Was Milton Friedman a Nobody?
Alan Blinder writes:
Thursday’s surprising report on first-quarter gross domestic product may contribute to a feeling of déjà vu all over again. High inflation reminds many Americans of the unhappy 1970s, when a series of food-price shocks in 1973-74 and a huge oil-price shock late in 1973 drove inflation through the roof—and a serious recession followed. Are we headed for a repeat performance?
Not quite. One big difference is that now the Federal Reserve and other central banks understand stagflation much better. In 1973 it was a puzzling new phenomenon, and no one knew how to think about it. Economists and central bankers of the day had lived through a history in which booming economies brought on rising inflation and sluggish economies brought on rising unemployment. The two maladies didn’t occur simultaneously. (italics added)
This is from Alan S. Blinder, “If We Get a Recession in 2022 or 2023, It’ll Be a Mild One,” Wall Street Journal, April 28, 2022. (April 29 print edition.)
But here’s what Milton Friedman said in his presidential address to the American Economics Association in December 1967:
Let us assume that the monetary authority tries to peg the “market” rate of unemploymentat a level below the “natural” rate. For definiteness, suppose that it takes 3 per cent as the target rate and that the “natural” rate is higher than 3 per cent. Suppose also that we start out at a time when prices have been stable and when unemployment is higher than 3 per cent. Accordingly, the authority increases the rate of monetary growth. This will be expansionary. By making nominal cash balances higher than people desire, it will tend initially to lower interest rates and in this and other ways to stimulate spending. Income and spending will start to rise.
To begin with, much or most of the rise in income will take the form of an increase in output and employment rather than in prices. People have been expecting prices to be stable, and prices and wages have been set for some time in the future on that basis. It takes time for people to adjust to a new state of demand. Producers will tend to react to the initial expansion in aggregate demand by increasing output, employees by working longer hours, and the unemployed, by taking jobs now offered at former nominal wages. This much is pretty standard doctrine.
But it describes only the initial effects. Because selling prices of products typically respond to an unanticipated rise in nominal demand faster than prices of factors of production, real wages received have gone down-though real wages anticipated by employees went up, since employees implicitly evaluated the wages offered at the earlier price level. Indeed, the simultaneous fall ex post in real wages to employers and rise ex ante in real wages to employees is what enabled employment to increase. But the decline ex post in real wages will soon come to affect anticipations. Employees will start to reckon on rising prices of the things they buy and to demand higher nominal wages for the future. “Market” unemployment is below the “natural” level. There is an excess demand for labor so real wages will tend to rise toward their initial level.
Even though the higher rate of monetary growth continues, the rise in real wages will reverse the decline in unemployment, and then lead to a rise, which will tend to return unemployment to its former level. In order to keep unemploymentat its target level of 3 per cent, the monetary authority would have to raise monetary growth still more.
In other words, Milton Friedman, well before the 1973 stagflation, anticipated that one can get “stagflation,” the combination of high unemployment and high inflation.
What misled Alan Blinder is that the economists he studied under, Robert Solow and Paul Samuelson, did not anticipate this combination because they were blinded by their Keynesian Phillips Curve way of thinking.
But that wasn’t the whole universe of economists. Friedman saw it clearly over 5 years before the 1973 stagflation.