The Economics Book

198

that “money matters.” Friedman

believed that money affects

output in the short run and prices

only in the long run. He argued

that monetary policy has a valuable

role to play in managing the

economy: an idea now known

as monetarism.

In 1963, Friedman published

A Monetary History of the United

States, 1867–1960 with his colleague

Anna Schwartz. They tracked the

role of money in business cycles,

finding that fluctuations in

monetary growth preceded

fluctuations in output growth.

In particular they attributed the

Great Depression of 1929–33 to

the incompetence of the Federal

Reserve, the central bank of

the US, allowing or causing

the quantity of money to fall

by more than one third.

Theory of consumption

Keynes’s case for government

spending in a slump was

based partly on his ideas about

consumption. He argued that

as people’s income rises, their

consumption also goes up, but

not by as much. In a slump people

hoard money, which prolongs the

slump. State spending in such a

MONETARIST POLICY

IN CONTEXT

FOCUS

Economic policy

KEY THINKER

Milton Friedman

(1912–2006)

BEFORE

1911 Irving Fisher formalizes

the quantity theory of money,

which proposes that prices are

directly related to the size of

the money supply.

1936 John Maynard Keynes

questions the effectiveness

of policies to control the

money supply.

AFTER

1970s Robert Lucas develops

models that assume “rational

expectations.”

1970s–80s Many countries

adopt formal monetary

growth targets, by which

governments attempt to

control growth in the size of

the money supply in order to

keep down inflation. The Great Depression saw millions

of Americans migrate west in search of

work on farms. Milton Friedman blamed

the slump on the Federal Reserve’s

reduction in the money supply.

W

riting in the 1930s, John
Maynard Keynes (p.161)
argued that policies
aimed at controlling the money
supply were often ineffective. He
believed that altering interest rates
or the money supply did not affect
the economy in a predictable way.
Instead, governments could better
use fiscal policy—changing the
mix of government spending
and taxation—to protect against
unemployment or inflation. By 1945,
his views were widely accepted.
From the 1950s, however, US
economist Milton Friedman began
to challenge Keynes with the idea