Articulo_Krugman_sobre_Friedman[1].doc

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THENEWYORKREVIEWOFBOOKS

VOLUME54, NUMBER2 FEBRUARY15, 2007

Who Was M!"o# F$%&'a#(

B) *a+! K$+'a#

1. The history of economic thought in the twentieth century is a bit like the history ofChristianity in the sixteenth century. Until John Maynard Keynes published TheGeneral Theory of Employment, Interest, and Moneyin 1!"# economics$at leastin the %nglish&speaking world$was completely dominated by free&marketorthodoxy. 'eresies would occasionally pop up# but they were always suppressed.Classical economics# wrote Keynes in 1!"# (con)uered %ngland as completely asthe 'oly *n)uisition con)uered +pain.( ,nd classical economics said that the

answer to almost all problems was to let the forces of supply and demand do their-ob.

ut classical economics offered neither explanations nor solutions for the /reat0epression. y the middle of the 1!s# the challenges to orthodoxy could no longer becontained. Keynes played the role of Martin 2uther# pro3iding the intellectual rigor neededto make heresy respectable. ,lthough Keynes was by no means a leftist$he came to sa3ecapitalism# not to bury it$his theory said that free markets could not be counted on topro3ide full employment# creating a new rationale for large&scale go3ernment inter3entionin the economy.

Keynesianism was a great reformation of economic thought. *t was followed# ine3itably# bya counter&reformation. , number of economists played important roles in the great re3i3alof classical economics between 14 and 5# but none was as influential as Milton6riedman. *f Keynes was 2uther# 6riedman was *gnatius of 2oyola# founder of the Jesuits.,nd like the Jesuits# 6riedman7s followers ha3e acted as a sort of disciplined army of thefaithful# spearheading a broad# but incomplete# rollback of Keynesian heresy. y thecentury7s end# classical economics had regained much though by no means all of its formerdominion and 6riedman deser3es much of the credit.

* don7t want to push the religious analogy too far. %conomic theory at least aspires to bescience# not theology8 it is concerned with earth# not hea3en. Keynesian theory initiallypre3ailed because it did a far better -ob than classical orthodoxy of making sense of theworld around us# and 6riedman7s criti)ue of Keynes became so influential largely becausehe correctly identified Keynesianism7s weak points. ,nd -ust to be clear9 although this essayargues that 6riedman was wrong on some issues# and sometimes seemed less than honestwith his readers# * regard him as a great economist and a great man.

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5. Milton 6riedman played three roles in the intellectual life of the twentieth century. Therewas 6riedman the economist7s economist# who wrote technical# more or lessapolitical analyses of consumer beha3ior and inflation. There was 6riedman the

policy entrepreneur# who spent decades campaigning on behalf of the policy knownas monetarism$finally seeing the 6ederal :eser3e and the ank of %ngland adopthis doctrine at the end of the 1;s# only to abandon it as unworkable a few yearslater. 6inally# there was 6riedman the ideologue# the great popularies and no. ,ll three roles were informed by6riedman7s faith in the classical 3erities of free&market economics. Moreo3er# 6riedman7seffecti3eness as a populari


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ut was it really a good idea to diminish the role of %conomic Man that much= @o# said6riedman# who argued in his 14! essay (The Methodology of Aositi3e %conomics( thateconomic theories should be -udged not by their psychological realism but by their abilityto predict beha3ior. ,nd 6riedman7s two greatest triumphs as an economic theorist camefrom applying the hypothesis of rational beha3ior to )uestions other economists had

thought beyond its reach.

*n his 14; bookA Theory of the Consumption Functionnot exactly a crowd&pleasingtitle# but an important topic$6riedman argued that the best way to make sense of sa3ingand spending was not# as Keynes had done# to resort to loose psychological theori


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is that hiring more workers becomes profitable when prices rise faster than wages. ut onceworkers understand that the purchasing power of their wages will be eroded by inflation#they will demand higher wage settlements in ad3ance# so that wages keep up with prices.,s a result# after inflation has gone on for a while# it will no longer deli3er the originalboost to employment. *n fact# there will be a rise in unemployment if inflation falls short of

expectations.

