The Future of Monetarism after Milton Friedman

Abstract

On the fiftieth anniversary of Milton Friedman receiving the Nobel Prize in economics, this article describes the legacy of monetarism: At a time of double-digit inflation in the U.S. and abroad, Friedman’s idea revolutionized monetary policymaking and macroeconomics. In the 1960s and 1970s, his approach led to a new paradigm in money/macroeconomics and monetary policy, including the use of monetary aggregates, monetary rules over discretion, inflationary expectations, and systematic policy to achieve credibility for achieving low inflation. He revived the centuries-old quantity theory of money—making it a useful empirical apparatus that challenged and defeated the prevailing Keynesian orthodoxy that “money didn’t matter.” Friedman’s monetarism has carried forward with the Shadow Open Market Committee, an external watchdog over the Fed’s tendency to follow discretionary policies.

The fiftieth anniversary of Milton Friedman receiving the Nobel Prize in economics seems a good time to reflect on the legacy of monetarism—his idea that revolutionized monetary policymaking at a time of great crisis, which involved double-digit inflation in the U.S. and abroad. This led in the 1960s and 1970s to a new paradigm in money/macroeconomics and in the conduct of monetary policy.

I survey Friedman’s genius in reviving the centuries-old quantity theory of money—making it a useful empirical apparatus that challenged and defeated the prevailing Keynesian orthodoxy that “money didn’t matter.” Monetarism vanquished the Great Inflation in the 1970s; but, faced with unforeseen developments that destabilized its core tenet—a stable demand for money—many of its elements became integrated into a new theoretical approach based on rational expectations.

Friedman’s insights on the influence of monetary aggregates on the macroeconomy, in his case for monetary rules over discretion, and the importance of inflationary expectations led to the development of modern macroeconomics. It also led central banks to attach primary importance to the use of systematic policy to achieve credibility for low inflation as its nominal anchor.

Friedman’s monetarism has carried forward with the Shadow Open Market Committee, founded in 1973 by his followers as an external watchdog over the Fed’s tendency to follow discretionary policies. This committee, as well as the hard currency European central banks (Deutsche Bundesbank and Swiss National Bank), follow Friedman’s emphasis on outsized increases in money growth as a predictor of inflation and view continuing monitoring of monetary aggregates as a key cross-check for interest-rate-based monetary policy.