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YOU DECIDE: What did Milton Friedman teach us?

January 26, 2007

By Dr. Mike Walden
North Carolina Cooperative Extension Service

MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

Dr. Mike Walden
Media representatives: For a black-and-white or color copy of this photo, call 919.513.3127 or e-mail dave_caldwell@ncsu.edu.
While Milton Friedman may not be a household name to most, he was the equivalent of a rock star to economists.

I say "was" because Professor Friedman died late last year, just a few years shy of the century mark in age.

One of the characteristics that made Friedman so special was his ability to span both the academic and the "real" world. In the academic world he published scores of research monographs, journal articles and university press books and, among many accolades, was awarded a Nobel Prize in economics.

But he also brought economics to the everyday person by writing popular books and newspaper articles, making appearances on TV and radio and giving presentations to non-economic groups. He was an inspiration to my own career at North Carolina State University.

What is Professor Milton Friedman's contribution? It would perhaps take an entire book to adequately cover all his insights and analyses, so I'll highlight only three areas that show the diversity and impact of his thinking.

Behind Inflation Is Money. Throughout time, inflation has been blamed on many factors: rising energy prices, natural disasters like hurricanes and droughts, the abandonment of the gold standard and even credit card debt.

Friedman dismissed all these explanations and said the cause of any sustained increase in prices is simple: too much money in circulation. When the amount of money in circulation grows faster than the quantity of products and services that money buys, then the excess money is "soaked up" by higher prices, that is, inflation will occur.

And who controls the money supply in any country? It's the country's central bank, which in the U.S. is the Federal Reserve. Therefore, Friedman argued, it is ultimately the responsibility of the government (via the Federal Reserve) to put a lid on inflation by keeping the growth in dollars in line with the growth in the economy's production.

Friedman's theory about inflation was backed up by meticulous research, which he continued to update right up to his death. Managers of central banks around the world have come to regard his monetary explanation of inflation as a key guide to their policies.

To Combat Poverty, Send Money. Professor Friedman had a simple solution for alleviating poverty: simply provide poor households with more income. Friedman would have had the IRS also act as the nation's primary poverty fighter. When a household filing an income tax form was identified as falling below the poverty level, that household would receive an income supplement from the government that could be used to improve its living standard. He called it a negative income tax.

Of course, such a program is different than curing poverty, which requires adequate education, training and economic opportunity. Yet curing poverty is a long-run proposition, while alleviating poverty assists people now. The beauty of Friedman’s idea is that it is simple, requires a minimum amount of government bureaucracy and gets cash in the hands of the poor.

Friedman's approach to assisting poor households was adopted - not as the nation's exclusive anti-poverty program - but still, as one of the most significant. The earned income tax credit program, which pays cash to working poor households, is the modern version of Friedman's negative income tax.

People Look Back and Ahead for Spending. One of Milton Friedman's earliest contributions was in the area of personal economics. Although his insight may seem trivial, it was really groundbreaking. Friedman concluded that people don't base their current spending only on how much income they have today. Instead, they try to form some estimate of what their long run trend in income will be; something he termed permanent income.

So a young person with relatively low income today but who has great future income prospects will live above his means today because he expects higher income down the road. Or an older person with high income may curtail her spending now because she knows her retirement income will be much lower. The point is that people not only look back, but also ahead, in setting their spending plans.

Milton Friedman has passed from us, but his theories and proposals will be discussed and debated well into the future.

Whether you agree with Friedman or not, I think you'll have to decide he was an economist with the power of ideas.

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Dr. Mike Walden is a William Neal Reynolds Professor and extension economist in the Department of Agricultural and Resource Economics of N.C. State University's College of Agriculture and Life Sciences. He teaches and writes on personal finance, economic outlook and public policy. The Department of Communication Services provides his You Decide column every two weeks. Earlier You Decide columns are at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm

Related audio files are at http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html

Posted by Dave at January 26, 2007 09:50 AM