New Ideas from Dead Economists: Milton Friedman

Posted: February 25, 2009

Friedman’s major contribution to the science of economics is his defense and argument for the quantity theory of money. This theory argues that the quantity of money available determines the price level and the value of money. It is a direct cause of inflation. More money available in the market drives the price level up and the value of money down. The devaluation of money is inflation.

Friedman was a passionate debater who fought the Keynesian model. Friedman had long held philosophical position that the true test of a theory is whether it correctly predicts events. On this base Friedman argued two main points. In an analogy, if an economy were a car government is usually a lousy driver. In direct contrast to the Keynesian position, he argued the economy’s brake and accelerators have little to do a fiscal policy.

He started an intellectual movement whose beliefs are encapsulated in monetarism. Monetarism asserts that that changes made to the money supply are most material in the business cycle and in long run. In the short run money can sway is not just prices but also economic activity. In the long run money supply only changes price. Monetarists believe the economy’s accelerator is ‘a higher money supply’ and the economy’s brake is ‘lower money supply’. According to, A Monetary History of the United States, ineffective monetary policy accompanied every severe recession and every significant inflationary period over the past and century (page 242). The Federal Reserve is responsible for monetary policy. The Fed affects the money supply through open market operations, the discount rate, and the reserve ratio. They effectively hold the reigns of the economy.

He also worked on the idea of money velocity or how fast money changes hands in an economy. The rate at which the money stock turns over each year is called the velocity of money. Monetarists believe That velocity is stable, Keynesians see is unstable. Historical data supports the monetarist position; as nominal GDP and the money supply increase velocity has stayed constant.