Milton Friedman's Unfinished Legacy

Today would be the 100th birthday of economist Milton Friedman. The towering figure of the economics profession has left an impressive, but incomplete legacy. On the one hand, many of the public policies that he advocated in his lifetime have either become mainstream policies, or are strongly supported in elite circles. As Timothy B. Lee writes:

Some of Friedman’s policy proposals, such as school vouchers and drug legalization, are still hotly debated today. But I think the most important measure of a thinker’s influence are his once-controversial ideas that are now considered so obvious that no one seriously disputes them. I’ve recently been reading a collection of Friedman’s Newsweek columns from the late 1960s and early 1970s, a time when he was at the peak of his fame and influence. Among the proposals he wrote about most frequently were: severing the link to gold and letting the dollar float, fighting inflation by reducing the growth of the money supply, ending the draft, abolishing wage and price controls, and cutting taxes.

Most of these proposals were adopted by the end of the 1970s. All are still practiced today. But more remarkably, they’re all now considered so obviously correct that few people seriously advocate returning to the policies of the 1970s.

But Friedman's analysis of monetary policy, the work that made him an academic, is still not fully heeded. This is especially true for large parts of the conservative movement which now look to Ludwig von Mises instead of Friedman to seek guidance on the Great Recession. David Beckworth corrects the record and writes what "The Real Milton Friedman" would advocate in response to the current economic downtown. The answer is expansionary monetary policy under a rules-based system:

Milton Friedman's call here for purchasing long-term government bonds as a way to push the Japanese economy out of its quasi-recession is similar to the Fed's justification for QE2 and Operation Twist. The only meaningful difference is that Friedman was advocating a continual, sustained purchase of securities until a robust recovery began. The Fed, on the other hand, has been applying a piecemeal approach (i.e. QE2, Operation Twist, long-term interest rate forecasts) that in someways creates more uncertainty. For example, when will the Fed do the next QE? No one, even the Fed, knows for sure.

Second, not only did Friedman call for large-scale asset purchases (LSAPs) but he also provided theoretical reasons for doing so. His main argument was that LSAPs created portfolio effects that in turn affected aggregate nominal spending. Edward Nelson, probably the foremost authority on Friedman's monetary views, has an excellent article that summarizes Friedman's view on LSAPs and its implications for the portfolio channel. Anyone who wants to make claims about Friedman's monetary views should read this article first.

Third, Milton Friedman was very clear that one should never look to the level of short-term interest rates as a guide to monetary policy. Some observers point to low interest rates as indicating the Fed has kept monetary policy super loose. Friedman called this the interest rate fallacy. In order to truly understand the implication of interest rates one needs to first know the level of the natural interest rate. Only if interest rates are lower than their natural rate level is monetary policy stimulative. Too many observers miss this point and thus fall prey to Friedman's interest rate fallacy.

Using Friedman's prescriptions to improve the current economic situation would be a great capstone to his legacy.