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Book Review: Monetarist Economics


Monetarist Economics
by Milton Friedman (Cambridge: Basil Blackwell, 1991); 188 pages; $29.95

In the 1950s, for all practical purposes, there was only one type of economics — Keynesian economics. In the ten years after John Maynard Keynes published his 1936 volume The General Theory of Money, Interest and Money, the vast majority of American and British economists were won over to the following ideas: 1) a market economy is inherently unstable, tending to generate prolonged periods of unemployment and depression; 2) changes in the money supply were not the cause of instability in the economy; instead, the amount of money circulating in the economy was a passive element dependent upon and changing with people’s willingness to spend and invest out of their income; and 3) it was within the power of government, through monetary and fiscal policy, to assure full employment and economic stability.

The critics of these propositions, who had been opponents of Keynes’s ideas before his death in 1946, were intellectually murdered by the economics profession in the years after the Second World War. Keynes’ followers treated their opponents as either old-fashioned cranks or weak-minded fools not worthy of recognition.

But by the late 1960s and early 1970s, it was Keynesian economics that was on the decline. The reason for this turn of events can be summed up in one man’s name — Milton Friedman. In 1956, Friedman edited and contributed to a collection of essays entitled Studies in the Quantity Theory of Money. Then, in 1963, there appeared a massive volume written by Friedman and Anna Schwartz entitled A Monetary History of the United States, 1865-1960. And in 1968, Friedman delivered a presidential address to the American Economics Association on “The Role of Monetary Policy.”

These works, as well as a growing economics literature by others who came to share Friedman’s views, brought about the defeat of Keynesian economics. Friedman and those of like mind became known as the monetarists, and their new brand of economics became known as monetarism.

The essays in the volume under review, Monetarist Economics, bring together Friedman’s monographs on this theme that have been published by the Institute of Economic Affairs in London; also included is his 1976 Nobel lecture on “Inflation and Unemployment: the New Dimension of Politics.” Friedman has been one of the most forceful and eloquent defenders of the free-market economy (as represented in his popular works Capitalism and Freedom and Free to Choose). He showed the weakness in every one of the Keynesian propositions. He demonstrated that when an economy is open and free-competitive and relatively unregulated by the government, markets are able to clear. That is, competitively determined wages and prices always assure that supply and demand in every market are brought into balance. Therefore, if significant unemployment arises and persists for any prolonged period of time, it can only be because of state intervention that prevents competition and prices from doing their job.

Friedman’s work in monetary history demonstrated that inflations and depressions are caused by mismanagement of the money supply by governments. Unexpected changes in the rate at which the supply of money is increased (or decreased) send out false information to the market that causes destabilizing changes in employment and output. And it is these unexpected fluctuations in monetary growth that set in motion the boom — and — bust cycles of inflation and depression (or recession).

Friedman concluded that discretionary monetary and fiscal policy by the government, rather than being a solution to economic instability, was, in fact, the cause. He argued that the best monetary policy was a simple, invariant and predictable rule: that the monetary authority be required to increase the money supply at a fixed annual rate.

But in the last few years, Friedman has had second thoughts about his policy proposals. In a presidential address he delivered at the Western Economics Association not long ago, he said that the corrupting and perverse incentives inevitably at work in government bureaucracies and in the halls of political power will inevitably result in those who control the money supply abusing their power. As a consequence, his monetary rule would never, in the long run, be followed by a central bank.

And this, in fact, points to the central weakness in Friedman’s important contributions to monetary theory and policy: a free and prosperous economy is only possible if money is totally taken out of the hands of the state — a position which Friedman has long resisted. Only if the market is left free to determine which commodities are to be used as money — and only if it is left up to the market to determine how much of these commodities is to be supplied (based on the profitability of producing them) — can economic freedom and stability be assured in the long run.

But to be able to debate the issue of government vs. market money, it was first necessary to overthrow Keynesian economics. And for leading the intellectual battle that brought this about, Milton Friedman deserves our eternal thanks.

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).