Milton Friedman and John Maynard Keynes are as integral to the story of economics as Adam Smith and Karl Marx. What Keynes wrought, Friedman undid, and supporters of the free market are deeply in debt to this Chicago school academic for his effort. In this article, we will look at the life and contributions of Milton Friedman. (To learn more about these great economic thinkers, read our related article The History Of Economic Thought.)
The Father of Income Tax Withholding
Milton Friedman was born in Brooklyn in 1912, one of four children born to Jewish immigrants. He studied at Rutgers University, Chicago University and Columbia, focusing on mathematics and economics. During his Ph.D., WWII broke out and Friedman took a break to work for the Treasury Department. He was part of a think tank that brought about income tax withholding as a "temporary" measure to help fund the war. Though he never questioned the necessity of it in wartime, Friedman later regretted having forced withholding on Americans. Friedman was appalled when the government made the emergency measure a permanent part of its peacetime taxation. (Learn how Milton Friedman's monetarist views shaped economic policy after World War II, read Monetarism: Printing Money To Curb Inflation.)
First Blood - Attacking the Keynesian Assumptions
Friedman continued his studies after the war and began to show his free-market colors in a time of Keynesian domination. Taking up a teaching post at the University of Chicago, Friedman wrote free-market analysis of the damage done by rent controls and monopolistic practices in the medical profession. In 1957, Friedman launched his first direct attack against Keynesian thinking with "A Theory of the Consumption Function" - an attack on one of the assumptions of Keynes' model. (Learn more about Keynes' models and policies in Giants Of Finance: John Maynard Keynes.)
Keynesians support short-term solutions to spur consumer spending and the economy. The idea is that by giving a temporary tax break like a stimulus check, the government can spur spending without giving up future tax revenues by making a meaningful tax cut – in short, the government gets to have its cake (economic recovery) and eat it too (maintain future taxes). Friedman took on this idea and analyzed actual empirical evidence. This was in contrast to Keynes and his followers who rarely did actual empirical studies.
Friedman showed that people adjusted their annual spending habits in response to real changes in their lifetime income, not temporary changes to their current income. In practice, this means that something concrete like a raise may prompt a family to spend more, but a short-lived boost from a stimulus check will not. This was the first crack in the Keynesian framework, but it was quickly followed by further attacks on the many dubious assumptions underlying the theory. (Find out how tax breaks can help the economy in our frequently asked question How do government-issued stimulus checks affect the economy?)
Friend of Investors and Savers
Instead of trying to boost the economy by trying to fool consumers, Friedman believed the same ends could be met by minimizing government involvement. This would be achieved by lessening taxes in the long term and ceasing inflationary policies. Inflation, Friedman pointed out, was just another attempt to fool consumers into thinking they were earning more, when the corresponding rise in the cost of living was actually canceling out any gains in wages. Friedman and the other economists at the Chicago school led attack after attack on concepts like the Keynesian multiplier and the damage of saving.
Friedman took issue with the Keynesian multiplier because it gave any form of government spending - even debt spending - a superior rating over private investment. Friedman pointed out that the more the government borrows to spend, the more pressure there is to inflate the currency to meet the payments in the future. Furthermore, government spending crowds out private investors who will sit on their capital when the government is paying for everything. Friedman argued that, at best, the multiplier was unjustified and the implications of government deficit spending needed to be looked at in a broader sense to measure the true impact.
Friedman Makes a Depressing Discovery
In his book, "A Monetary History of the United States" (1963), Milton Friedman and his coauthor Anna Schwartz showed how it was monetary policy, and not a failure of free market capitalism, that led to the Great Depression. Friedman surveyed almost a century of monetary policy during crashes, booms, recessions and depressions, and came to the conclusion that the Fed was a main cause of the depression because it shrunk the money supply by over a third between 1929 and 1933. This contraction turned a crash, something the U.S. had bounced back from many times before, into an extended depression. The connection was never made before because no figures on money supply were published until after Friedman and Schwartz's book. (Learn more about the Great Depression in What Caused The Great Depression? and The Great Depression (1929) section of our Crashes Special Feature.)
