Milton Friedman and the "Chicago School"

A Billion-Mark Note


"The competitive system, viewed simply as a want-satisfying mechanism, falls far short of our highest ideals. To the theoretical tendencies of perfect competition must be opposed just as fundamental limitations and counter-tendencies, of which careful scrutiny discloses a rather lengthy list... and if the existing order were more purely competitive, if social control were reduced in scope, it seems clear that the divergence would be enormously wider still. Moreover, untrammeled individualism would probably tend to lower standards progressively rather than to raise them. "Giving the public what it wants" usually means corrupting popular taste. The system is also inefficient in utilizing resources to produce the values which it sets up...It distributes the produce of industry on the basis of power, which is ethical only in so far as right and might are one. It is a confessed failure in the field of promoting many forms of social progress...Left to itself, such a system "collapses" at frequent intervals through the dilution of its value unit and through other causes which produce violent oscillation instead of the equilibrium of theory."

(Frank H. Knight, "The Ethics of Competition", 1923, Quarterly Journal of Economics)

"I am willing to consider the existence of a "Chicago School" (but not one confined to the economics department and not embracing all of the department) and that this "School" had been in operation, and had won many able disciples, for years before I left Chicago. But at no time was I consciously a member of it, and it is my vague impression that if there was such a school it did not regard me as a member, or at least as a loyal and qualified member"

(Jacob Viner, Letter to Patinkin, Nov. 24, 1969).



The term "Monetarism" was coined in 1968 by Karl Brunner to refer to the macroeconomic theories and doctrines most closely associated with University of Chicago economist Milton Friedman. Although "born" in 1956, Monetarism only became a powerful intellectual force in the late 1960s and early 1970s, and had to wait until the late 1970s and early 1980s to be channeled into economic policy. By the mid-1980s, however, Monetarism was largely a spent force and, today, one would have to search very far indeed to find an old-fashioned "Monetarist".

To the lay public, Milton Friedman is best known for his political views. Its well-known features are captured succinctly in his words:

"The basic long-run objectives, shared, I am sure by most economists, are political freedom, economic efficiency and substantial equality of economic power...I believe - and at this stage agreement will be far less widespread - that all three objectives can best be realized by relying, as far as possible, on a market mechanism within a "competitive order" to organize the utilization of economic resources."

(M. Friedman, 1948)

Already in his early years, long before Monetarism became formulated as a distinct economic approach, Friedman had already formed his basic "vision" of macroeconomics and the role of government policy, a vision made famous later in his popular tracts such as Capitalism and Freedom (1962) and Free to Choose (1980, with Rose Friedman) and numerous newspaper and magazine columns, interviews, television shows, etc.

However, we should note that Friedman's belief in the market system as an efficient allocator of resources and his conviction that planning and intervention aggravated rather than cured economic difficulties, are not central tenets of "Monetarism", however compatible they may seem to be. Unfortunately, Friedman's political economy has tended to obscure his valuable contributions to economic theory proper. Indeed, much of the vitriol exchanged among the participants in the Monetarist debates of the 1960s and 1970s can be ascribed to the fact that Friedman's outspoken political views tended to act as a lightning rod for foe and friend alike.

As noted, "Monetarism" no longer exists as an independent intellectual force in economics. Most of its advocates have graduated on to the New Classical school (a.k.a. "Monetarism Mark II"). Both Monetarism and New Classicism have been referred to as two different incarnations of the "Chicago School". This label is due in part to the fact that Milton Friedman was both a student and a highly influential professor at the University of Chicago in the post-war period.

But there is an older pre-Friedman Chicago School of inter-war University of Chicago economists Frank H. Knight, Jacob Viner, Lloyd Mints and Henry C. Simons. Their distinction lay in the fact that they were among the few centers of higher learning in the world that resisted both the Keynesian Revolution and the Monopolistic Competition Revolution of the 1930s and 1940s. Instead, throughout this period, the Chicago School stubbornly maintained its Neoclassical flavor.

Milton Friedman has made much of the relationship between his own "Monetarism" to the old "Chicago School". Friedman's claim of descendence is both true and false. To the extent to which Friedman was both a student and a professor at Chicago, remained immune from the Keynesian Revolution, sported a largely libertarian political doctrine and employed Marshallian price theory as the primary tool of analysis, Friedman is indeed a bona fide "Chicago School" economist. Where the old Chicago School and Friedman part ways is in their theory of the business cycle and monetary theory. On this account, other Chicago economists such as Don Patinkin (1969, 1972, 1981) and Harry G. Johnson (1971) have provided more than sufficient evidence that, save for a few scattered elements in the policy work of Henry Simons (1948), there was no perceptible "oral tradition" at Chicago in the inter-war period which can be related to theoretical structure of Friedman's Monetarism. Nonetheless, as noted, Friedman himself has fostered a tradition at Chicago since the 1950s, when he began to mount a challenge against the Neo-Keynesian orthodoxy. Thus, his Monetarism can be justly perceived as the "Second Chicago School".

