Question

What did Milton Friedman add to economic theory? Do you agree with his ideas?

Answer 1

Milton Friedman created the theory of monetarism in his 1967 address to the American Economic Association. He said that the antidote to inflation was higher interest rates, which in turn reduces the money supply. Prices then fall as people would have less money to spend. Milton also warned against increasing the money supply too fast, which would be counter-productive by creating inflation. But a gradual increase is necessary to prevent higher unemployment rates.

Defying Keynes and most of the academic establishment of the time, Friedman presented evidence to resurrect the quantity theory of money—the idea that the price level depends on the money supply. In Studies in the Quantity Theory of Money, published in 1956, Friedman stated that in the long run, increased monetary growth increases prices but has little or no effect on output. In the short run, he argued, increases in money supply growth cause employment and output to increase, and decreases in money supply growth have the opposite effect.

In comparing the two, fiscal policy generally has a greater impact on consumers than monetary policy, as it can lead to increased employment and income. Monetary policy is most widely used for ‘fine-tuning’ the economy. Making minor changes to interest rates is the easiest way to influence the economic cycle. Deflationary fiscal policy is highly politically unpopular. However, in some circumstances, monetary policy has its limitations. In serious recessions, a combination of two policies may be needed.