Monetarist economics is Milton Friedman's direct criticism of Keynesian economics theory. Simply put, the difference between these theories is that monetarist economics involves the control of money in the economy, while Keynesian economics involves government expenditures. Monetarists believe in the control of the supply of money in the economy and allow the rest of the market to fix itself. Keynesian economists believe that a troubled economy continues in a downward spiral unless something is done to drive consumers to buy more goods and services. Both of these macroeconomic theories directly impact the way lawmakers create fiscal and monetary policies. If both types of economists were equated to motorists, monetarists would be most concerned with adding gasoline to their tanks, while Keynesians would be most concerned with keeping their motors running.
Keynesian Economics Simplified
The economic terminology of demand-side economics is synonymous to Keynesian economics. Keynesian economists believe the economy is best controlled by manipulating the demand for goods and services, although, these economists do not completely disregard the role the money supply has in the economy and on affecting gross domestic product, or GDP. They do, however, believe it takes a great amount of time for the economic market to adjust to any monetary influence.
Keynesian economists believe in consumption, government expenditures and net exports to change the state of the economy. Fans of this theory may also enjoy the New Keynesian economic theory, which expands upon this classical approach. The New Keynesian theory arrived in the 1980s and develops some concepts the classical theory did not, such as government intervention and the behavior of prices. Both theories are a reaction to depression economics.
Monetarist Economics Made Easy
Monetarists are certain the money supply is what controls the economy. They believe that controlling the supply of money directly influences inflation. Additionally, monetarists believe that by fighting inflation with the supply of money, they can influence interest rates in the future. Imagine adding more money to the current economy and the effects it would have on business expectations and the production of goods. Now imagine taking money away from the economy. What happens to supply and demand?
Monetarist economics founder Milton Friedman believed monetary policy was so incredibly crucial to a healthy economy that he publicly blamed the Federal Reserve for causing the Great Depression. He implied it is up to the Federal Reserve to regulate the economy.
Different Economic Theories in Politics
Presidents and other lawmakers have applied multiple economic theories throughout history. Soon after the Great Depression, President Herbert Hoover failed in his approach to balance the budget, focusing primarily on the needs of businesses in a time of turmoil. President Roosevelt followed next. He was concerned with increasing demand and lowering unemployment. It is worth noting that Roosevelt's New Deal and other policies increased the supply of money in the economy. Events similar to the Great Depression nearly happened again in 2008. President Obama and other lawmakers decided to solve economic problems by bailing out banks and fixingunderwater mortgages for government-owned housing. In these instances, it appears elements of both theories were used to resolve national debt.
When Keynes died, in April 1946, The Times of London gave him the best farewell since Nelson after Trafalgar: “To find an economist of comparable influence one would have to go back to Adam Smith.” A few years later, Alvin Hansen, of Harvard University, Keynes’ leading disciple in the United States, wrote , “It may be a little too early to claim that, along with Darwin’s Origin of Species and Marx’s Capital, The General Theory is one of the most significant book which have appeared in the last hundred years. … But… it continues to gain in importance.”
In fact, the influence of Keynes’ book, as opposed to the vision of “macroeconomics” at the heart of it, and the penumbra of fame surrounding it, already had begun its downward arc. Civilians continued to read the book, more for its often sparkling prose than for the clarity of its argument. Among economists, intermediaries and translators had emerged in various communities to explain the insights the great man had sought to convey. Speaking of the group in Cambridge, Massachusetts, Robert Solow put it this way, many years later: “We learned not as much from it – it was…almost unreadable – as from a number of explanatory articles that appeared on all our graduate school reading lists.”
Instead it was another book that ushered in an era of economics very different from the age before. Foundations of Economic Analysis, by Paul A. Samuelson, important parts of it written as much as ten years before, appeared in 1947. “Mathematics is a Language,” proclaimed its frontispiece; equations dominated nearly every page. “It might be still too early to tell how the discoveries of the 1930s would pan out,” Samuelson wrote delicately in the introduction, but their value could be ascertained only by expressing them in mathematical models whose properties could be thoroughly explored and tested. “The laborious literary working-over of essentially simple mathematical concepts such as is characteristic of much of modern economic theory is not only unrewarding from the standpoint of advancing the science, but involves as well mental gymnastics of a particularly depraved type.”
Foundations had won a prize as a dissertation, so Harvard University was required to publish it as a book. In Samuelson’s telling, the department chairman had to be forced to agree to printing a thousand copies, dragged his feet, and then permitted its laboriously hand-set plates to be melted down for other uses after 887 copies were run off. Thus Foundations couldn’t be revised in subsequent printings, until a humbled Harvard University Press republished an “enlarged edition” with a new introduction and a mathematical appendix in 1983. When Samuelson biographer Roger Backhouse went through the various archival records, he concluded that the delay could be explained by production difficulties and recycling of the lead type by postwar exigencies at Press.
It didn’t matter. With the profession, Samuelson soon would win the day.
