Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him!

In the comments to Scott Sumner’s post asking for a definition of currency manipulation, one of Scott’s regular commenters, Patrick Sullivan, wrote the following in reply to an earlier comment by Bob Murphy:

‘For example, if Fed officials take some actions during the day and we see interest rates go up, surely that’s all we need to know if we’re going to classify it as “tight” or “loose” money, right?’

As I was saying just a day or so ago, until the economics profession grasps that interest rates are NOT the price[s] of money, there’s no hope that journalists or the general public will.

Bob Murphy, you might want to reread ‘Monetary Policy v. Fiscal Policy.’ The transcript of the famous NYU debate in 1968 between Walter Heller and Milton Friedman. You’ve just made the same freshman error Heller made back then. Look for Friedman’s correction of that error in his rebuttal.

Friedman’s repeated claims that the rate of interest is not the price of money have been echoed by his many acolytes so often that it is evidently now taken as clear evidence of economic illiteracy (or “a freshman error,” as Patrick Sullivan describes it) to suggest that the rate of interest is the price of money. It was good of Sullivan to provide an exact reference to this statement of Friedman, not that similar references are hard to find, Friedman never having been one who was loathe to repeat himself. He did so often, and not without eloquence. Even though I usually quote Friedman to criticize him, I would never dream of questioning his brilliance or his skill as an economic analyst, but he was a much better price theorist than a monetary theorist, and he was a tad too self-confident, which made him disinclined to be self-critical or to admit error, or even entertain such a remote possibility.

So I took Sullivan’s advice and found the debate transcript and looked up passage in which Friedman chided Heller for saying that the rate of interest is the price of money. Here is what Friedman said in responding to Heller:

Let me turn to some of the specific issues that Walter raised in his first discussion and see if I can clarify a few points that came up.

First of all, the question is, Why do we look only at the money stock? Why don’t we also look at interest rates? Don’t you have to look at both quantity and price? The answer is yes, but the interest rate is not the price of money in the sense of the money stock. The interest rate is the price of credit. The price of money is how much goods and services you have to give up to get a dollar. You can have big changes in the quantity of money without any changes in credit. Consider for a moment the 1848-58 period in the United States. We had a big increase in the quantity of money because of the discovery of gold. This increase didn’t, in the first instance, impinge on the credit markets at all. You must sharply distinguish between money in the sense of the money or credit market, and money in the sense of the quantity of money. And the price of money in that second sense is the inverse of the price level—not the interest rate. The interest rate is the price of credit. As I mentioned earlier, the tax increase we had would tend to reduce the price of credit because it reduces the demand for credit, even though it didn’t affect the money supply at all.

So I do think you have to look at both price and quantity. But the price you have to look at from this point of view is the price level, not the interest rate.

What is wrong with Friedman’s argument? Simply this: any asset has two prices, a purchase price and a rental price. The purchase price is the price one pays (or receives) to buy (or to sell) the asset; the rental price is the price one pays to derive services from the asset for a fixed period of time. The purchase price of a unit of currency is what one has to give up in order to gain ownership of that unit. The purchasing price of money, as Friedman observed, can be expressed as the inverse of the price level, but because money is the medium of exchange, there will actually be a vector of distinct purchase prices of a unit of currency depending on what good or service is being exchanged for money.

But there is also a rental price for money, and that rental price represents what you have to give up in order to hold a unit of currency in your pocket or in your bank account. What you sacrifice is the interest you pay to the one who lends you the unit of currency, or if you already own the unit of currency, it is the interest you forego by not lending that unit of currency to someone else who would be willing to pay to have that additional unit of currency in his pocket or in his bank account instead of in yours. So although the interest rate is in some sense the price of credit, it is, indeed, also the price that one has to pay (or of which to bear the opportunity cost) in order to derive the liquidity services provided by that unit of currency.

