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Money and Economic Development
The Horowitz Lectures of 1972
Milton Friedman

FIRST LECTURE: A Survey for the Evidence of Monetarism

The Evidence

The drastic change in the role assigned money has been produced partly by experience during the past few decades, partly by scholarly work.


Let me turn first to experience. The most important element was widespread disillusion with the predictions derived from Keynesian theory. In general, in all areas, people vote against and not for. Almost all elections are decided by which candidate people are against rather than which they favour. Very much the same thing is true in science. No new theory or new approach has a chance until for some reason people are disillusioned with an earlier theory. The experience that was most important in producing widespread disillusion with the Keynesian theory consisted of three elements: first, the failure of a great post-war depression to occur, as was widely predicted at the end of the war. That depression kept being expected but it never occurred.

Second, the widespread failure of cheap money policies. The Keynesian analysis led to the view that the small role which monetary policy had was to keep interest rates low. Country after country tried this policy. In every country it failed, and the idea of a cheap money policy had to be abandoned.

Third, instead of the widely feared depression, inflation emerged as the pre-eminent problem of the post-war period—partly as a consequence of cheap money policies.

All three of these elements of Keynesian thought are expressed succinctly in a talk on post-war monetary and economic problems given in 1945 by Emanuel A. Goldenweiser, at the time Director of the Division of Economic Research of the Federal Reserve Board. Herewith a few excerpts: first, he dismissed inflation as something "we are likely to escape in this post-war period"; he then said, "A much more serious and lasting problem will be finding jobs." Finally, on monetary policy, he said: "This country [that is the U.S.] will have to adjust itself to a 21⁄2 per cent interest rate as the return on safe, long-time money." Well, it would be hard to find three predictions in the course of a single talk that have been more clearly falsified by subsequent experience. Inflation turned out to be the problem. We did not have a lasting problem of finding jobs, and we certainly did not have to adjust ourselves to a 21⁄2 per cent interest rate.

This disillusion with the predictions that were drawn from the Keynesian theory in the immediate post-war period was strongly reinforced, at least in the United States, by a number of episodes during the 1960s. At the time of the tax cut in 1964, when acceptance of the new economics and of the Keynesian revolution was at its height, everything looked rosy. But shortly, the rosy glow faded, because the U.S. entered a period of inflation, which, in turn led to a number of almost controlled experiments that pitted monetary policy against fiscal policy in 1966 and 1967, again in 1968, and again in 1969 and 1970. In each case, monetary policy went in the opposite direction from fiscal policy and in each case monetary policy dominated the outcome. Those episodes probably did more than anything else to persuade the public at large to pay more serious attention to monetarism and to give less credence to the approach that had come to be designated the New Economics, and that relied almost entirely on fiscal policy as an instrument of control.


1. Nominal income is net national product; money is currency outside commercial banks plus all deposits (time and demand) of the public at commercial banks.
2. Each rate of change is computed as the slope of a least squares straight line between the natural logarithm of the variable (income or money) and time fitted to three successive phase averages.
3. This summary is adapted from Milton Friedman, The Counter-Revolution in Monetary Theory, Occasional Paper 33 (London: Institute of Economic Affairs, 1970), pp. 22-26.
4. See my "The Optimum Quantity of Money" in The Optimum Quantity of Money and Other Essays (Chicago: Aldine Publishing Co. 1969).
5. "Government Revenue from Inflation, "Journal of Political Economy, Vol. 79 (July/August, 1971), 846-856.

Reprinted from Money and Economic Development The Horowitz Lectures 1972 by Milton Friedman, copyright © 1973

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