The “new” economics that he represented – the earliest developments had commenced in the years after World War I – conquered the profession, high and low. The next year Samuelson published an introductory textbook, Economics, to inculcate the young. Macroeconomic theory was to be put to work to damp the business cycle and, especially, avoid the tragedy of another Great Depression. The new approach swiftly attracted a community away from alternative modes of inquiry, in the expectation that it would yield new solutions to the pressing problem of depression-prevention. Alfred Marshall’s Principles of Economics eventually would be swept completely off the table. Foundations was a paradigm in the Kuhnian sense.
At the very zenith of Samuelson’s success, another sort of book appeared, in 1962, A Monetary History of the United States, 1869-1960, by Milton Friedman and Anna Schwartz, published by the National Bureau of Economic Research. At first glance, the two books had nothing to do with one another. A Monetary History harkened back to approaches that had been displaced by Samuelsonian methods – “hypotheses” instead of theorems; charts instead of models, narrative, not econometric analytics. The volume did little to change the language that Samuelson had established. Indeed, economists at the University of Chicago, Friedman’s stronghold, were on the verge of adapting a new, still- higher mathematical style to the general equilibrium approach that Samuelson had pioneered.
Yet one interpretation of the relationship between the price system and the Daedalean wings that A Monetary History contained was sufficiently striking as to reopen a question thought to have been settled. A chapter of their book, “The Great Contraction,” contained an interpretation of the origins of the Great Depression that gradually came to overshadow the rest. As J. Daniel Hammond has written,
The “Great Contraction” marked a watershed in thinking about the greatest economic calamity in modern times. Until Friedman and Schwartz provoked the interest of economists by rehabilitating monetary history and theory, neither economic theorists nor economic historians devoted as much attention to the Depression as historians.
So you could say that some part of the basic agenda of the next fifty years was ordained by the rivalry that began in the hour that Samuelson and Friedman became aware of each other, perhaps in the autumn of 1932, when both turned up the recently-completed Social Science Research Building of the University of Chicago, at the bottom of the Great Depression. Excellent historians, with access to extensive archives, have been working on both men’s lives and work: Hammond, of Wake Forest University, has largely completed his project on Friedman; Backhouse, of the University of Birmingham, is finishing a volume on Samuelson’s early years. Neither author has yet come across a frank recollection by either man of those first few meetings. Let’s hope one or more second-hand accounts turn up in the papers of the many men and women who knew them then. When I asked Friedman about their relationship in 2005, he deferred to his wife, who, somewhat uncomfortably, mentioned a differential in privilege. I lacked the temerity to ask Samuelson directly the last couple of times we talked; he clearly didn’t enjoy discussing it.
Biography is no substitute for history, much less for theory and history of thought, and journalism is, at best, only a provisional substitute for biography. But one way of understanding what happened in economics in the twentieth century is to view it as an argument between Samuelson and Friedman that lasted nearly eighty years, until one aspect of it, at least, was resolved by the financial crisis of 2008. The departments of economics they founded in Cambridge and Chicago, headquarters in the long wars between the Keynesians and the monetarists, came to be the Athens and Sparta of their day.
. Hard Times, Salad Days
Samuelson arrived at the University of Chicago first, in January 1932, as a sixteen-year-old enrolled in a freshman class of twelve hundred in what was then a big boisterous football school. His father, a successful pharmacist, had lost a good deal of money in the 1926 Florida land bubble. Now only moderately prosperous, the family had moved a few miles down the rail line from Gary, Indiana, to Chicago’s South Shore neighborhood, presumably for the schools. Samuelson was the middle of three boys, obviously gifted and sufficiently competitive that he could be mistaken for the oldest of the three. Samuelson took to college instantly and was quickly recognized as a nonpareil in economics. “I could not believe that the rest of the class were making heavy weather of such problems as what would be the effect on the price of kidneys of Minot’s discovery that liver cured anemia, or the effect on mutton price if Orlon were invented.”
Friedman arrived that autumn from New Jersey as a graduate student. A pair of Columbia University graduate students, Arthur Burns and Homer Jones, had been among his teachers at Rutgers University; they had urged him to defer his plan to become an actuary in favor of economics. He had studied Alfred Marshall’s text with Burns; learned statistics and heard about what was even then called “the Chicago view” from Jones, who had been one of Frank Knight’s star pupils at Chicago. (Burns would become a professor at Columbia, head of the National Bureau of Economic Research and, for eight years, chairman of the Federal Reserve; Jones would head the Federal Reserve Bank of St. Louis for many years.) He had shed the habit of shouting his opinions that earned him the nickname “Shallow” in grade school, after someone mentioned that “still waters run deep,” but he remained sufficiently exuberant at 22 as to be described as “brash.” Already at Chicago’s campus when Friedman arrived were a third-year graduate student Aaron Director and his beautiful, brainy younger sister Rose, who was entering the graduate program herself. By custom according to alphabetical order, she was seated next to Friedman in Economics 301, Jacob Viner’s price theory class.