It therefore makes perfect sense to speak about the rate of interest as the price of money. It is this price – the rate of interest – that is the cost of holding money and governs how much money people are willing to keep in their pockets and in their bank accounts. The rate of interest is also the revenue per unit of currency per unit of time derived by suppliers of money for as long as the unit of money is held by the public. Money issued by the government generates a return to the government equal to the interest that the government would have had to pay had it borrowed the additional money instead of printing the money itself. That flow of revenue is called seignorage or, alternatively, the inflation tax (which is actually a misnomer, because if nominal interest rates are positive, the government derives revenue from printing money even if inflation is zero or negative).

Similarly banks, by supplying deposits, collect revenue per unit of time equal to the interest collected per unit of time from borrowers. But all depositors, not just borrowers, bear that interest cost, because anyone holding deposits is either by paying interest — in this theoretical exposition I ignore the reprehensible fees and charges that banks routinely exact from their customers — to the bank or is foregoing interest that could have been earned by exchanging the money for an interest-bearing instrument.

Now if banking is a competitive industry banks compete to gain market share by paying depositors interest on deposits held in their institutions, thereby driving down the cost of holding money in the form of deposits rather than in the form of currency. In an ideal competitive banking system, banks would pay depositors interest nearly equal to the interest charged to borrowers, making it almost costless to hold money so that liquidity premium (the difference between the lending rate and the deposit rate) would be driven close to zero.

Friedman’s failure to understand why the rate of interest is indeed a price of money was an unfortunate blind spot in his thinking which led him into a variety of theoretical and policy errors over the course of his long, remarkable, but far from faultless career.

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22 Responses to “Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him!”


  1. 1 Nick Rowe September 7, 2017 at 7:59 pm

    David: I’m unconvinced. Take a world where money pays interest (some does). It would be better to say that the *difference* between the interest rates on money and on other assets is the opportunity cost of holding money instead of those other assets.

    I am trying to remember something Dennis Robertson said in response to Keynes on interest rate as the price of liquidity. Something about a boy winning a race, and being given the choice of two prizes. Something like: “Can he not proudly say he won the apple for winning the race, rather than for foregoing a banana?”. You would probably remember it better than me.

  2. 2 David Glasner September 7, 2017 at 8:09 pm

    Nick, Sorry. I don’t recognize the story, and I don’t get the point of the story, but I certainly agree that the difference between the interest rate and the deposit rate is the actual cost of holding money. I thought that my penultimate paragraph made that point clear, but perhaps I should have been more explicit. But my larger point is that Friedman completely missed the idea of the interest rate (or some interest-rate spread) could be treated as the rental price of money. His constant refrain about the price of money being the inverse of the price level was just silly.

  3. 3 John Hall September 7, 2017 at 8:11 pm

    Very clear post. I liked it.

  4. 4 Nick Rowe September 7, 2017 at 8:53 pm

    David: the point of Dennis Robertson’s story (I’m not 100% sure it was Robertson, but it does sound like him) is that interest is the reward for postponing consumption, not for foregoing liquidity.

    And interest would still exist in a world without money.

    And it would be equally true that interest is the (rental) price of owning a cast-iron frying pan, or jewelry, or land. So while I find it OK to say that the rental price of money is the rate of interest (assuming money pays no interest), I am less happy to say that the rate of interest is the (rental) price of money. The latter formulation picks out one asset (money) among many assets for which it is equally true.

  5. 5 Bob Murphy September 7, 2017 at 9:42 pm

    BTW just to avoid confusion: In the quotation from me (which prompted Patrick Sullivan to accuse me of making a freshman error), I wasn’t offering my statement as something I actually believed. Instead, I was making a rhetorical point to try to show Scott Sumner that his critique of Glasner would throw out market monetarism.

    In retrospect I realize what I wrote was confusing unless you were very familiar with my trolling style, but I want to be clear that I don’t hold the quoted viewpoint.

  6. 6 JKH September 8, 2017 at 3:24 am

    The inverse of the price level (and subsets of that) and the interest rate are obviously both important factors.

