Monetarists and Milton Friedman (1912 – 2006) (and some Rational Expectations Stuff too)

Keynesianism was a great reformation of economic thought. It was followed, inevitably, by a counter-reformation. A number of economists played important roles in the great revival of classical economics between 1950 and 2000, but none was as influential as Milton Friedman. If Keynes was Luther, Friedman was Ignatius of Loyola, founder of the Jesuits. And like the Jesuits, Friedman’s followers have acted as a sort of disciplined army of the faithful, spearheading a broad, but incomplete, rollback of Keynesian heresy. By the century’s end, classical economics had regained much though by no means all of its former dominion, and Friedman deserves much of the credit. 

- Paul Krugman (The New York Review of Books, Feb. 2007)

The Economist described Friedman as "the most influential economist of the second half of the 20th century…possibly of all of it."

 

Milton Friedman was born in Brooklyn, New York, to recent Jewish immigrants.  Friedman did graduate work at the University of Chicago, earning a Masters  in 1933. He was strongly influenced by Jacob Viner, Frank Knight and Henry Simons. It was at Chicago that Friedman met his future wife, economist Rose Director. During 1933–34 he had a fellowship at Columbia University where he studied statistics with renowned statistician and economist Harold Hotelling. He was back in Chicago for 1934–35, spending the year working as a research assistant. In 1945, Friedman submitted Incomes from Independent Professional Practice (co-authored with Kuznets and completed during 1940) to Columbia as his doctoral dissertation. The university awarded him a Ph.D. in 1946.

Also known as part of the Chicago School of Economics, he taught at the University of Chicago for 30 years (from 1946 on).

In 1976 Friedman won the Novel Memorial Prize in Economics "for his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of the complexity of stabilization policy."

As others - Friedman felt that Keynes was different (better?) than his followers:

"[Monetarism] has benefited much from Keynes' work...If Keynes was alive today, he would no doubt be at the forefront of the counter-revolution. You must never judge a master by his disciples."   -Friedman

 

 

Monetarism 

Friedman was best known for reviving interest in the money supply as a determinant of the nominal value of output, that is, the quantity theory of money (which we have seen many times).  Monetarism is the set of views associated with modern quantity theory.

MV = PQ

-emphasizes the role of governments in controlling the amount of money in circulation. It is the view that changes in the money supply has major influences on national output in the short run and the price level over longer periods.

Objectives of monetary policy are best met by targeting the growth rate of the money supply.

Hence, with respect to Phillips curve: 

 Friedman’s explanation: the short run trade-off but long run vertical Phillips curve.

Adaptive Expectations:

So inflation,  “which, perhaps after a lag, becomes fully anticipated by everyone”

–        “what raises the price level, if at all points markets are cleared and real magnitudes are stable? ... Because everyone confidently anticipates that prices will rise…”

–        Increasing Ms raises prices, no impact on output in long run (short run impact until expectations adapt)

Graph:

 

 

 

 

 

From Monetarism to Rational Expectations

 

Friedman adaptive expectations

–        expectations adapt to change after experience of inflation caused by increased money supply

–        short-term impact of policy neutralised in long term (neutralized meaning policy not effective)

Then comes along:

Rational Expectations (Muth/Sargent/Lucas): expectations predict consequence of change based on rational model of reality:

–        “expectations … are essentially the same as the predictions of the relevant economic theory.”

–        “the public knows the monetary authority’s feedback rule and takes this into account in forming its expectations… unanticipated movements in the money supply cause movements in y [output], but anticipated movements do not.”

 

        “Predictions of relevant theory” are: increased Ms will increase price level --> instant adjustment of prices to government Ms policy --> no impact on output

–        “Natural rate” of unemployment + rational expectations = policy ineffectiveness hypothesis:

    even in the short run policy will not be effective -- the only effective policy will be one that is a completely random shock!