There is no record of the circumstances in which Samuelson and Friedman met, or, for that matter, how they first became aware of one another – none that I’ve found, anyway. Nor is it clear when they began to think of one another as professional and political rivals. What is clear is that they wanted it that way. For the next seventy-five years they successfully kept the origins of their relationship on the down-low, well aware of the risk that it could be used to reduce their subtle and profound differences of opinion to a simple story of personalities. Friedman, entering as A graduate student, would have become aware of Samuelson, who already had been identified as a prodigy by, among others, Director, who had taught him his introductory economics course. But neither he nor Rose Director Friedman mentioned Samuelson in Two Lucky People, the memoir they wrote together, except to note that the two men were already “good personal friends” when they began writing columns for Newsweek magazine in 1966. Samuelson, seventy five years later, told an interviewer,
Milton Friedman and I became known as two poles, early on, but we managed to stay on civil and fairly friendly terms…. He is as bright a guy as you would ever meet. But I don’t think he realizes the tremendous number of mistakes he has made in his life. I don’t think anybody has read every item of Milton Friedman’s work in the world but me…. Sometimes I say he’s got such a high IQ that he’s got no protection against himself. He looks at his work and is satisfied with it. However, I think that it is a tragedy when somebody really takes the wrong train in life.
From the first, significant differences were apparent. Friedman arrived in Chicago with a $300 loan from his telegrapher sister instead of a fellowship (Chicago and Brown University had offered him scholarships to cover tuition but no additional support. He worked two jobs instead of one: waiting lunchtime tables at A campus restaurant in exchange for a room upstairs; all day Saturday in a shoe store (he quit the second job after his commissions for a twelve-hour day added up to 75 cents). His father had died when he was fifteen; his seamstress mother lived above the family dry goods store and ice cream parlor in Rahway, N.J. He had put himself through college working as a department store clerk, operator of a roadside fireworks stand, and proprietor for his high school principal of a remedial summer school. Samuelson, on the other hand, never worked in college except as recipient of scholarship aid, and spent his summers at the beach: “I wanted to work summers to pay for my education,” he recalled many years later, but “I had friends who would apply to 800 companies and not get one nibble unless you knew somebody.”
The autumn of 1932 was the beginning of the fourth year of the Great Depression, the worst by far the country had ever known. Friedman ran out of money at the end of the year. A favorite professor, Henry Shultz, arranged for him to study with Harold Hotelling at Columbia, a mathematical economist, who produced a generous fellowship. He repaid his sister, and had money enough left over to thoroughly enjoy New York with his friends. (Before he left Chicago he had a date with Rose Director, from whom, she records, he tried unsuccessfully to steal a kiss.)
At Columbia, he discovered price theory was scarcely taught, and with his friend Moses Abramowitz organized a student seminar. In Chicago, sophomore Samuelson spent hours in a basement storage room in which entering graduate students W. Allen Wallis and George Stigler had squatted. They were “exalted, Samuelson remembers; he was engaged in make-work because he had a scholarship job. “We would gossip for hours over the inadequacies of our betters and the follies of princes who try to set right the evils of the marketplace.” On the walls were slogans, including “Mathematics has no symbol for confused ideas.”
Friedman returned to Chicago for the ’34-’35 academic year as a teaching assistant to Schultz, having spent a carefree summer in Canada with Abramowitz. He was on easy street; Stigler and Wallis became close friends; he would have seen Samuelson occasionally then, too, in their company. He picked up where he had left off with Rose. His crowning achievement: having caught a cold, he stayed home and composed a note on some error he had found in A.C. Pigou, professor of economics of Cambridge University, the most eminent economist in the world. He sent it to the Economic Journal in Cambridge, England, where editor John Maynard Keynes turned it down, whereupon the more legendary editor (at that time, at least) Frank Taussig accepted it for Harvard’s Quarterly Journal of Economics. Heady stuff for a third-year student! Friedman was all squared away except for his dissertation. But once again, he was out of money. By the summer of 1935, he needed a job. So off he went to Washington with Wallis. He wouldn’t receive his PhD for another ten years.
Samuelson finished college at Chicago in a blaze of glory that year. He was awarded a Social Science Research Council fellowship in the first year they were given. The New Deal experiment involved choosing eight promising economics students by nationwide competitive examination, and then paying for their entire graduate education. The practice, since taken over by the federal government, has become general in all the sciences and humanities. The full ride came with only one stipulation: Samuelson couldn’t remain where he was. His professors recommended Columbia; but he chose Harvard instead, and spent another summer at the beach. Samuelson and Friedman had arrived in Hyde Park from very different backgrounds, in very different situations. Their circumstances had narrowed by the time they left, but only slightly.
Samuelson arrived at Harvard in September 1935, expecting, he later said, a tidy little New England town. Instead he found a grimy industrial city with an old university at the leafy end of town. He took a room on Athens Street and began meeting a series of persons who would make a lasting impression.