,t the time 6riedman and Ahelps propounded their ideas# the United +tates had littleexperience with sustained inflation. +o this was truly a prediction rather than an attempt toexplain the past. *n the 1;s# how&e3er# persistent inflation pro3ided a test of the6riedman&Ahelps hypothesis. +ure enough# the historical correlation between inflation andunemployment broke down in -ust the way 6riedman and Ahelps had predicted9 in the1;s# as the inflation rate rose into double digits# the unemployment rate was as high orhigher than in the stable&price years of the 14s and 1"s. *nflation was e3entuallybrought under control in the 1Bs# but only after a painful period of extremely highunemployment# the worst since the /reat 0epression.

y predicting the phenomenon of stagflation in ad3ance# 6riedman and Ahelps achie3edone of the great triumphs of postwar economics. This triumph# more than anything else#confirmed Milton 6riedman7s status as a great economist7s economist# whate3er one maythink of his other roles.

Gne interesting footnote9 although 6riedman made great strides in macroeconomics byapplying the concept of indi3idual rationality# he also knew where to stop. *n the 1;s#some economists pushed 6riedman7s analysis of inflation e3en further# arguing that there isno usable trade&off between inflation and unemployment e3en in the short run# becausepeople will anticipate go3ernment actions and build that anticipation# as well as pastexperience# into their price&setting and wage&bargaining. This doctrine# known as (rationalexpectations#( swept through much of academic economics. ut 6riedman ne3er wentthere. 'is reality sense warned that this was taking the idea ofHomo economicustoo far.,nd so it pro3ed9 6riedman7s 1"; address has stood the test of time# while the moreextreme 3iews propounded by rational expectations theorists in the +e3enties and %ightiesha3e not.

!.(%3erything reminds Milton of the money supply. ?ell# e3erything reminds me of sex#but * keep it out of the paper#( wrote M*T7s :obert +olow in 1"". 6or decades#Milton 6riedman7s public image and fame were defined largely by hispronouncements on monetary policy and his creation of the doctrine known asmonetarism. *t7s somewhat surprising to reali


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things. Currency$pieces of green paper with pictures of dead presidents on them$ ismoney# and so are bank deposits on which you can write checks. ut stocks# bonds# and realestate aren7t money# because they ha3e to be con3erted into cash or bank deposits beforethey can be used to make purchases.

*f the money supply consisted solely of currency# it would be under the direct control of thego3ernment$or# more precisely# the 6ederal :eser3e# a monetary agency that# like itscounterpart (central banks( in many other countries# is institutionally somewhat separatefrom the go3ernment proper. The fact that the money supply also includes bank depositsmakes reality more complicated. The central bank has direct control only o3er the(monetary base($the sum of currency in circulation# the currency banks hold in their3aults# and the deposits banks hold at the 6ederal :eser3e$but not the deposits peopleha3e made in banks. Under normal circumstances# howe3er# the 6ederal :eser3e7s directcontrol o3er the monetary base is enough to gi3e it effecti3e control of the o3erall moneysupply as well.

efore Keynes# economists considered the money supply a primary tool of economicmanagement. ut Keynes argued that under depression conditions# when interest rates are3ery low# changes in the money supply ha3e little effect on the economy. The logic wentlike this9 when interest rates are H or 4 percent# nobody wants to sit on idle cash. ut in asituation like that of 1!4# when the interest rate on three&month Treasury bills was only.1H percent# there is 3ery little incenti3e to take the risk of putting money to work. Thecentral bank may try to spur the economy by printing large )uantities of additionalcurrency8 but if the interest rate is already 3ery low the additional cash is likely to languishin bank 3aults or under mattresses. Thus Keynes argued that monetary policy# a change inthe money supply to manage the economy# would be ineffecti3e. ,nd that7s why Keynesand his followers belie3ed that fiscal policy$in particular# an increase in go3ernmentspending$was necessary to get countries out of the /reat 0epression.

?hy does this matter= Monetary policy is a highly technocratic# mostly apolitical form ofgo3ernment inter3ention in the economy. *f the 6ed decides to increase the money supply#all it does is purchase some go3ernment bonds from pri3ate banks# paying for the bonds bycrediting the banks7 reser3e accounts$in effect# all the 6ed has to do is print some moremonetary base. y contrast# fiscal policy in3ol3es the go3ernment much more deeply in theeconomy# often in a 3alue&laden way9 if politicians decide to use public works to promoteemployment# they need to decide what to build and where. %conomists with a free&marketbent# then# tend to want to belie3e that monetary policy is all that7s needed8 those with adesire to see a more acti3e go3ernment tend to belie3e that fiscal policy is essential.

