Misconceptions About Milton Friedman’s 1968 Presidential Address

For macroeconomists, Milton Friedman’s (1968) Presidential Address to the American Economic Association about “The Role of Monetary Policy” marks a central event (American Economic Review, March 1968, pp. 1-17).Friedman argued that monetary policy had limits. Actions by a central bank like the Federal Reserve could have short-run effects on an economy–either for better or for worse. But in the long-run, he argued, monetary policy affected only the price level. Variables like unemployment or the real interest rate were determined by market forces, and tended to move toward what Friedman called the “natural rate”–which is potentially confusing term for saying that they are determined by forces of supply and demand.  

Here, I’ll give a quick overview of the thrust of Friedman’s address, a plug for the recent issue of the Journal of Economic Perspectives, which has a lot more, and point out a useful follow-up article that clears up some misconceptions about Friedman’s 1968 speech.

The Winter 2018 issue of the Journal of Economic Perspectives, where I work as Managing Editor, we published a three-paper symposium on “Friedman’s Natural Rate Hypothesis After 50 Years.” The papers are:
 

I won’t try to summarize the papers here, along with the many themes they offer on how Friedman’s speech influenced the macroeconomics that followed or what aspects of Friedman’s analysis have held up better than others. But to giver a sense of what’s a stake, here’s an overview of Friedman’s themes from the paper by Mankiw and Reis:
 

“Using these themes of the classical long run and the centrality of expectations, Friedman takes on policy questions with a simple bifurcation: what monetary policy cannot do and what monetary policy can do. It is a division that remains useful today (even though, as we discuss later, modern macroeconomists might include different items on each list). 

“Friedman begins with what monetary policy cannot do. He emphasizes that, except in the short run, the central bank cannot peg either interest rates or the unemployment rate. The argument regarding the unemployment rate is that the trade-off described by the Phillips curve is transitory and unemployment must eventually return to its natural rate, and so any attempt by the central bank to achieve otherwise will put inflation into an unstable spiral. The argument regarding interest rates is similar: because we can never know with much precision what the natural rate of interest is, any attempt to peg interest rates will also likely lead to inflation getting out of control. From a modern perspective, it is noteworthy that Friedman does not consider the possibility of feedback rules from unemployment and inflation as ways of setting interest rate policy, which today we call “Taylor rules” (Taylor 1993).

“When Friedman turns to what monetary policy can do, he says that the “first and most important lesson” is that “monetary policy can prevent money itself from being a major source of economic disturbance” (p. 12). Here we see the profound influence of his work with Anna Schwartz, especially their Monetary History of the United States. From their perspective, history is replete with examples of erroneous central bank actions and their consequences. The severity of the Great Depression is a case in point.

“It is significant that, while Friedman is often portrayed as an advocate for passive monetary policy, he is not dogmatic on this point. He notes that “monetary policy can contribute to offsetting major disturbances in the economic system arising from other sources” (p. 14). Fiscal policy, in particular, is mentioned as one of these other disturbances. Yet he cautions that this activist role should not be taken too far, in light of our limited ability to recognize shocks and gauge their magnitude in a timely fashion. The final section of Friedman’s presidential address concerns the conduct of monetary policy. He argues that the primary focus should be on something the central bank can control in the long run—that is, a nominal variable … ”