The first was Edwin B. Wilson, a major figure on the Harvard landscape in the 1930s. A mathematical physicist by training, Wilson was a reformer by temperament. He had been a protégé of the Yale thermodynamicist Willard Gibbs (1839-1903), perhaps the first great American scientist (or second, if Benjamin Franklin is to be counted). Gibbs was an inventor of statistical mechanics and a founder of physical chemistry. Wilson had been a contributor to the earliest stages of quantum physics. As an MIT professor of physics in the ’20s, Wilson had become critical of what he took to be the low estate of literary economics; he led an unsuccessful attempt to place the economics section of the American Association for the Advancement of Science in receivership. President A. Lawrence Lowell had brought him to Harvard to head its new School of Vital Statistics, soon renamed its School of Public Health.
Wilson taught a small course in mathematical economics each spring in alternate years. Samuelson would talk to him for an hour after every lecture; it was in Wilson’s class that Samuelson had perhaps his single greatest epiphany, he recalled: the recognition that the truth of a mathematical tool was independent of the context in which it was employed. In this case it was the mathematics underlying a principle devised a century before by French chemist Henry LeChatelier to describe changes in pressure, volume and temperature of an ideal gas which could just as easily be adapted to calculate changes in elasticities of demand in a system of factor prices. The mathematical insight arrived in an instant. It would take a decade to reason through its implications.
In Wilson’s class, too, he met Joseph Schumpeter, forty years his senior, trying (without much success) to acquire the new mathematical tools. Samuelson described the thrill: in Chicago, everybody had known all the answers; economics was a completed science; at Harvard, Schumpeter made economics seem a developing subject, you would be doing great things, everything was left to be done. Schumpeter was a believer in paradigms before Thomas Kuhn, Samuelson would recall: “He would say, ‘You never in economics kill a theory by fact; you kill a theory by a better theory.’” Still another mentor was Wassily Leontief, with his input-output table, escaped first from Russia, then from Germany, six years older than Samuelson and a world of experience wiser.
Samuelson took his general exams at the end of his first year, in May 1936 – further evidence of his status, at 21, as a wunderkind. In 1937, there was a second lush new appointment: three years in Harvard’s newly-chartered Society of Fellows, a scheme conjured into existence by President Lowell, Alfred North Whitehead and others to create an Old World alternative to the PhD. Twenty-four young scholars would be invited to study anything they pleased in any department of the university for three years, as long as it didn’t involve active pursuit of a PhD. Samuelson used the opportunity to publish a dozen mathematical papers: capital theory, life-cycle savings, utility theory, international trade, Keynesian multiplier-accelerator dynamics, revealed preference. “Miraculously it dawned on me there was some unity of method and logic underlying these researches, as well as much of the rest of current and historical economic theory.”
It was “A Note on the Pure Theory of Consumers’ Behavior,” in 1938, that made him famous. Never mind the “subjective utility” of the nineteenth-century marginalists, Samuelson said. It could never be measured; pay attention instead to what consumers do with their money. The doctrine of “revealed preference” gave economists something to measure. Samuelson was “operationalizing” economics, defining a previously fuzzy concept in such a way that meaningful theorizing about it could be undertaken with a view to eventual testing.
That first autumn of ’35, Canadian graduate Robert Bryce had arrived from Cambridge University, full of excitement, with a mimeographed copy of what would become Keynes’ General Theory under his arm. Samuelson remembered himself as a reluctant convert, more interested in debating the pure theory of capital, “like a tuna, fighting every inch of the way.” But the Depression dragged on. Then in 1937, Harvard hired Alvin Hansen, from the University of Minnesota, an expert on business cycles who in 1929 had ventured that before long they would have become a thing of the past. By the time he arrived in Cambridge, Hansen had become persuaded by Keynes. By 1938 Samuelson was working with Hansen on a new book, Full Recovery or Stagnation. “The great thing is that we were all students, trying to figure [The General Theory] out,” he recalled. The fundamental concepts of the Keynesian system were being worked out: the accelerator/multiplier model and a diagram known as the Keynesian cross, which permitted the extent of a given stimulus to be worked out. Years later, Samuelson would often quote William Wordsworth’s lines on the French Revolution:
Bliss was it in that dawn to be alive
but to be young was very heaven!
. … and the Bureau
Friedman arrived in Washington in August ’35 to join a nationwide study of consumer purchases funded by the Works Progress Administration. He lived with Wallis in the apartment of friends Rose arrived the next spring, her dissertation now in abeyance. She found work as a researcher at the newly created Federal Deposit Insurance Corp., in a section headed by none other than Friedman’s old professor Homer Jones. Their courtship had advanced. Washington was a wonderful place for young economists – an effervescent swirl of young professionals. “We had the feeling – or illusion –that we were in at the birth of a new social order,” Milton wrote in their memoir. The New Deal had been a life-saver for both.
In early 1937, Friedman attended the annual Conference on Research in National Income and Wealth of the National Bureau of Economic Research. There he met Simon Kuznets. The NBER was one of a number of new institutions set up after World War I with the aim of producing sound empirical research – the Brookings Institution in Washington , DC, was another. With an intramural staff of a handful of prominent scholars, the NBER had turned into the functional equivalent of a research university’s economics department.