%conomic thinking after the triumph of the Keynesian re3olution$as reflected# say# in theearly editions of Aaul +amuelson7s classic textbookI$ ga3e priority to fiscal policy# whilemonetary policy was relegated to the sidelines. ,s 6riedman said in his 1"; address to the,merican %conomic ,ssociation9

The wide acceptance of IKeynesian 3iews in the economics profession meant that forsome two decades monetary policy was belie3ed by all but a few reactionary souls to ha3ebeen rendered obsolete by new economic knowledge. Money did not matter.

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,lthough this may ha3e been an exaggeration# monetary policy was held in relati3ely lowregard through the 1Hs and 14s. 6riedman# howe3er# crusaded for the proposition thatmoney did too matter# culminating in the 1"! publication of A Monetary History of theUnited States, !"#$%" with ,nna +chwart


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,n analogy may be helpful here. +uppose that a flu epidemic breaks out# and later analysissuggests that appropriate action by the Centers for 0isease Control could ha3e containedthe epidemic. *t would be fair to blame go3ernment officials for failing to take appropriateaction. ut it would be )uite a stretch to say that the go3ernment causedthe epidemic# or touse the C0C7s failure as a demonstration of the superiority of free markets o3er big

go3ernment.

>et many economists# and e3en more lay readers# ha3e taken 6riedman and +chwart


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Monetarism was a powerful force in economic debate for about three decades after6riedman first propounded the doctrine in his 14 bookA +roram for Monetary Sta-ility.Today# howe3er# it is a shadow of its former self# for two main reasons.

6irst# when the United +tates and the United Kingdom tried to put monetarism into practice

at the end of the 1;s# both experienced dismal results9 in each country steady growth inthe money supply failed to pre3ent se3ere recessions. The 6ederal :eser3e officiallyadopted 6riedman&type monetary targets in 1;# but effecti3ely abandoned them in 1B5when the unemployment rate went into double digits. This abandonment was made officialin 1BH# and e3er since then the 6ed has engaged in precisely the sort of discretionary fine&tuning that 6riedman decried. 6or example# the 6ed responded to the 51 recession byslashing interest rates and allowing the money supply to grow at rates that sometimesexceeded 1 percent per year. Gnce the 6ed was satisfied that the reco3ery was solid# itre3ersed course# raising interest rates and allowing growth in the money supply to drop to


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dri3en by a re3i3al of business in3estment to take ad3antage of new technologicalopportunities. ut monetary policy ne3er was able to get any traction.

*n effect# Japan in the @ineties offered a fresh opportunity to test the 3iews of 6riedman andKeynes regarding the effecti3eness of monetary policy in depression conditions. ,nd the

results clearly supported Keynes7s pessimism rather than 6riedman7s optimism.

H. *n 1H" Milton 6riedman made his debut as a populari


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surely helped accelerate the process# both in the United +tates and around the world. yany measure $protectionism 3ersus free trade8 regulation 3ersus deregulation8 wages setby collecti3e bargaining and go3ernment minimum wages 3ersus wages set by the market$the world has mo3ed a long way in 6riedman7s direction. ,nd e3en more striking than hisachie3ement in terms of actual policy changes has been the transformation of the

con3entional wisdom9 most influential people ha3e been so con3erted to the 6riedman wayof thinking that it is simply taken as a gi3en that the change in economic policies hepromoted has been a force for good. ut has it=

Consider first the macroeconomic performance of the U+ economy. ?e ha3e data on thereal income$that is# income ad-usted for inflation$of ,merican families from 1H; to54. 0uring the first half of that fifty&eight&year stretch# from 1H; to 1;"# Milton6riedman was a 3oice crying in the wilderness# his ideas ignored by policymakers. ut theeconomy# for all the inefficiencies he decried# deli3ered dramatic impro3ements in the

standard of li3ing of most ,mericans9 median real income more than doubled. y contrast#the period since 1;" has been one of increasing acceptance of 6riedman7s ideas8 althoughthere remained plenty of go3ernment inter3ention for him to complain about# there was no)uestion that free&market policies became much more widespread. >et gains in li3ingstandards ha3e been far less robust than they were during the pre3ious period9 median realincome was only about 5! percent higher in 54 than in 1;".

