What Would Milton Friedman Say?

Contributors: Peter Ireland | Joshua Hendrickson | Patrick Horan | Julius Probst | David Beckworth | Scott Sumner

Milton Friedman was one of the most important economists of the 20th century—and was never lost for an answer. Although he was famous for his work in many areas of economics, he was most famous as a monetary economist and a founding member of the “monetarist school of thought,” which emphasizes the central role of money in business cycles. Friedman was also a longtime supporter of the idea that monetary policy should be determined by rules rather than central bank discretion as fallible central bankers would be more likely to do harm than good in setting policy.

Today, monetary policy is at a crossroads. The COVID-19 pandemic prompted the Federal Reserve (Fed) and many central banks to pursue unprecedented monetary policies. Although this response arguably helped stave off the worst economic effects of the pandemic, the United States and many other countries have been grappling with the highest inflation seen in decades. This is also taking place as the Fed carries out its new policy of flexible average inflation targeting (FAIT). Some politicians are also calling for the Fed’s mandate to be expanded to include goals related to climate change and social equity.

What would Milton Friedman think of current monetary policy?

Although we can only speculate what Friedman, who passed away in 2006, would think of policy today, his voluminous academic writing and popular commentary offers many insights for the present. The Mercatus Center has published six essays addressing key policy questions and how Friedman might answer them.

What are the likely consequences of the surge in money supply since 2020?

Peter Ireland’s essay examines the surge in the M2 money supply since 2020. This rapid money growth is unprecedented in postwar American history. Although many economists began to lose interest in monetary aggregates in the 1990s, Ireland argues that Friedman would be alarmed by this development. Despite research indicating a weakening of the relationship between money, income, and prices, insights from Friedman’s research show that money is still important for these other variables. Ireland concludes that “[un]less the Federal Reserve acts soon and decisively to recalibrate its monetary policy strategy, higher inflation will quite likely persist.”

How important is it to coordinate monetary and fiscal policy?

Given that the United States saw dramatic expansions in both monetary and fiscal policy in response to the COVID-19 pandemic, Joshua Hendrickson’s essay addresses the subject of monetary-fiscal coordination. Earlier in his career, Friedman proposed a coordinated rules-based approach to both monetary and fiscal policy. Under this plan, the government would finance a budget deficit through money creation when nominal income fell below trend. This may be surprising to those who are more familiar with Friedman’s later work, much of which argued in favor of a constant money growth rule and against the use of fiscal policy. However, a close reading of both his earlier and later work shows that Friedman always argued in favor of a rules-based approach for macroeconomic policy, given that policymakers’ errors tend to be destabilizing rather than stabilizing. What did change between his earlier and later work is that he later recognized that monetary policy is more important than fiscal policy in producing stability because the former offsets the latter.

How can we make the Fed more rules-based in its approach?

Patrick Horan’s essay looks at the Fed’s new “flexible average inflation targeting” (FAIT) framework through a Friedmanite lens. Before turning to FAIT, he argues that Friedman in general would have strong reason to support a nominal income or nominal GDP level target (NGDPLT). Such a target can be thought of as a velocity-adjusted money supply target. To the extent that FAIT mimics NGDPLT, Friedman might find merits in the Fed’s new framework, but he would likely also be very critical of the degree of discretion the Fed retains under the new framework. Since the Fed is unlikely to adopt an NGDPLT in the near term, one way for the Fed to make FAIT more rules based would be to explicitly interpret FAIT as a temporary price-level target.

Does the economy systematically hover above and below a sustainable, natural growth rate?

Julius Probst’s essay draws a connection between the Fed’s new framework and Friedman’s plucking model. Much of standard macroeconomics assumes that the economy symmetrically hovers above and below a sustainable, natural growth rate. Although this view suggests the economy is just as prone to booms as it is to busts, Friedman’s plucking model argues that the economy generally exhibits busts from the natural or potential growth rate but not booms. An implication of this view is if policymakers allow output to fall below its potential growth rate, the economy can suffer from permanent scars, which damage its long-run capacity to produce goods and services. Probst argues that the Fed’s new framework, which expressly addresses shortfalls in maximum employment, is a testament to the notion that the plucking model more accurately describes reality than the standard view.

What are the two principles for achieving financial stability?

David Beckworth’s essay discusses financial stability from a Friedmanite perspective. He argues Friedman’s work suggests two principles for achieving financial stability. First, a stable monetary regime would produce stable nominal income growth, which, in turn, would support financial stability. Second, banks and other financial institutions should be robust to economic shocks, which could cause fluctuations in the money stock and lead to volatility in nominal income. Since Friedman supported simple rules for monetary and financial policy, he would likely argue that the Fed should call for higher capital funding for banks, but he would be alarmed by the Fed’s interest in determining whether nonmonetary problems such as climate change are sources of financial risk. By becoming more involved in political issues beyond its congressional mandate, the Fed risks losing its legitimacy.

What caused the Great Recession?

Scott Sumner’s essay asks what Friedman would think of market monetarism, a new school of thought. Like traditional monetarists, market monetarists argue that the market economy generally functions well on its own as long as monetary policy is stable. Unlike traditional monetarists, market monetarists argue in favor of targeting nominal GDP rather than the money supply and using market forecasts to set policy. Although Friedman was the most important monetarist and played a critical role in overturning the Keynesian consensus in the 1960s and 1970s, problems with money supply targeting forced Friedman to reconsider some of his views. Since Friedman passed away in 2006, it is impossible to tell what he would have thought about the Great Recession and its aftermath. Nevertheless, Sumner argues that Friedman would have likely agreed with the market monetarist analysis that tight monetary policy caused the Great Recession and the weak economic recovery that followed.

Symposium Essays

Beckworth, David. “What Would Milton Friedman Say about Financial Stability?” April 2022. 

Hendrickson, Joshua. “What Would Milton Friedman Say about the Coordination of Monetary and Fiscal Policy?” April 2022. 

Horan, Patrick. “What Would Milton Friedman Say about the Fed’s New Framework?” April 2022.

Ireland, Peter. “What Would Milton Friedman Say about the Recent Surge in Money Growth?” April 2022.

Probst, Julius. “What Would Milton Friedman Say about Business Cycles? The Plucking Model View.” April 2022

Sumner, Scott. “What Would Milton Friedman Say about Market Monetarism?” April 2022.