How Would Milton Friedman Have Reacted to
the Financial Crisis?*
The repercussions of the financial crisis that began in 2007 are still
being felt. In the United States and in Europe, the crisis led to the
strong resurgence of a theory, Keynesianism, that seemed to have been
discredited since the 1970s. One of the main opponents of John Maynard
Keynes’s statist and interventionist conception of the economy, Milton
Friedman, who died in 2006, would have turned 100 this year. Friedman
was a fierce defender of the free market and is considered one of the
most influential economists of the last century.
What would Friedman think of the Keynesian stimulus policies adopted
practically everywhere in 2008, namely the spending programs of
governments and the money-creation programs of central banks? Would he
have systematically opposed them? The answer is not as obvious as one
The Logic of Stimulus Plans
For Keynesians, capitalism is a profoundly unstable economic system that
inevitably finds itself in crisis at regular intervals.
An unexpected shock is all that’s required to disrupt the behaviour of
market actors and derail economic growth. Investors, driven not by a
rational evaluation of risks and opportunities but by “animal spirits,”
shift suddenly from a blind optimism to an equally arbitrary pessimism.
This change of attitude leads to a slowing down of production, a rise in
unemployment and a decrease in household income. Consumers in turn lose
confidence, save more and buy less, which leads production to drop
Since a capitalist economy, according to Keynes, possesses no automatic
stabilization mechanism, this spiral can go on indefinitely, until the
total collapse of the economy. Only the government, which has the means
to substitute its own actions for those of private actors in order to
sustain demand, can turn the situation around.
By spending on various programs and public works, the government puts
idle factors of production back to work. In addition, by lowering
interest rates and increasing the supply of money in circulation, the
central bank encourages consumers to spend and businesses to invest. For
Keynes, the debt and inflation that could result from these policies are
not serious threats.
With regard to the first aspect of stimulus plans, Friedman considered
the notion that public spending could raise overall demand and stimulate
the economy an unfounded presumption that focused solely on one part of
It is easy to understand that if the government raises taxes in order to
spend more, then higher public spending will be offset by lower private
Even when government borrows funds, those who lend them will have to
reduce their own spending or lend less to other, private actors. “All
that happens is that government expenditures go up and private
expenditures down,” he wrote in Capitalism and Freedom, published
For Friedman, this propensity to increase spending and multiply programs
during a recession illustrates above all the dominance of intellectual
fashions and statist policies, and only served to feed the growth of the
state all through the 20th century. Indeed, most of the
programs supposedly created to stabilize the economy during the New Deal
and subsequent recessions were maintained afterward, and governments
continued to post deficits even in periods of economic growth.
Friedman would not have been at all surprised to see the mixed results
of the budgetary stimulus plans put in place since 2008, or the
government budgetary crises provoked by the taking on of massive debt
observed today in the United States and Europe.
Milton Friedman’s main contribution to the analysis of business cycles
is contained in his monumental A Monetary History of the United
States, 1867–1960, published in 1963 in collaboration with Anna
It is in this work that he lays down the foundations of his monetarist
theory. This theory replaced Keynesianism as the monetary orthodoxy
starting in the late 1970s, when Paul Volker was named Chairman of the
Federal Reserve. Volker put the brakes on monetary creation and
implemented draconian interest rate hikes in order to rein in the
runaway inflation of the preceding years, at the cost of the recession
“According to Milton Friedman
and Anna Schwartz, the reasons the crisis lasted so long is
not because of the inherent instability of a market economy,
but rather because of the ineptitude of the Fed.”
The feature of Friedman’s monetary theories that is most often noted is
his opposition to a too-rapid increase in prices. Contrary to Keynesians
who had a very different explanation for such an increase, and in
accordance with classical economists, Friedman maintained that it was
inevitably provoked by a monetary policy that was too expansionist.
As he famously put it: “Inflation is always and everywhere a monetary
phenomenon in the sense that it is and can be produced only by a more
rapid increase in the quantity of money than in output.”
Monetarism also offers an explanation of the causes of the Great
Depression. According to Friedman and Schwartz, the reasons the crisis
lasted so long is not because of the inherent instability of a market
economy, but rather because of the ineptitude of the Fed.
According to them, during the 1930s, the Fed did nothing to prevent—and
it even at times deliberately provoked—a substantial reduction in the
This policy led to the bankruptcy of thousands of banks and a drop in
national income, and it nipped any burgeoning economic recovery in the
At first glance, monetarism therefore appears to be a theory that
criticizes government action—central banks being monopolies established
by governments to create and manage the currency—and that defends the
Paradoxically, this explanation nonetheless makes Friedman an ally of
Keynes when it comes to monetary policy, the second aspect of stimulus
plans. Although their evaluations of the dangers of inflation diverge
considerably, Keynesians and monetarists actually agree on a crucial
point: that the central bank must, in the financial jargon, “inject
liquidity” into the economy in times of crisis. In other words, it must
artificially create currency in order to support economic activity,
protect banks from failure and prevent a temporary readjustment from
turning into a recession or an extended depression.