Aart of the reason the second postwar generation didn7t do as well as the first was a slowero3erall rate of economic growth$a fact that may come as a surprise to those who assumethat the trend toward free markets has yielded big economic di3idends. ut anotherimportant reason for the lag in most families7 li3ing standards was a spectacular increase ineconomic ine)uality9 during the first postwar generation income growth was broadly spreadacross the population# but since the late 1;s median income# the income of the typicalfamily# has risen only about a third as fast as a3erage income# which includes the soaringincomes of a small minority at the top.

This raises an interesting point. Milton 6riedman often assured audiences that no specialinstitutions# like minimum wages and unions# were needed to ensure that workers wouldshare in the benefits of economic growth. *n 1;" he told (e)s)ee*readers that tales ofthe e3il done by the robber barons were pure myth9

There is probably no other period in history# in this or any other country# in which theordinary man had as large an increase in his standard of li3ing as in the period between theCi3il ?ar and the 6irst ?orld ?ar# when unrestrained indi3idualism was most rugged.

E?hat about the remarkable thirty&year stretch after ?orld ?ar **# which encompassedmuch of 6riedman7s own career=F >et in the decades that followed that pronouncement# asthe minimum wage was allowed to fall behind inflation and unions largely disappeared asan important factor in the pri3ate sector# working ,mericans saw their fortunes lag behindgrowth in the economy as a whole. ?as 6riedman too sanguine about the generosity of thein3isible hand=

1


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To be fair# there are many factors affecting both economic growth and the distribution ofincome# so we can7t blame 6riedmanite policies for all disappointments. +till# gi3en thecommon assumption that the turn toward free&market policies did great things for the U+economy and the li3ing standards of ordinary ,mericans# it7s striking how little support onecan find for that proposition in the data.

+imilar )uestions about the lack of clear e3idence that 6riedman7s ideas actually work inpractice can be raised# with e3en more force# for 2atin ,merica. , decade ago it wascommon to cite the success of the Chilean economy# where ,ugusto Ainochet7s Chicago&educated ad3isers turned to free&market policies after Ainochet sei


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Those states that# for whate3er reason# didn7t get on the deregulation bandwagon in the1s now consider themsel3es lucky. ,nd the luckiest of all are those cities that somehowdidn7t get the memo about the e3ils of go3ernment and the 3irtues of the pri3ate sector# andstill ha3e publicly owned power companies. ,ll of this showed that the original rationalefor electricity regulation$the obser3ation that without regulation# power companies would

ha3e too much monopoly power$remains as 3alid as e3er.

+hould we conclude from this that deregulation is always a bad idea= @o$it depends onthe specifics. To conclude that deregulation is always and e3erywhere a bad idea would beto engage in the same kind of absolutist thinking that was# arguably# Milton 6riedman7sgreatest flaw.

*n his 1"4 re3iew of 6riedman and +chwartale economistand @obel laureate James Tobin gently chided the authors for going too far. (Consider the

following three propositions#( he wrote. (Money does not matter. *t does too matter. Moneyis all that matters. *t is all too easy to slip from the second proposition to the third.( ,nd headded that (in their


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The answer# * suspect# is that he got caught up in an essentially political role. Milton6riedman the great economist could and did acknowledge ambiguity. ut Milton 6riedmanthe great champion of free markets was expected to preach the true faith# not gi3e 3oice todoubts. ,nd he ended up playing the role his followers expected. ,s a result# o3er time therefreshing iconoclasm of his early career hardened into a rigid defense of what had become

the new orthodoxy.

*n the long run# great men are remembered for their strengths# not their weaknesses# andMilton 6riedman was a 3ery great man indeed$a man of intellectual courage who was oneof the most important economic thinkers of all time# and possibly the most brilliantcommunicator of economic ideas to the general public that e3er li3ed. ut there7s a goodcase for arguing that 6riedmanism# in the end# went too far# both as a doctrine and in itspractical applications. ?hen 6riedman was beginning his career as a public intellectual# thetimes were ripe for a counterreformation against Keynesianism and all that went with it.ut what the world needs now# *7d argue# is a counter&counterreformation.

(otesI+ee Aaul ,. +amuelson#Economics0 The 1riinal %2! EditionEMc/raw&'ill# 1;F.

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