Milton Friedman’s Contribution to Present Day Macroeconomic Policy
Written by Thabani Nyoni a Bsc (Hons) Economics (final year) student at Bindura University of Science Education, Bindura, Zimbabwe.
Milton Friedman is an American economist who is well known in Economics for launching the monetarist attack against orthodox Keynesian analysis and policy activism during the 1950s and 1960s. His contribution to present day macroeconomic policy is based on monetarism or simply the monetarist school of thought. According to Durlauf and Blume (2010) monetarism is the view that the quantity of money has a major influence on economic activity and the price level and that the objectives of monetary policy are best achieved by targeting the rate of growth of money supply.
Friedman’s takeoff-point was one in which he sought to re-establish the quantity theory of money approach to macroeconomic analysis which had been down-played by the Keynesian revolution. Friedman initially presented his now famous 1956 restatement of the quantity theory of money as a theory of the demand for money rather than a theory of the general price level or money income. In his paper, Friedman asserted that the demand for money function was stable, an assertion which lies at the heart of the modern quantity theory approach to macroeconomic analysis. If the demand for money function is stable, it therefore implies that the velocity of money will also be stable, changing in a predictable manner if any of the limited number of variables in the demand for money function should change.
In his restatement of the quantity theory of money demand, Friedman postulated that individuals may hold money as a medium of exchange for financing transactions or purely as a store of value. This postulation is however, explicitly applicable in Zimbabwe because economic agents are using money to purchase goods and services as well as a store of value. This is currently very applicable empirically here in Zimbabwe because some individuals nowadays keep their wealth in money since the United States (US) dollar currency has more value unlike our own Zimbabwe dollar that we used to have before the multicurrency regime was adopted in 2009.
Friedman’s landmark (1957) work, A Theory of the Consumption Function, took on the Keynesian view that individuals and households adjust their expenditures on consumption to reflect their current income. Friedman argued that, instead, people’s annual consumption is a function of their “permanent income”. In this regard, Friedman used the term “permanent income” to mean a measure of the average income people expect over a few years. The idea behind Friedman’s permanent-income hypothesis is that consumption depends on what people expect to earn over a considerable period of time.
As in the life-cycle hypothesis, people smooth out fluctuations in income so that they save during periods of unusually high income and dissave during periods of unusually low income. Thus, for example; an undergraduate student should have a higher level of consumption than a graduate student if both have the same current income. In this regard his postulations are applicable in Zimbabwe since they explain the main reason why most people are investing in education; simply because they are looking ahead to a much higher future income.
Friedman is also an early proponent of flexible exchange rates. Whereas the argument that flexible exchange rates facilitate macroeconomic adjustment is arguably obvious, Friedman’s arguments against the dangers of destabilizing speculation seem to be debatable. In line with his ideological predisposition for markets and against government intervention, Friedman ruled out destabilizing speculation. His argument was that; there exists a fundamental equilibrium price, and if prices depart from this; speculators see a profit opportunity and drive prices back. However, experience has shown that exchange rates and asset markets are prone to speculative bubbles, and it has been extremely difficult to find a relation between exchange rates and fundamentals-whatever they are (Taylor, 1995).
While such findings do not support fixed exchange rates, they do support a case for sensible exchange rate management by well-informed officials who can do a better job than speculative markets. Yet, the triumph of Friedman’s anti-government economics means that this sensible policy approach has been ignored by most policymakers in Zimbabwe because most economic policies that have been implemented so far are arguably Keynesian in nature.
Probably Friedman’s most celebrated work is his contribution to monetarism in which he postulated that ‘inflation is everywhere and is always a monetary phenomenon’. Hence increases in money supply will only affect nominal variables such as nominal prices and nominal Gross Domestic Product (GDP) and result in inflation. Real variables will not be affected.
- Quote paper
- Thabani Nyoni (Author), 2015, Milton Friedman’s Contribution to Present Day Macroeconomic Policy. Postulations and Applicability in Zimbabwe, Munich, GRIN Verlag, https://www.grin.com/document/299841