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Milton Friedman's presidential address to the American Economic Association holds a mythical status as the harbinger of the supply-side counter-revolution in macroeconomics – centred on the rejection of the long-run Phillips-curve inflation–unemployment trade-off. Friedman (seconded by Edmund Phelps) argued that the long run is determined by ‘structural’ forces, not demand, and his view swept the profession and dominated academic economics and macro policymaking for four decades. Friedman, tragically, put macroeconomics on the wrong track which led to disaster: secular stagnation, rising inequality, mounting indebtedness, financial fragility, a banking catastrophe and recession – and no free lunches. This is Friedman's legacy. We have to unlearn the wrong lessons and return macroeconomics to the right track. To do so, this paper shows that Friedman's (and Phelps's) conclusions break down in a general model of the long run in which productivity growth is endogenous – aggregate demand is driving everything again, short and long.
Friedman's presidential address was about ‘The role of monetary policy’. Its famous discussion of inflation–unemployment interrelationships was subservient to this broader topic. The program it promoted influenced monetary policy in the 1970s and early 1980s with mixed results, but enough of it survived to be a clearly visible influence on today's inflation-targeting regimes.
It is noted that Friedman (1968) suggested the adjustment to a change in the rate of inflation would take decades and that this is rather a long time. Various suggestions as to why Friedman may have said this are considered. It is argued that he may have had in mind not a more or less rational change in expectations, but something more like a change in the habits of thought. It is noted that if this is correct, his view on the point is not generally accepted.
Antonella Stirati and Walter Paternesi Meloni
A major contribution of Friedman's 1968 presidential address was the introduction of the long-run vertical Phillips curve. That view, which is consistent with neoclassical foundations, has become so profoundly entrenched in macroeconomists' thinking that increasing evidence of ‘hysteresis’ has not as yet dislodged it. The prevailing notion of the non-accelerating inflation rate of unemployment (NAIRU) is constructed in terms of the ‘natural’ unemployment rate, which has allowed for some changes regarding its microeconomic determinants. However, the macroeconomic features of Friedman's natural rate and the NAIRU remain very much the same and unchanged. The blatant path-dependence of empirically estimated NAIRUs creates a dissociation between macroeconomic theory and empirics which, in our view, is unacceptable and demands a change of perspective. Adopting an alternative theory of distribution and employment might rehabilitate the original approach taken by Phillips vis-à-vis Friedman's legacy.
Roger E.A. Farmer
I review the contribution and influence of Milton Friedman's 1968 presidential address to the American Economic Association. I argue that Friedman's influence on the practice of central banking was profound and that his arguments in favour of monetary rules were responsible for 30 years of low and stable inflation in the period from 1979 through 2009. I present a critique of Friedman's position that market economies are self-stabilizing and I describe an alternative reconciliation of Keynesian economics with Walrasian general equilibrium theory from that which is widely accepted today by most neoclassical economists. My interpretation implies that government should intervene actively in financial markets to stabilize economic activity.
Louis-Philippe Rochon and Sergio Rossi
The ‘natural rate of unemployment’ was not an important part of Friedman's presidential address, although it is what the paper is remembered for. On the 50th anniversary of the paper, we argue that there is no ‘natural rate of unemployment’, and that the relation between inflation and unemployment is not the one assumed by Friedman or neoclassical theory. In Section 2 we present the conventional framework in which the Phillips curve is drawn by neoclassical economists. It emphasizes the exogenous nature of money, as well as the assumption that (a large part of) unemployment has to do with workers’ trade-off between paid work and leisure time (in a utility maximization perspective). Section 3 explains that the neoclassical framework is flawed, because money is endogenous and unemployment is not simply an outcome of workers’ choices with regard to the observed ‘equilibrium’ wage level. This section points out that inflation cannot be controlled with an interest-rate policy and that unemployment is the result of a lack of effective demand (hence it is involuntary). Section 4 provides two alternative macroeconomic analyses, one where inflation as well as unemployment are explained by the disorderly working of the banking system and another where conflict in the functional distribution of income within a monetary economy of production dominates. The conclusion offers some policy-oriented remarks as regards contemporary fiscal and monetary policies that a variety of countries have been adopting in their (largely ineffective) attempt to emerge from the crisis that erupted in 2008 at the global level – whose negative consequences still affect a relevant part of the world population.