Economic theories of Milton Friedman

The poor economic situation of the country is causing significant problems for the US citizens and it has now almost become a struggle for survival for some of the most highly affected segments of population. Oil and gas prices have hit new records, the cost of daily living is constantly increasing and there is no respite from the talk about recession. Milton Friedman’s theories from the last 60 years are as valid today as they were back then. His insights related to economic policy have focused on the welfare of people. Friedman discussed and analyzed how the governments’ decisions affected the American people. Today, we are all affected by the economic decisions of our government and it is important that we apply Milton Friedman’s theories to the economic situation of today. The theories of Milton Friedman would have proposed the government to inject sufficient liquidity into the economy, and limit its intervention in the industry. This economist believed that the main role of the government was to protect the freedom of people to allow for competitive capitalism in a free market.

About Friedman

Friedman was born in 1912 to Jewish immigrants in the New York City. He was highly educated in the field of economics, having obtained a bachelor’s degree from Rutgers University in 1932, a master’s degree from the University of Chicago in 1933, and a doctorate of economics from Columbia University in 1946. In his earlier years after graduation, Friedman gained much experience as a research economist. He worked for the National Bureau of Economic Research in New York, US Treasury Tax Research Division, closely dealt with wartime tax policy and was a teacher and researcher at universities that include University of Wisconsin, University of Minnesota, University of Chicago and Hoover Institute at Stanford University. The University of Chicago became his main intellectual home after he took the place of one of his former professors teaching economic theory. (Ebenstein, 2009)

Theories Of Friedman

Through his years of study and research, Friedman developed many economic beliefs and theories, which are highly regarded to this day. Some of these include the permanent income hypothesis, the inherent weakness of fiscal policy, the quantity theory of money, and the natural rate hypothesis. The permanent income hypothesis states that the consumption pattern of consumers is based on their long term income expectations rather than the current income. He believed that people with low incomes have a relatively higher tendency to consume, while people with higher incomes have a lower average tendency to consume. This led to his theory of the consumption function (Hirsch & Marchi, 1992).

Friedman’s inherent weakness of fiscal policy claims that the government’s efforts to spend more money to boost the economy would not create new wealth but rather relocate existing wealth. He supported his beliefs through empirical evidence based on the American economy during World War One, World War Two and the Civil War. He concluded that monetary policy produces a more positive effect on the economy (Friedman, 2008). This led him to believe in the quantity theory of money, which asserts that increases in the supply of money will lead to substantial rises in nominal incomes, and not prices. This idea was against the Keynes theory about the liquidity traps (Friedman, 2008).

The natural rate hypothesis theory considers unemployment and the government’s role in this regard. Friedman believed that in the long run, the economy faces a natural level of unemployment that cannot be permanently changed by monetary changes. He stated that in a short term situation, the government can lower unemployment through inflation, but in the long run the employment statistics are not affected by inflation. In order to lower the natural rate of unemployment, Friedman believes that the government must make actual structural changes in the economy by introducing measures like de-regulating and lowering minimum wage rather than inflating the money supply (Hirsch & Marchi, 1992).

As Friedman researched these theories, studying the role of money and monetary policy in the economy, Friedman created the ‘monetarist’ school of thought. This was perhaps his greatest contribution to economics. This doctrine considers the supply of money to be the primary determinant of nominal income and prices in the economy. According to this view, the private economy will basically remain stable unless a disturbance of rapid money supply fluctuations or other government actions occur. He advocated the idea that the nation’s money supply grow steadily to avoid overexpansion and inflation. (Hirsch & Marchi, 1992)

Friedman’s Economic Plan for the Current Economy

The economic situation in the United States today in many ways parallels the economic situation of the 1970’s. After the Vietnam War, the economic infrastructure was weakened and the situation became worse with an increase of political instability in the Middle East. At that point in time, the Middle East had become the United States’ main source of oil. Due to the United States’ alliance with Israel, the Arab states enacted a trade embargo against the United States, to whom they primarily exported oil. This caused a major rise in gas prices throughout the country. Milton Friedman’s economic theories relate to this sort of inflation and its effects on the market and its buyers. In a time where prices are once again on the rise, Friedman’s theories are as pertinent as ever. The economic theories of Milton Friedman have as much merit today as they did in the 1970’s. (Moore, 2009)

Milton Friedman believed that Great Depression could have been avoided had the government injected sufficient liquidity into the economy. This modern day economist opposed Keynesian views. He believed in limited government intervention and that the main role of the government was to protect the freedom of people to allow for competitive capitalism in a free market.

The views of Ben Barnanke, Chairman of the Federal Reserve, are similar to Friedman. Friedman would have also injected liquidity in the system and might have saved the banks, and other financial institutions from crumbling in a crunch situation. However, one thing that Friedman would have done differently would have been to limit the government intervention. He would not have let the government own the healthcare sector, Fannie Mae, or any such institution (Moore, 2009). Thus, this appraoch would have been in a way beneficial for ths US as it has been seen that although the bailout plans costing billions of dollars have enabled these institutions to survive, the desried results have not been achieved. The job creation and employment rates remain low, and there is no guarantee that these troubled institutions would mend their ways because the fault lies deeply in their structures and value systems. The intervention appraoch by government is also against the values of the American society and capitalist economy. Further, the economy would have fared much better if the huge amount of money would have been invested elsewhere, rather being doled out to rescue institutions. Friedman would have clearly suggested injecting sufficient liquidity into the economy and spending in areas which would have directly improved the lives of millions of Americans. Another reason why he would have criticized government intervention was that the executives of many major corporations that were rescued had become greedy and still benefitted from huge bonuses and incentives, despite the poor performance.

Conclusion

While Friedman was an incredibly intelligent man with a keen sense for understanding economics, his accomplishments are far reaching and stand the test of time. The relevance of theories in every era seems to be the true judge of an economists work. One can only wonder how others will view his theories in another time. Once this recessionary period is over, it remains to be wondered how these economies will affect the views of economists worldwide. Perhaps economics is an area that will never be completely understood as it is something that could be continually improved upon. It is interesting to see the far-reaching effects of this one man’s economic studies, research, and one might wonder, if his theories last for many years to come.

References

Ebenstein, L. (2009). Milton Friedman: A Biography. New York: Palgrave Macmillan.

Friedman, M. (2008). Milton Friedman on Economics: Selected Papers . Chicago : University of Chicago Press Journals.

Hirsch, A., & Marchi, N. d. (1992). Milton Friedman: Economics in Theory and Practice . Michigan: University of Michigan Press.

Moore, S. (2009). How Barack Obama is Bankrupting the U.S. Economy . Tennessee: Encounter Books.