Milton Friedman Is More Relevant Than Ever

Economists have gotten a lot wrong over the course of this pandemic, and long before that, but there is one whose ideas have never looked better: Milton Friedman, the Nobel laureate who died in 2006.

Friedman’s reputation suffered after the Great Recession, as the market forces he so believed in were at fault. Worse yet, after the financial crisis, the U.S. Federal Reserve expanded the money supply dramatically, but the rate of price inflation remained stubbornly low. Monetarism, the theory he is best known for, appeared irrelevant.

Yet it isn’t, as the current debate over inflation attests. People might disagree over what is causing a 6.2% inflation rate, but there is consensus on the solution: It will be up to the Fed — and monetary policy — to get rates of price inflation back down. Furthermore, as Friedman would predict, this disinflation process will be painful and may cause a recession.

And while there is plenty of debate over the correct timing of this response — markets are expecting multiple rate hikes over the next year — the importance of the Fed’s decisions is not in question. Restoring monetary stability is once again a major issue, both for financial markets and for the American public.

In his earlier writings, Friedman erred by stressing the stability of money demand. That is usually a safe assumption, but the Fed started paying interest on reserves in 2008, dramatically increasing bank demand to hold reserves. That offset the huge increase in the money supply aggregates and blunted the inflationary pressures. Friedman’s theories did not apply at that time.