Milton Friedman's monetary mantle

In the early postwar era, the cause of the Great Depression of the 1930s was something of a mystery. Analysts often assumed it was the 1929 stock market crash. Or perhaps it was widespread commercial bank failures, or the Smoot-Hawley Tariff Act that steeply raised trade barriers. Whatever. By 1932, 1 of every 4 Americans was jobless.

Then, in 1963, like detectives who'd solved a crime, economists Milton Friedman and Anna Schwartz charged that it was the Fed who dunnit. In a statistics-heavy tome, "A Monetary History of the United States, 1867-1960," the two scholars fingered the Federal Reserve System. The central bank had shrunk the nation's money stock by one-third between 1929 and 1933. There wasn't enough money left to maintain reasonable prosperity.

Professor Friedman, who died Nov. 16, is regarded as one of the most influential economists of the 20th century. The Nobel Prize winner revived recognition of the role of the nation's money supply in economic growth and inflation. With his libertarian views of government, he moved the thinking of economists and policymakers to the right in other areas.

"His influence has been profound," says Mrs. Schwartz, still laboring at the midtown New York offices of the National Bureau of Economic Research (NBER).

But it took more than a decade and "Milton's tireless insistence on the importance of the money supply" to persuade the economics fraternity that the quantity of money mattered, she adds.

Reporting for the Monitor in New York, I attended the press conference on the publication of the Friedman-Schwartz book. The conference had been called by then-NBER president Arthur Burns, later Nixon's Fed chairman.

Fed economists in New York tried to shoot down the book's conclusions. They were influenced by famed British economist John Maynard Keynes, who saw interest rates and fiscal policy as more important than money in controlling inflation and the business cycle. Nor did they like hearing the Fed charged with the misery of the Great Depression.

My own economics training, at Carleton College in Ottawa, was by a Keynesian. Over time, though, it became clear that money was an excellent predictor of the business cycle and inflation. Research by such economists as Beryl Sprinkel, then chief economist for Harris Trust & Savings Bank in Chicago (later Reagan's chief economist) and Allan Meltzer of Carnegie Mellon University, Pittsburgh (now writing a second volume of "A History of the Federal Reserve"), found a close correlation between changes in the money supply and, after a delay, the nation's output of goods and services.

By the late 1970s, Friedmanites and Keynesians were engaged in a hot debate.

A commercial firm capitalized on this debate by selling taped discussions of topical issues. Friedman would speak one week and Paul Samuelson, also a Nobel Prize-winning economist, the next.

Every two weeks, Dr. Samuelson would cross the Charles River from his office at the Massachusetts Institute of Technology to be interviewed by me in a Monitor radio studio. Though he had the questions in advance, Samuelson often winged his answers – brilliantly. Friedman, interviewed in Chicago by his wife, Rose, was often more prepared – and also lucid and logical.

Despite their keen differences on economics, the two remained personal friends for 74 years, says Samuelson.

Samuelson frequently debated Friedman at staged public events. Often, says Samuelson, "it was not a pure pleasure." Friedman was a formidable opponent – witty, intelligent – and he loved to argue.

I interviewed Friedman perhaps hundreds of times on the phone or in person. Friedman was always patient and clear in his explanations of his often-unorthodox views.

"He didn't mind being regarded as a nut," notes Samuelson.

In the US, Friedman's influence probably peaked in October 1979 when the new Fed chairman, Paul Volcker, announced that to cure high inflation the Fed would track money, not interest rates, in its monetary policy.

At that time, I wrote in the Monitor that this "historic decision" would eliminate inflation in three or four years and cause a recession with more unemployment. That assessment proved correct.

The nation still benefits from the pattern of low inflation that Mr. Volcker established and his successor, Alan Greenspan, maintained.

The blossoming of money substitutes (money-market funds, credit cards, junk bonds, and many others), plus the globalization of the economy and the reduction of commercial banking's share in the nation's financial system have made it harder to measure money and reduced the Fed's influence on the economy.

Samuelson advocates an "eclectic" approach to monetary policy today.

Dr. Meltzer says the money supply can't be used today to predict quarterly changes in the nation's gross domestic product. But the money supply remains important in determining future inflation and output. The European Central Bank, the Bank of England, and Sweden's central bank pay much more attention to money than the Fed does, Meltzer says.

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