Before you read on: which of these did Milton Friedman propose in 1962?
In Capitalism and Freedom (1962) Friedman proposed a negative income tax. He opposed the draft.
- Lived
- Born 31 July 1912 in Brooklyn, New York; died 16 November 2006 in San Francisco
- Nationality
- American
- Work
- University of Chicago from 1946, for some 30 years; National Bureau of Economic Research; Hoover Institution, Stanford, from 1977. Nobel prize in economics, 1976
- Key works
- A Theory of the Consumption Function (1957), Capitalism and Freedom (1962), A Monetary History of the United States, 1867 to 1960 (1963, with Anna Schwartz), and Free to Choose (1980, with Rose Friedman)
- School
- Monetarism, of which he was the leading figure
What Friedman was reacting to
In the decades after the Second World War, Keynesian economics guided policy in most Western governments. Many Keynesians gave money only a small part in explaining booms and slumps. Friedman set out to show that changes in the money supply matter a great deal.
He also took issue with two other ideas common at the time. One was that households base their spending mainly on this year's income. The other, widely held in the early 1960s, was that governments could keep unemployment low for good by accepting a little more inflation.
Friedman's key ideas
Can you name Friedman's four key ideas?
Households base spending mainly on the income they expect on average over several years, which Friedman called permanent income. A one-off change in income moves spending far less.
Can you think of an example?
A worker is laid off for one month and keeps her spending almost unchanged, because her long-run income has barely changed.
Milton Friedman and Edmund Phelps argued that there is no lasting trade-off between inflation and unemployment. The natural rate is the level of unemployment the economy settles at once inflation is fully expected. Policy can hold unemployment below it only while inflation runs ahead of expectations.
Can you think of an example?
A government spends more, and unemployment falls while prices rise faster than expected. Once people expect the higher inflation, unemployment drifts back up.
Friedman argued that the central bank should increase the money supply at a fixed rate each year, in line with the economy's long-run growth, whatever the state of the economy. He put the rate at 3 to 5 per cent.
Can you think of an example?
The money supply grows by 4 per cent this year and 4 per cent next year, in a boom or a slump.
Households above an income threshold pay tax, and households below it receive a payment from the state that grows with the shortfall. Friedman set out the idea in Capitalism and Freedom.
Can you think of an example?
With a threshold of £10,000 and a rate of 25 per cent, a family earning £8,000 receives £500. A family with no income receives £2,500.