    But I think it’s counterproductive and unnecessary to define “price” on the basis of its applicability to one and not the other.

    (Reasoning from a single word?)

    Furthermore, the two things are entirely different from a dimensional stock/flow (accounting) perspective. The terms price, cost, revenue, and expense should at least be used with some discrimination in the discussion.

    Anyway, I’m always attracted to a touch of Friedman bashing. It ranks in my mind pari passu with “I love the smell of napalm in the morning”.

    (Even in the face of a bit of bank bashing alongside)

    : )

  7. 7 David Glasner September 8, 2017 at 8:46 am

    John, Thanks.

    Nick, OK, I see what you mean. I am somewhat sympathetic to your point about what “interest” really is, but that raises some tricky philosophical issues about essentialism versus nominalism. A nominalist — and following Karl Popper, I reluctantly consider myself to be one — is not interested in what “interest” really is, but only in how it functions. So, in a certain context interest may function as the reward for foregoing consumption and in another context interest can perfectly well be the reward for foregoing liquidity. Problem solved. As for your assertion that interest can be the rental price of any asset, I don’t think that is quite true. Interest is only the rental price of those assets whose nominal price is unity.

    Bob, Clarification noted. Happy trolling!

    JKH, I didn’t mean to deny that the inverse of the price level can be properly considered to be the price of money. I am perfectly OK with having multiple prices of money, depending on the particular circumstances that are relevant to whatever discussion we are having.

    I totally agree that there are different dimensions associated with a purchase price and a rental price, and I tried to keep those dimensions straight in my post. I hope I didn’t slip up, but perhaps I was careless.

  8. 8 JP Koning September 8, 2017 at 9:55 am

    “…whose nominal price is unity. ”

    Not sure what that means. Does that mean they are used as the unit of account?

  9. 9 David Glasner September 8, 2017 at 10:01 am

    JP, Yes, the unit of account or the numeraire, so its purchase price is necessarily one, implying that the rental price is the nominal rate of interest, or stated differently, implying that the interest rate is the rental price of an asset with a nominal price of unity.

  10. 10 Rob Rawlings September 8, 2017 at 10:02 am

    While it is true that ‘any asset has two prices, a purchase price and a rental price’ in common parlance it is first sense that the word price is reserved for. The second usage would probably be called ‘rent’ for goods and ‘interest for money.

    I take Friedman merely to be correctly claiming that interest is not ‘the price of money’ in the first sense and his claim that interest is ‘the price of credit’ to be consistent with the second type of ‘price’.

  11. 11 David Glasner September 8, 2017 at 10:06 am

    Rob, If that were all Friedman were saying, he would not have been criticizing Heller for speaking about the rate of interest as the price of money, or at least he would have had to frame his criticism in a more sophisticated way than he framed it. To say flatly that the interest rate is not the price of money is to deny the basic proposition that the (nominal) interest rate is the opportunity cost of holding money (under the assumption that money is non-interest-bearing which was a standard assumption back in 1968).

  12. 12 Bob Murphy September 8, 2017 at 11:22 am

    David,

    Can you (either here in the comments or in a follow-up post) elaborate on your last paragraph, where you claim that Friedman’s narrow-minded focus on just the one definition led him to make policy errors over his career?

    I mean, my initial reaction to your post is to think that probably both economists understood the perspective of the other. Just as someone might say, “Wow apartment prices are really high in San Francisco!” and really what they mean is the rental price, and it would be churlish to correct the person.

    So can you show e.g. that in the context of this debate, that Friedman’s “correction” didn’t really affect the substance of the dispute, or even better that Friedman ended up pushing a bad policy because he was thinking one way rather than the other?

  13. 13 David Glasner September 8, 2017 at 11:38 am

    Bob, What I had in mind was that Friedman, who was brought up on the Chicago 100% reserve plan, always thought that competition in the supply of money was inherently self-destructive because it would cause the value of money to be debased as lower cost substitutes would drive down the value of money to the cost of the paper it was written on. What he didn’t realize was that the price of money that would be affected by competition was not the purchase price of money, but the rental price as banks would compete with each other to reduce the price of money by paying interest on deposits. Thanks for posing the question and forcing me to articulate a point that I hadn’t stated as succinctly until now.