Kuznets was one of these scholars, an unusual economist who preferred facts and measurement to deduction. Born in 1901, in Pinsk, Russia, he had briefly headed a Soviet statistical office in Ukraine before he left. Now he was teaching at the University of Pennsylvania and, at the NBER, creating a conceptual apparatus for a system of national income and product accounts, a statistically sophisticated ledger of the stream of goods and service, of wages, profits and rents, which, taken altogether, would add up to that previously altogether hazy concept, national product. He and Friedman hit it off. Kuznets hired the younger man as his assistant; and in September Friedman moved to New York. He wrote Rose (whom he would marry in June ’38):
… [I]f in Washington they set somebody to work on the distribution of income by size, they’d expect a completed distribution in three months. Here, Kuznets says, we know you can’t make a decent estimate as things are now. The thing to do, says he, is to spend two or three years on exploratory studies to lay the basis for decent estimates. Now that’s the way to do research!
Another Kuznets project involved the measurement of independent professional incomes – physicians and dentists in particular. It was incomplete and Friedman took it over and completely rewrote it as his dissertation, coming at it from a different angle – the approach now known as “human capital.” Doctors in those days generally made a third more than dentists. True, their training was more extensive; but after three years of study, Friedman concluded that around half the difference stemmed from barriers to entry created by the American Medical Association in the form of residency requirements. There was no similar bar to the practice of dentistry. Medical doctors, many of them Jewish, were entering the United Stated in growing numbers, but finding themselves unable to practice. The unstated implication was that licensure of medical occupations did more harm than good. A flap ensued. One member of the NBER board, a pharmaceutical executive, exercised his right to stall the study’s publication.
Samuelson was moving smoothly ahead at Harvard. He had met and, in July 1938, married fellow Midwesterner Marion Crawford, a graduate student in economics and a Leontief protégeé. To him, the controversy was faintly ridiculous. “Only MF could argue – argue seriously – that therefore everyone should be able to practice surgery.” Finished in ‘41, Friedman’s Incomes from Independent Professional Practice wasn’t published until 1945. (Of course the war contributed to the delay).
The working version of the incomes study was, however, enough to finally win Friedman an academic offer – a tenure-track job teaching statistics at the University of Wisconsin, starting in the fall of 1940. The move to Madison turned out badly. Friedman found himself on the losing side of a department divided into two warring camps – quantitative up-and-comers vs. well-entrenched institutionalists. Friedman’s appointment suffered from a certain amount of straightforward anti-Semitism as well. When the department failed to approve the administration’s offer of a professorship, Friedman withdrew and returned east, to a job in the Treasury Department. Embarrassment and bitterness over the affair plagued the Wisconsin department for many years.
Samuelson, meanwhile, had his own experiences of routine anti-Semitism at Harvard; the stories seem astonishing in the present day. His department’s distaste for mathematical economics, though, probably had more to do with what happened next. He had hoped for a second three-year appointment as a Junior Fellow, but his appointment wasn’t renewed; instead, the deeply-divided economics department made him an instructor in the spring of 1940, which meant he was able to keep his office in Leverett House, but offered no other inducements. Out of caution, he had spliced together a series of published papers and submitted them as a dissertation for the PhD. The following year it would win the department’s top prize, which included the promise of subsidized publication by the university’s press. He would be free to enter the job market. As the autumn term began in 1940, the Boy Wonder was finally at the mercy of the minority of the department that liked him least.
Franklin Roosevelt was running for a third term as president against Wendell Willkie. German had invaded the Lowland countries and France in May. Its bombing campaign against Britain had begun in September. In early October, weeks after classes began, the Massachusetts Institute of Technology, a mile down the road, made Samuelson an offer: the rank of assistant professor and the opportunity to build a doctoral program from scratch, if he would begin teaching immediately. (Several of its faculty had left for national security duty in Washington,) When Harvard failed to make a counter-offer, Samuelson decamped.
The physicist Wilson weighed in with a long handwritten letter to Samuelson, expressing approval; describing the histories of mathematics, physics, and geology in Cambridge; and explaining why the move might work to the advantage of both universities. (Biographer Backhouse describes these events to good effect in a chapter of MIT and the Transformation of American Economics, Duke University Press, 2015.) The Harvard chairman, Edward Chamberlin, sheepishly phoned to ask Samuelson to return his September check.
The Depression lingered throughout the 1930s. US unemployment was 14 percent in November 1940. Germany was preparing to invade Britain. Roosevelt’s response was the Lend-Lease Act. “We must be the great arsenal of democracy,” he told listeners in December in a famous fireside chat. The war ended the Depression. By mid-1941, everyone had plenty to do. The US entered the war after Pearl Harbor.
Never before had science been forced into such close cooperation with such urgency. Big labs, with people from many disciplines working together became the rule: radar, cryptanalysis, machine computation, the fission bomb, sulfa drugs, jet propulsion, petroleum refining, beef ranching. That so much had been accomplished so quickly owed much to a far-sighted scientist-practitioner, similar in many ways to Federal Reserve chairman Marriner Eccles (and almost exactly contemporaneous with him), MIT physicist Vannevar Bush.
