for the notion of liquidity preference, a major innovation in monetary theory; instead he invented, to the eternal consternation of Don Patinkin and Harry Johnson, a ‘Chicago verbal tradition’ in which the idea (in a more sophisticated version) had been employed by Friedman’s mentors long before Keynes thought of it. 1/10 for entertaining pantomime.