Free Market Hero and Hard Money Advocate
Friedman began to focus more and more on the role of money in the economy. Originally, he supported a gold standard to check inflation and prevent bank runs, but he moved toward a hard money policy where the amount of money in circulation would increase at the same pace as the nation's economic growth. He believed this would be a sufficient check to keep governments from printing as much money as they pleased, while still increasing the money supply enough to allow growth to continue. In 1962, Friedman's book "Capitalism and Freedom" set him up in the academic and public arenas as one of the rare defenders of free market capitalism.
"Capitalism and Freedom" espoused the free-market solutions to many problems and caught a lot of attention for proposing a negative income tax for people under a certain income and school vouchers to improve the education system. Friedman also wrote a regular column in Newsweek to explain both free-market principles and his monetary stance. In the 1980s, Friedman took his defense of the free market onto the airwaves with a PBS show called "Free to Choose" followed by a book of the same title that arguably made him the most famous economist alive.
Friedman Advocates for Currency Trading
In keeping with his opposition to Keynesian thinking, Milton Friedman took an active dislike to the Bretton Woods Agreement, an attempt to fix currencies rather than let them float in free-market fashion. In 1967, Friedman was positive that the British pound was overvalued and attempted to sell it short. He was refused by all the Chicago banks he called and vented his indignation in his Newsweek column, laying out the necessity of floating currencies for both public futures and a currency trading markets.
Friedman's articles inspired Leo Melamed of the Chicago Mercantile Exchange to push for the creation of a forex market in 1972. Melamed consulted with Friedman about the probability of Bretton Woods falling apart - an event the viability of the new markets depended on. As Friedman assured Melamed, the Bretton Woods agreement collapsed and one currency after another was given over to float. The currency market is now the largest in the world, and is much more efficient than arbitrary pegging. (Learn the basics of the forex market by reading Getting Started In Forex.)
Stagflation and the Rise of Monetarism
Before his public success in the 1980s, Friedman had already gained considerable clout in economic circles. When the Keynesian system buckled under stagflation in the 1970s, academics began to take Friedman's anti-inflation, hard money policies much more seriously. Monetarism started to eclipse Keynesian solutions. Friedman and other Chicago School economists became economic advisors to many governments. Collectively, they urged policies for hard money and small government, a throwback to the days of Adam Smith. (Read Stagflation, 1970s Style to learn more about how Milton Friedman's monetarist theory helped bring the U.S. out of the economic doldrums.)
Friedman and the Chicago school garnered several Nobel Memorial Prizes in Economic Sciences for their work in dismantling the most damaging Keynesian concepts, but Friedman said himself in a 1998 speech, "We have gained on the level of rhetoric, lost on the level of practice." By this he meant that academic circles had accepted free market principles as superior to Keynesian thinking, but governments were still enamored with Keynes. According to critics of Keynesianism, Keynesian economics is attractive to governments because it justifies even their most wasteful projects and excuses the bureaucratic excesses of big government. Friedman and his colleagues brought another alternative to big government, but felt that few governments were willing to give up the reins. (To learn more about the Nobel Memorial Prize in Economic Sciences, read Nobel Winners Are Economic Prizes.)
Milton Friedman came to the forefront of economics at a time when free market economists were in short supply. At every opportunity, Friedman argued passionately against government intervention and in favor of the free market. A firm believer in freedom, both in the markets and in personal life, Friedman was a member of the Mont Pelerin Society and later served as its president. He allowed that free market capitalism may not be the perfect solution, but asserted that it was by far the best out of all the alternatives known to us today.
Friedman's awards and recognition are numerous, including his 1976 Nobel Memorial Prize, but the highest praise is that he continued to toil tirelessly defending freedom and debating all comers right up to his death in 2006. Countries like India and China that took Friedman's message to heart and, many believe they are now reaping the economic benefits as a result. Friedman's free market ideals provided a new way of looking at the economy and offered alternative ways for countries to build and maintain strong economies.