Bush had left MIT for Washington in 1939 to become president of the Carnegie Institution. In May 1940, he asked Roosevelt’s uncle, Frederic Delano, to arrange a meeting with the president. The upshot was the creation of a National Defense Research Committee, headed by Bush, to coordinate “the fundamental research which is basic to modern warfare.” Bush turned to businessmen to direct the mobilization of science: to Delano, a retired railroad executive; to Alfred Loomis, a bond underwriter who in the 1920s had financed much of the building of the nation’s electrical grid; to Frank Jewett, the head of Bell Laboratories.
Economists were pressed into service along with everyone else. They counted inventories, planned production and identified constraints, predicted, assessed. The timing of the invasion of Europe hinged on estimates of gross national product by Kuznets and his student Robert Nathan and their new National Income and Product Accounts, a story well told in Keep from All Thoughtful Men: How US Economists Won World War II, by Jim Lacey (Naval Institute Press, 2011). Promising economics students in universities were drawn off as quickly as they could be produced into positions at the US Treasury, Federal Reserve Board, the Office of Price Administration, the War Production Board, the Office of Strategic Services.
Keynes was not yet the authority he would become after the war. A heart attack in 1937 had put him largely on the sidelines as economists in Britain and New England argued about what to make of The General Theory. The outbreak of war in Europe brought him gradually back into commission, first as author of “the Keynes plan” and the broadside How to Pay for the War (compulsory savings instead of the inflation that had financed World War I); then as an internal consultant at the Treasury after the Battle of Britain began. When John Winant replaced Joseph Kennedy’s as Roosevelt’s ambassador to Britain in March 1941, Keynes suddenly had a direct connection to Washington. He made the first of four official trips to Washington during the war in April 1941. By June 1944, he was leading Britain’s team of experts to the conference on post-war financial arrangements at Bretton Woods.
Samuelson remained in Cambridge, starting his PhD program in 1941. He hired a Polish refugees named Leo Hurwicz, a lawyer, to teach. But the next year he turned down a fellowship applicant from Columbia University named Kenneth Arrow. Lawrence Klein, fresh from the University of California at Berkeley, required only fifteen months of course work to become MIT’s first economics PhD; his dissertation, The Keynesian Revolution, became a book. In 1942 Samuelson published a much more general formulation of the economic interdependences hinted at by his earlier presentation of the multiplier, including the insight that LaGrange multipliers, mathematics developed 150 years before in connection with classical mechanics, had an economic interpretation as describing a system of prices in equilibrium. He was drawing up the blueprints of the economics with which the economy henceforth would be understood. Samuelson biographer Backhouse gives an especially lucid account of these developments in “Revisiting Samuelson’s Foundations of Economics,” in the June 2015 issue of the Journal of Economic Literature.
Friedman returned east from Wisconsin in the summer of 1941, to a job in the Division of Tax Research at the Treasury Department. Rose worked part-time at the Bureau of Home Economics. By then the Treasury was hard at work on a far-reaching revision of the tax code. Friedman was assigned to build a Keynesian model of how much to raise taxes to pay for war. He helped create the income tax withholding system – an institution whose durability he came to regret in later years. He came to know all the big players – Treasury Secretary Henry Morgenthau; his assistant Harry Dexter White; Fed chairman Eccles. He was assigned for a time to be tax tutor to the influential Senator Robert Taft (R-Ohio), an unsuccessful presidential candidate (three more attempts came later). Nevertheless, when in 1943 his old friend Allen Wallis invited him to join the Statistical Research Group he was organizing in New York, Friedman didn’t hesitate – his only regret was that he wouldn’t be around for the post-war reorganization at Bretton Woods.
The SRG turned out to be a rapturous experience, one good idea after another. Wallis later described it as “surely the most extraordinary group of statisticians ever organized,” Abraham Wald, Harold Hotelling, Jacob Wolfowitz and Leonard Savage among them. Early on, Wallis and Friedman hit on its single biggest invention, the recognition that it wouldn’t be necessary to test every item in, say, a batch of bullets, before deciding whether the batch was bad. A “secret weapon” of considerable importance, militarily and, eventually, commercially, the concept eventually was elaborated after the war in a major book by another member of the group, the brilliant Abraham Wald. Friedman went on to work on issues of aircraft vulnerability, the optimal use of proximity fuses, sampling inspection and high temperature alloys – two and a half years during which his command of mathematical statistics reached its peak.
In 1944, MIT shut down most of its economics teaching in favor of war work; Samuelson joined the Radiation Laboratory for a year. In the spring of 1945, with the war winding down, he was one of three young PhDs assigned to assist science adviser Bush to write a draft of what would become Science: The Endless Frontier. (John Edsall, a Harvard biochemist, and Robert Morison, a Rockefeller Foundation MD, were the others.) The wordsmith claimed no credit for what emerged. Bush was the author, Samuelson later wrote, and the measures he proposed faced a tortuous passage through Congress. But the book turned out a blueprint for post-war funding of American science: Pentagon funding for technological innovations, a National Institute of Health for medical research; a National Science Foundation for the support of the physical and the more quantitative social sciences, including economics.