It is this policy that Volker’s successor, Alan Greenspan, put in place
for 19 years while he was Chairman of the Fed. Each time the American
economy showed signs of slowing down or experienced any crisis (the
stock market crash of 1987, the Savings and Loan Crisis, the Mexican
crisis, the Asian crisis, the Y2K bug, the September 11, 2001 attacks,
the bursting of the tech bubble, etc.), Greenspan stepped on the
monetary accelerator. An open supporter of the free market, he took
inspiration not from Keynes, but from Friedman.
During a conference on the occasion of Friedman’s 90th
birthday in 2002, the current Chairman of the Fed, Ben Bernanke, also
endorsed the analysis of Friedman and Schwartz: “I would like to say to
Milton and Anna: Regarding the Great Depression, you’re right, we did
it. We’re very sorry. But thanks to you, we won’t do it again.”
Since 2007, Bernanke has set up, not surprisingly, a series of
“quantitative easing” programs, another euphemism for the creation of
money from nothing. According to American journalist Penn Bullock, by
all accounts, Friedman would have approved of these measures. He writes
in Reason.com that while it is true that the Obama administration is
pursuing Keynesian fiscal stimulus, the Federal Reserve under Bernanke
has deliberately put in practice the lesson of Friedman and Schwartz on
the need to grow the money supply.
It is after all the same quantitative easing policy that Friedman had
suggested to the Japanese government, itself facing an economic crisis
following the bursting of a housing bubble starting in 1990: “The surest
road to a healthy economic recovery is to increase the rate of monetary
growth,” he wrote in 1997.
The Austrian Critique
More than three years after the start of the current crisis, there are
no signs that the stimulus plans, budgetary or monetary, have succeeded
in getting the economy back on a sustainable track.
For Keynesians like Paul Krugman, this is proof that they did not go far
enough. Monetarists inspired by Friedman are, for their part, on the
defensive. It is another theory, much more intransigently opposed to
government interventionism, that is gaining influence: that of the
Austrian School of economics, represented by economists Friedrich A.
Hayek and Ludwig von Mises, among others.
For adherents of the Austrian School (who, despite their name, are found
just about everywhere in the world today), supporters of a return to the
gold standard and a denationalisation of the currency, it is the very
existence of fiat money that is the source of the problem. Monetary
creation from nothing is a fraud perpetrated by the government upon
holders of currency, which moreover entails a misallocation of resources
and leads inevitably to recessions.
We cannot, as Friedman recommends, solve the problem by resorting to the
policies that caused it in the first place. By coming to the rescue of
the markets every time there was a slowdown, Greenspan only postponed
the crisis, and made it worse. From an Austrian point of view,
therefore, monetarists are in the end just as responsible for the
crisis, and for its continuation, as Keynesians are.
The most well-known proponent of Austrian economics is undoubtedly Ron
Paul, a Representative in Congress and a current Republican presidential
candidate. The author of a book entitled End the Fed, he warned
Americans about the danger of an overly expansionist monetary policy and
of a potential crash years before it happened, as did other commentators
inspired by the Austrian School.
According to Ron Paul, “Friedman’s very, very libertarian—except on
monetary issues.” Indeed, almost all of Friedman’s body of work was in
defence of individual liberty and the free market. He would no doubt
have denounced the Keynesian-inspired budgetary stimulus plans put in
place for the past three years.
However, if we take him at his word, he would have sided with the
Keynesians in favour of the monetary stimulus plans. Perhaps the current
crisis will bring about a paradigm change on this subject in favour of
another school of thought.
article was originally published in French on January 21, 2012, in the
Montreal daily paper
From the same author
The fed's wireless hangup: Does Canada really need
more players in its telecom market?
322 – May 15 2014)
"L'Austerità" è Responsabile per la Crisi in Europa?
313 – August 15 2013)
Ist die "Austeritäts"- Politik schuld an der Krise in Europa?
313 – August 15 2013)
¿Es la "austeridad" responsable de la crisis en Europa?
313 – August 15 2013)
Sú ekonomické úsporné opatrenia zodpovedné za krízu v Európe?
313 – August 15 2013)
First written appearance of the
word 'liberty,' circa 2300 B.C.
Le Québécois Libre
Promoting individual liberty, free markets and voluntary
cooperation since 1998.