As a final note, we should add that the leader of the New Classicals, Robert E. Lucas, once a student and now a professor at the University of Chicago, has also placed his own distinctive stamp at Chicago. Thus New Classicism can be regarded as an even more modern "Third Chicago School". It is important, however, to note that the original brand of "Monetarism" has a different flavor from this later incarnation. Notably, the New Classical result that (anticipated) monetary policy is inconsequential goes almost directly against Friedman's basic assertion that money supply and monetary policy is (almost) all that matters for nominal output fluctuations. In addition, unlike Friedman's "gentle Marshallianism" -- which permitted him to talk comfortably in the language and employ the intuition of Keynes and the Keynesians -- the New Classical modeling techniques are relentlessly formal, their language is almost Walrasian in tone, and their analysis is certainly far more unyielding than Friedman ever was. However, unlike its older namesakes, the New Classicals' "Chicago School" is the orthodoxy. In this survey, we shall concentrate almost exclusively on Friedman's brand of Monetarism. New Classicism will be reviewed elsewhere.

If the inter-war Chicago School is excluded, then the sources of Friedman's "Monetarism" must be sought elsewhere. Monetary theories of the cycle have an old tradition stretching back to Wicksell, Hayek, Hawtrey, early Keynes, etc. which could be appealed to as an influence. However, Friedman himself gives central importance to the Quantity Theory of Money and the theory of fluctuations derived therefrom. Friedman is notably keen at tracing the ancestry of his ideas to the seminal work of the leading Yale economist Irving Fisher (1911, 1923). However, as we shall see, there are significant differences between the Quantity Theory as expounded by Irving Fisher (and later made more precise by Don Patinkin (1956)) and Friedman's own Monetarism.

Closer in spirit and letter to Friedman's Monetarism is the work of non-Chicago economists such as James W. Angell (1933, 1936) of Columbia, Lauchlin Currie (1934) of Harvard and, perhaps most importantly, in the pioneering work of Clark Warburton (1946, 1950, 1952, 1966), a government economist at the Federal Deposit Insurance Corporation (FDIC).

We could also give a significant amount of credit to John Maynard Keynes's General Theory (1936) itself. As Friedman (1968, 1970, 1974) himself has acknowledged, his brand of Monetarism is, for the most part, couched in quite Keynesian terms. It is in the Monetarism of Karl Brunner and Allan H. Meltzer (1972) and, most notably, the "Monetarism Mark II" of Lucas, Sargent and the New Classicals, that we really find the great departures from Keynesian notions and the resurrection of Neoclassical macroeconomics. As theorists such as Don Patinkin (1969, 1972) and Frank H. Hahn (1971, 1980, 1984) have insisted, the "proper" Neoclassical monetary tradition is quite different from Friedman's Monetarism - and perhaps quite different from New Classicism as well.

What are the main features of Friedman's "Monetarism"? The central ones can be listed as follows:

(1) monetarist transmission mechanism: urging that agents dispose of excess money supply by purchasing goods rather than bonds.

(2) stability of money demand: belief that, in practice, the demand for money is a stable function of wealth, prices, price changes and interest.

(3) money-to-income causality: that movements in the money supply have been the primary cause of business fluctuations and that movements in aggregate demand for goods have relatively little impact.

(4) natural rate of unemployment hypothesis: belief that there exists a unique rate of unemployment that is associated with non-accelerating inflation and that, in the long run, the economy will settle at such an unemployment rate.

(5) superiority of monetary policy rules: assertion that monetary policy is much more effective than fiscal policy, recommendation that Central Banks target money aggregates rather than interest rates, and that following a steady money supply growth rule is, at least in the long run, better than a discretionary, counter-cyclical monetary policy.

There have been effectively two distinct stages of "Monetarism" - one surrounding the money-income causality debate that raged roughly within the 1960s and another stage surrounding the Phillips Curve and the acceleration hypothesis which was dominant in the 1970s. Both of them stem from two extraordinary pieces by Milton Friedman - one published in 1956, another in 1968. Although superficially distinct, both these contributions are intimately related within the research program of Monetarism.

At the policy level, Monetarism had its age of glory in the late 1970s and early 1980s. Two policy moves that have been traced to Monetarism were the abandonment of interest rate targets and the adoption of money supply targets by many Central Banks in the late 1970s and, most infamously, the attempted disinflations via monetary policy around the same time in the United States and the United Kingdom. The largely disastrous results of these policy experiments did much to discredit strict Monetarist doctrine among economic policy-makers, but certain aspects of it - most notably the natural rate hypothesis and the money supply-inflation link - remain standard beliefs even today.

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