By now, Samuelson was among those who were pessimistic about the prospects for employment after the war. In 1944 he took to the pages of The New Republic to write “Depression Ahead.” The embarrassment was profound. But Congress passed the Employment Act of 1946, assigning the Federal Reserve Board a “dual mandate” — foster job growth as well as maintain price stability – and establishing a three-member Council of Economic Advisers to the president whose prestige would steadily grow in the years ahead.
VJ-day in August 1945 found Milton Friedman at loose ends. The SRG was shutting down, his graduate school friend Stigler, another member of the unit, had returned to a job at the University of Minnesota. He could return to the Treasury Department, but he ached for an academic career. So grim was the outlook that his old teacher Arthur Burns, by now running the National Bureau of Economic Research, took Rose aside to tell her not to worry. Days later, a hoped- for offer from Minnesota arrived. Friedman financed his drive to the Twin Cities by selling his furniture to the next family to rent his apartment, the strike-price was greatly facilitated by the rent- control ordinance New York City had adopted in 1943.
In 1946, Friedman finally received his PhD – from Columbia University, which accepted the study of professional incomes as his dissertation. A few weeks earlier, Friedman’s old professor Jacob Viner, who had spent the wat at the Treasury Department, announced he would leave Chicago after fifteen years for the Institute for Advanced Study at Princeton. The economics department in Chicago sought to hire George Stigler, but he alienated the provost during his final interview, whereupon Stigler accepted a job at Brown University. So Chicago hired Friedman instead. Promising Rose an eventual West Coast retirement, he felt, he said, as if he were finally home.
. … and peace
There was much squaring away to be done. No sooner had Friedman arrived than there was a mortal threat: the department, led by liberal Paul Douglas, voted to make an offer to Samuelson. Friedman was cast down. He wrote to Stigler in November: “The Keynesians have the votes and mean to use them… Brown or [Johns] Hopkins may be pretty good after all.” Samuelson was greatly tempted – he loved Chicago. He actually accepted before, after 24 hours, he decided to remain at MIT.
Then there was Chancellor Robert Hutchins. He had become president of the University of Chicago in 1929, a 30-year-old prodigy from Yale Law School, with strong ideas about almost everything, By 1939 he had eliminated football and quit the Big Ten conference, on grounds that athletes ought not to upstage scholars; by 1944, he enraged the faculty by proposing the abolition of rank; and by the time of his retirement, in Samuelson’s words, he had “reduced a thriving college of 5000 undergraduates to a few hundred underage neurotics.” In ’47, Chicago’s trustees had begun trying to bring about Huchins’s resignation, and by 1951 they succeeded, but not before he installed New Dealer Rexford Tugwell as head of a Program in Education and Research in Planning and hired Friedrich Hayek onto the Committee for Social Thought, after the economics department declined to make Hayek an offer.
More nettlesome was Hutchins’s enthusiasm for the Cowles Commission. Alfred Cowles was the Cincinnati stockbroker whom Irving Fisher had persuaded to fund the creation of the Econometric Society in 1930. Cowles created a group of his own to study business cycles as well, and during the ‘30s many of the leading mathematical economists in Europe and the United States had journeyed to Cowles’s summer home in the Colorado Rockies for seminars. With the outbreak of World War II, Cowles wished to shorten his lines of communication; Hutchins invited him and his group to share space with the economics department (Cowles was a part owner of the Chicago Tribune). A government contract was forthcoming: Cowles would build an econometric model of the US economy for planning purposes. Jacob Marshak was appointed director and hired the best talent on the market,
These were, from Friedman’s point of view, Keynesians and worse, mathematical economists trained in the axiomatic traditions of the French grandes écoles. Friedman took an instant dislike to the severe mathematical style. When Tjalling Koopmans, a Dutch physicist-turned-economist, criticized the work of Friedman’s beloved National Bureau as “measurement without theory,” Friedman took umbrage. And when Koopmans replaced Marshak as director, the friction increased. In 1953 the Cowles Commission departed for Yale, dissipating a remarkable collection of researchers, including several who would eventually receive Nobel Prizes: Kenneth Arrow, Gerard Debreu, and Koopmans among them.
In the spring of 1947, Friedman. joined Stigler on what the latter described as “a junket to Switzerland… to save liberalism.” At first it seemed a side-trip; later the Mont Pelerin Society became a big part of Friedman’s life. The background was the profound pessimism that had gripped Europe in the ashes of war. Faith in planning had become “the political religion” of post-war Europe, as the historian Tony Judt wrote in his magisterial Postwar: A History of Europe Since 1945. The English historian A.J.P. Tylor told a BBC audience in November 1945, “Nobody in Europe believes in the American way of life – that is, private enterprise, or, rather, those who believe in it are a defeated party which seems to have no more future than the Jacobites in England after 1688.”