  14. 14 Nick Rowe September 8, 2017 at 3:18 pm

    Good Q Bob and good A David.

  15. 16 Philip George September 10, 2017 at 5:52 am

    I have no doubt that you are right. Interest is the rent for money.

    What do we mean when we say that the price of potatoes is $1 a kilogram? We mean that when A buys potatoes from B for $1 a kilogram, he hands over $1, gets a kilo of potatoes and that is the end of the transaction. Never do the twain meet again.

    If an interest rate of 5% were to mean the price of money, that would mean that A hands over $5 to B, gets $100 in exchange, and the transaction ends at that point. But of course it doesn’t. B expects to get the $100 back at the end of the contracted period, just as a landlord expects to get his rented property at the end of the contracted period.

    See point No 2 of http://www.philipji.com/item/2011-04-21/paul-krugman-money-and-rent-control

    PS. I do not agree entirely with the post now.

  16. 17 Frank Restly September 12, 2017 at 4:35 pm

    David,

    I think it’s important to remember what the units are for interest and other prices. The price of apples and airplanes is expressed as Dollars / apple or Pesos / airplane.

    The units for interest are % / year or % / month.

    Hence, an interest rate is not the price (either rental or fixed) of money or any other physical good. It is the price of time.

    If we all lived forever then the notion of interest rates goes totally out the window. Don’t have enough apples? Don’t borrow. Wait a year or three or 10,000.

    It is only because we have fixed lifespans (time is precious) that interest has any meaning.

  17. 18 The Arthurian September 15, 2017 at 1:34 am

    Good topic. Interesting post. Great comments. Here’s what I think:

    https://newarthurianeconomics.blogspot.com/2017/09/credit-is-not-same-as-money-even-if-you.html

  18. 19 John Hutchinson September 16, 2017 at 7:09 am

    Why don’t you bloggers read Tobin’s “Money” in the Palgrave Dictionary? You can read a more scholarly version of “David Glasner’s” two-part contribution….

  19. 20 Frank Restly September 17, 2017 at 4:25 pm

    David,

    Apples trade today for 1 million apples per airplane. I as a producer of apples am willing to give you 800 thousand apples today for 1 airplane delivered two years from now. Meaning I am getting a 12.5% nominal interest (about 6% per year) on the apples that I give to you.

    In this example you are not renting apples. Once you receive the apples that I give you, they are yours to do with as you wish – I do not want them back and will not accept them back. However, I am still charging you interest. I am charging that interest on the time it takes for you to deliver that airplane.

    Over that two year time frame, a lot of things could happen:
    1. You could eat all the apples that I give you and then default
    2. You could perish and be unable to deliver that airplane

    If the relative prices of apples and airplane does not change over that two year time frame I am getting both 12.5% nominal and real interest. If the relative price of apples rises from 1 million to 800 thousand apples per airplane, then I am still getting 12.5% nominal interest but 0% real interest (neglecting the depreciation of the specific apples that I gave you).

    In a monetary economy, debts are more often than not denominated and repaid in the medium of exchange, and so it is convenient to say that interest is the cost of money. In a barter economy with a system of credits, this is not the case. In a barter economy, I can today “borrow” apples (or oranges, or bananas, or grapefruit) and 2 years, 5 years, 20 years from now deliver an airplane, a sailboat, or a rocket.


  1. 1 Should-Read: David Glasner: Milton Friedman Says that the Rate of Interest Is NOT the Price of Money: Don’t Listen to Him! - Daily Economic Buzz Trackback on September 10, 2017 at 7:55 am
  2. 2 Milton Friedman and the Chicago School of Debating | Uneasy Money Trackback on September 11, 2017 at 6:20 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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