Commenting on a supremely silly and embarrassingly uninformed (no, Ms. Shlaes, A Monetary History of the United States was not Friedman’s first great work, Essays in Positive Economics, Studies in the Quantity Theory of Money, A Theory of the Consumption Function, A Program for Monetary Stability, and Capitalism and Freedom were all published before A Monetary History of the US was published) column by Amity Shlaes, accusing Ben Bernanke of betraying the teachings of Milton Friedman, teachings that Bernanke had once promised would guide the Fed for ever more, Paul Krugman turned the tables and accused Friedman of having been a crypto-Keynesian.
The truth, although nobody on the right will ever admit it, is that Friedman was basically a Keynesian — or, if you like, a Hicksian. His framework was just IS-LM coupled with an assertion that the LM curve was close enough to vertical — and money demand sufficiently stable — that steady growth in the money supply would do the job of economic stabilization. These were empirical propositions, not basic differences in analysis; and if they turn out to be wrong (as they have), monetarism dissolves back into Keynesianism.
Krugman is being unkind, but he is at least partly right. In his famous introduction to Studies in the Quantity Theory of Money, which he called “The Quantity Theory of Money: A Restatement,” Friedman gave the game away when he called the quantity theory of money a theory of the demand for money, an almost shockingly absurd characterization of what anyone had ever thought the quantity theory of money was. At best one might have said that the quantity theory of money was a non-theory of the demand for money, but Friedman somehow got it into his head that he could get away with repackaging the Cambridge theory of the demand for money — the basis on which Keynes built his theory of liquidity preference — and calling that theory the quantity theory of money, while ascribing it not to Cambridge, but to a largely imaginary oral tradition at the University of Chicago. Friedman was eventually called on this bit of scholarly legerdemain by his old friend from graduate school at Chicago Don Patinkin, and, subsequently, in an increasingly vitriolic series of essays and lectures by his then Chicago colleague Harry Johnson. Friedman never repeated his references to the Chicago oral tradition in his later writings about the quantity theory, e.g., his essay on the quantity theory of money in the International Encyclopedia of the Social Sciences. But the simple fact is that Friedman was never able to set down a monetary or a macroeconomic model that wasn’t grounded in the conventional macroeconomics of his time.
Friedman was above all else a superb applied price theorist who wound up doing a lot of worthwhile empirical work and historical on monetary economics, but his knowledge of the history of monetary theory seems to have been pretty much confined to whatever he learned from his teacher Lloyd Mints’s book, A History of Banking Theory in Great Britain and the United States and probably from a classic book, Studies in the Theory of International Trade, by Jacob Viner, another one of Friedman’s teachers at Chicago That’s why when Friedman finally published an article in two part in the Journal of Political Economy in the early 1970s entitled “A Theoretical Framework for Monetary Analysis,” the papers pretty much flopped, and are now almost completely forgotten (but see here). Actually Friedman’s intellectual forbears were really W. C. Mitchell and Friedman’s teacher at Columbia Arthur Burns from whom Friedman was schooled in the atheoretical, empirical approach of the old NBER founded by Mitchell.
But Krugman is not totally right either. Although Friedman obviously liked the idea that the LM-curve was vertical, and liked the idea that money demand is very stable even more, those ideas were not essential to his theoretical position. (Whether the stability of the demand for money was essential to his position would depend on whether Friedman’s 3-percent growth rule for the money supply is central to his thought. Although Friedman obviously loved the 3-percent rule, I don’t think that objectively it was really that important to his intellectual position, his sentimental attachment to it notwithstanding.) What really mattered was the idea that, in the long run, money is neutral and the long-run Phillips Curve is vertical. Given those assumptions, Friedman could argue that ensuring reasonable monetary stability would lead to better economic performance than discretionary monetary or fiscal policy. But Friedman, as far as I know, never actually considered the possibility of a negative equilibrium real interest rate. That’s why, when we look for guidance from Friedman about the current situation, we can’t be completely sure what he would have said. His comments on Japan suggest that he would have indeed favored quantitative easing. But inasmuch as he did not explicitly advocate inflation, supporters and opponents of QE can make a case that Friedman would have been on their side. My own view is that the argument that Friedman would have supported QE is not one of the five or even ten strongest arguments that could be made on its behalf.
Uneasy Money 