- Person
- Milton Friedman
- Lived
- 1912–2006
- Field
- Economics
- From
- American
The story
In the 1960s many economists believed that governments could choose a permanent trade-off between inflation and unemployment: accept somewhat higher prices and enjoy lower joblessness. This relationship was known as the Phillips curve, after a statistical pattern showing that wages tended to rise faster when unemployment was low. It suggested that policymakers could simply pick the mix they preferred.
Milton Friedman disagreed. He had sketched the idea in 1966, and in his presidential address to the American Economic Association in December 1967, published in 1968, he argued that there is a natural rate of unemployment, set by real features of the labour market such as the cost of finding jobs and moving between them. Pushing unemployment below that rate through expansionary policy would only make inflation accelerate.
His reasoning turned on expectations. Unemployment might fall for a while if inflation took people by surprise, because wages would lag behind prices. But once workers and employers came to expect higher prices, wages would catch up, and unemployment would return to its natural level, leaving only the inflation behind. In the long run, he argued, the Phillips curve was vertical.
The insight, associated with both Friedman and Edmund Phelps, predicted what would come to be known as stagflation, the combination of rising prices and stagnant growth. In the 1970s many countries experienced exactly that. The Royal Swedish Academy of Sciences noted in 1976 that Friedman was the first to demonstrate that the accepted trade-off was only temporary, and that modern ideas about how wages are set rested heavily on his view of the importance of inflation expectations. It was part of the demonstration of the complexity of stabilisation policy that the Nobel committee cited. Phelps received his own Nobel Prize in 2006.
Later economists, notably Robert Lucas, refined the idea by adding rational expectations, and surveys have found that two-thirds to three-quarters of economists agree that the economy tends toward a natural rate of unemployment in the long run.
The idea still shapes central banking. Policymakers today watch inflation expectations closely, accept that monetary policy cannot permanently push unemployment below the level set by the labour market, and look to structural reforms that improve how the labour market works to lower that level instead.
Why it matters
Friedman's insight changed how economists and central banks think about the limits of using inflation to fight unemployment.
About Milton Friedman
Chicago economist and 1976 Nobel laureate whose monetarism and free-market advocacy reshaped central banking, ended the US draft and influenced governments worldwide.
More about Milton Friedman
- Milton Friedman made the case for floating exchange ratesMilton Friedman's 1953 essay The Case for Flexible Exchange Rates argued for floating currencies at a time when most experts thought the idea unrealistic.
- Milton Friedman showed what caused the Great DepressionIn their 1963 Monetary History of the United States, Milton Friedman and Anna Schwartz argued that a collapse in the money supply turned a downturn into the Great Depression.
- Milton Friedman explained how families plan their spendingIn his 1957 book A Theory of the Consumption Function, Milton Friedman introduced the permanent income hypothesis, which he considered his best scientific work.
- Milton Friedman helped invent sequential samplingDuring the Second World War, Milton Friedman and colleagues at Columbia developed sequential sampling, which became the standard method of quality control inspection.
Sources
- Milton Friedman Wikipedia
- The Sveriges Riksbank Prize in Economic Sciences 1976 NobelPrize.org
- Natural rate of unemployment Wikipedia
- Press release: The Prize in Economic Sciences 1976 NobelPrize.org
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