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19 November 2010
Basic Economics Part Eight
Chicago School
A return to unregulated, free-
came as a reaction to Keynesianism and the
debts governments racked up in its name
Milton Friedman (left) was born in 1912 and was one of the leading conservative economists
in the second half of the 20th century.
Following his death in November 2006 at the age of 94, The Economist wrote that he was “...the most influential economist of the second half of the 20th century…possibly of all of it.”
Return to Laissez-
He became the leading figure of the so-
Both these economic schools stressed the importance of social and market freedoms. They favoured government intervention in the economy being kept to a minimum. In fact, they favoured all government being kept to a minimum.
Friedman is the leading believer in the conservative, free-
Friedman became one of the leading American advocates of the monetarist school of economics, which holds that the business cycle is determined primarily by money supply and interest rates rather than by a government’s fiscal policy (how much it raises through taxation and how much it spends).
He believed that central banks (the Bank of Canada for example) can best promote economic stability by increasing the supply of money at a fairly fixed rate instead of sharply expanding or contracting it.
Monetarism Explained
One way of understanding monetarism is through a very clever exam question that University of Chicago economics students were asked to answer.
“There once was an upright and very proper Englishman who regularly took his summer vacation on a tiny, agreeable, Greek island. The Englishman had returned to the island so many times that his creditworthiness had been established beyond any possible doubt. There was absolutely no chance that the Englishman’s bank would fail to honour his cheques and, indeed, all of them had been honoured promptly.
“Because the Englishman’s credit was so sound, the islanders were totally happy to allow him to pay by cheque, with the certain knowledge that they were good cheques. Indeed, so well known and trusted was the Englishman on this tiny island that the islanders were happy to accept the Englishman’s cheques from each other. For example, if the restaurant owner wished to pay the grocer partly with a cheque he had received from the Englishman in payment for a meal, the grocer was happy to accept the cheque.
“The grocer was then able to buy gas with the cheque, and the Englishman’s cheques circulated in this way around the island. Indeed, the cheques were never returned to the Englishman’s bank for collection.”
The exam question then asked: “Who paid for the Englishman’s holiday?”
The answer is that all the islanders together shared the cost. How?
The Englishman’s cheques had the effect of increasing the money supply on the Greek
island. But, the supply of goods and services remained the same. So, a larger supply
of money was chasing the same amount of goods and services, driving up their price
-
Criticism of Keynes
Friedman’s monetary policy approach to economics offers a major alternative to the
fiscal policy of the Keynesians. In A Monetary History of the United States, 1867-
Friedman’s ideas had a profound impact on economic policy in the United States and elsewhere; they won him the 1976 Nobel Prize for Economics.
His most popular work is Capitalism and Freedom (1962), which expresses his humanitarian interests. In it he argues for a negative income tax plan, or guaranteed income.
Friedman said it’s horribly inefficient to employ a large bureaucracy to collect taxes, shuffle the money around, and then hand it back in the form of social programs.
He believed this kind of system damaged traditional values of individual enterprise and looking after yourself. With a guaranteed income, payments to the poor would be made automatically if their incomes fall below a certain level.
Friedman saw this approach as the best way of breaking the cycle of welfare dependency.
Politics and Economics Meet
The place where politics and economics meet became the place where Milton Friedman’s fame grew.
Friedman was a passionate believer in unrestricted capitalism. The core of Milton
Friedman’s theories is that the free market, motivated by profit and self-
Britain’s Prime Minister Margaret Thatcher (in office 1979-
Shortly after his death, Lady Thatcher was quoted by The Independent (November 17, 2006) as saying, "Milton Friedman revived the economics of liberty when it had been all but forgotten...I shall greatly miss my old friend's lucid wisdom..."
Thatcherism and Reaganomics
Under various socialist regimes the British government had come to own the coal, steel, oil, and electricity industries, several auto companies, the railway system, the telephone service, a major airline, and much more. These were all sold off to private enterprise by Thatcher. Reagan was not as radical, but he did privatize a rail freight business, Conrail, and Fannie Mae.
Both leaders also heeded Friedman’s advice to cut government red tape. In 1982, Ronald
Reagan signed into law the Garn-
This deregulation of the financial industry was recommended by Reagan’s advisers, one of whom was Milton Friedman.
Economist Paul Krugman, writing in The New York Times (May 31, 2009) says this bank
deregulation “ended New Deal restrictions on mortgage lending -
Families began to pile on debt on a scale that would have been impossible if regulations had remained in place.
Eventually, overstretched borrowers ran into trouble and began defaulting on their
loans. “These defaults,” wrote Krugman, “in turn wreaked havoc with a financial system
that -
It was all tied to the economic theories of Milton Friedman and the people who followed his advice, and brought about the financial collapse of 2008 and the start of the Great Recession.
Image credit
Mike Gifford
Sources
Hazlitt, Henry. Economics in One Lesson,Three Rivers Press, 1988.
Henderson, David R, et al, Concise Encyclopedia of Economics.
McConnell, Campbell R, Brue, Stanley L. Economics, McGraw Hill
Samuelson, Paul. Economics, McGraw Hill, 1948.
Sloman, John. Essential of Economics, Prentice Hall, 1998
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NOTHING IS PERFECT
While prices generally balance supply and demand, it doesn’t always work that way: sometimes a price increase also increases demand, if consumers think the price is going to continue to rise.
Then, speculation enters the picture: demand continues to go up, which continues to push prices up, which supports the decision to continue buying.
That’s what happened before the stock market crash of 1929. The lucky, and perhaps more knowledgeable, investors sold out when prices were high and left “the innocent, the avaricious and the gullible,” as economist John Kenneth Galbraith described them, at rock bottom financially, as they watched the surplus of stocks drive the prices down drastically.
Some were so convinced they would become wealthy by buying more stocks that they borrowed money to do so. Even though they had to put up 45% to 50% of the purchase, they still faced financial disaster when their stocks became worthless and they were left with huge debts.
Milton Friedman was scornful of the ability of government to provide services for people, once saying, according to The Economist (August 7, 2008), “If you put the federal government in charge of the Sahara Desert, in five years there’d be a shortage of sand.”
EPIC DEBT
Despite apparently following the advice of Milton Friedman for three decades -
Writing in The New York Times (July 31, 2010) President Reagan’s former budget chief David Stockman pointed out that,
“The nation’s public debt — if honestly reckoned to include municipal bonds and the $7 trillion of new deficits baked into the cake through 2015 — will soon reach $18 trillion.”
He adds that mismanagement has “crippled our economy.”
CASINO CAPITALISM
French President Nicolas Sarkozy was another ardent fan of laissez-
But then the world’s financial system fell apart after banks were tripped up by peddling worthless debt among themselves because no government regulators were available to control them.
In a September 2008 speech in Toulon, France Sarkozy said, “Self-
He was quick to add that capitalism itself is not finished and it isn’t. It will take on a different form from what critics have come to call “casino capitalism.”
In October 2008, The Economist wrote that “…all the signs are pointing in the same direction: a larger role for the state, and a smaller and more constrained private sector.”