20 November 2006

Friedman's limited legacy

Nobel Prize winning economist and Thatcher-Reagan pin-up Milton Friedman died last week aged 94, and has attracted a generous range of tributes from the usual right-wing suspects as well as many on the centre and left who simply don't understand his real legacy, such as it was. One of the most wrong-headed assessments comes from the supposed economic genius, Gordon Brown:

He had a major influence on post-war economic policy not least in establishing the importance of credibility in monetary policy making.

Utter and complete balls. Friedman did make a vital contribution to consumption theory in economics - the permanent income hypothesis - and he provided a powerful counterargument against the idea that there was a trade-off between unemployment and inflation, popular in the 1960s but destroyed in the "stagflation" of the 1970s.

But his recommended macroeconomic policy framework - monetarism - was tried in both the US and the UK in the early 1980s and proved to be a total disaster. Friedman thought that to stop inflation, all the government had to do is to make sure that the money supply grew by a constant percentage rate per year. In the event, empirical studies during the 1980s showed that there was very little relation between the growth rates "narrow money" (notes and coins in circulation), "broad money" (bank balances, building society accounts etc.) and the inflation rate. Moreover, the monetarist cover story was used by Thatcher and Geoffrey Howe to justify a policy of severe conventional deflation by whacking interest rates up to ridiculous levels in the early 1980s, which certainly killed off inflation, but killed off huge swathes of the economy as well, as unemployment rose to over 3 million. It was an insane experiment which it took Britain years to recover from. Nowadays monetarism is hardly ever mentioned, except occasionally by Simon Heffer - but then he probably still uses pound notes when he goes shopping.

With the death of monetarism, Friedman's legacy today is pretty severely limited (and has been for at least 20 years), so don't believe the hype. As Larry Elliott notes in a perceptive article in today's Guardian, central banks today use monetary policy in a way that is much more Keynesian than monetarist. At the same time, the "big government" which Friedman railed against in books like Free to Choose is alive, well and on the rampage, both in Europe and the US. George Dubya Bush's debt-ridden, pork-barrelling balloon of an administration is very little like what Friedman's followers in the "Chicago School" of right-wing economics would have you believe is the optimal model for human affairs. But then maybe, as with monetarism, this 'small government' guff always was a cover story and the real truth was much more Orwellian in nature? Who knows...

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