Even before the war, Hayek, corresponding with the American journalist Walter Lippmann, had proposed a society of transatlantic intellectuals committed to decentralized market capitalism. Now known mainly as the author of The Road to Serfdom and supported by the conservative Volker Fund of St. Louis, Hayek in April assembled 36 scholars, most of them economists, but with a sprinkling of historians and philosophers, in a little resort near Montreux to discuss “the state and the possible fate of liberalism.” Among those attending were Stigler, Friedman, and Director – as well as Karl Popper, Raymond Aron, Walter Eucken, Ludwig von Mises, Michael Oakeshott and Lionel Robbins. The meeting made a considerable impression on Friedman – “Pelerin,” he noted, means “pilgrim” – but he didn’t attend another for ten years. He returned to Chicago. He was ready to strike out on his own
Foundations appeared that same year. The next year, in 1948, came the textbook. It had taken three years instead of one to write, but it was an instant success, for even the best textbooks – such as that of Taussig at Harvard – were now fifteen years out of date. The book had been written for those who would never take more than a semester or two of economics, Samuelson began, but who were interested in the subject as part of a good general education. It was organized around topics of interest to the non-specialist, he added – public debt, employment, inflation, social security and, above all, national income; it skimped on the boring stuff, especially banking matters. It communicated the bare bones of Keynesian doctrines: that the interplay of savings and investment propensities determined national income; but the word “macroeconomics” didn’t appear. Not long thereafter, Samuelson declined not one offer from Harvard but two.
In 1949, MIT again hired a Harvard graduate student just short of his PhD, just as it has hired Samuelson nine years before. This was Robert Solow, a veteran of the Army’s grueling campaign in Italy, now said to be the brightest of Wassily Leontief’s students. Solow spent a year on leave at Columbia learning statistics, then returned to Cambridge to begin teaching. For the next sixty years he and Samuelson were inseparable; at one point in the 1970s Solow turned down the presidency of Harvard to remain at MIT. Around them grew up a department as legendary for its collegiality as for its inventiveness.
After fifteen years of Depression and war, the landscape of economics had changed completely. To take account of the discontinuity, the American Economic Association in 1947 established two new medals, one of them designed to be a set of headlights, the other something of a rear-view mirror. The Francis A. Walker Medal, named for the first president of the association, was to be awarded every five years to recognize lifetime achievements. Eventually the Walker Medal would be supplanted by the Nobel Prize. The John Bates Clark Medal, commemorating the first American to have made a durable contribution to the global tradition, was be awarded every other years to the economist under forty,not necessarily an American, judged to have made the most consequential contributions to the field. Economists, like mathematicians and physical scientists, tended to have their most important ideas when young.
The first Clark Medal was awarded in 1947 to 32-year-old Paul Samuelson. The second, in 1949, went to Kenneth Boulding, a winsome Englishman who had recently published an introductory textbook that didn’t so much as mention Keynes. Boulding, too, had arrived at the University of Chicago in the seminal year of in 1932, from Oxford, traveling on a Commonwealth Fellowship. He had studied with Schumpeter at Harvard the following year. Boulding was a favorite of the profession’s Old Guard because of his mastery of traditional Marshallian tools.
The third Clark Medal was awarded, in 1951, to Milton Friedman, who was best known at the time for his work on the Keynesian consumption function. Would the committee have made the same choice if Friedman’s rapidly changing research agenda was better understood? We’ll never know. In 1953 the committee declined to make an award; apparently no candidate of suitable age quite fit the bill. In 1955, the committee named James Tobin. of Yale University; and, in 1957, Kenneth Arrow, of Stanford. The profession’s leadership for the next fifty years had been settled.
. … Synthesis
In the third edition of his textbook, in 1955, Samuelson announced what he called “the neoclassical synthesis.” He wrote,
In recent years 90 percent of American economists have stopped being “Keynesian” economists or “anti-Keynesian” economists. Instead they have worked towards a synthesis of whatever is valuable in older economics and in modern theories of income determination. The result might be called neoclassical economics and accepted in its broad outlines by all but about 5 percent of extreme left wing and right wing writers.
The modern mixed economy had in the twentieth century replaced nineteenth-century conceptions of an economy best governed by leaving it alone. With modern concessions to warfare and welfare, the size of government had grown relative to all else, from less than an eighth of the economy in 1920s to more than a quarter in the 1950s. Much of this had to do with income maintenance: social security and unemployment insurance, and these programs were discovered in Keynesian terms to be “automatic stabilizers.”
That is, fiscal adjustments would result from social programs that would cushion the effects on national income of declines in autonomous spending, while progressive income taxes would work in the opposite direction, restraining the increase in income when private spending rises. “All modern economists agree that the important factor in causing income and employment to fluctuate is investment,” wrote Samuelson.
Keynesian macroeconomics of the business cycle was being added to the time-honored microeconomics of prices and quantities, with the understanding, at least in Cambridge, that it was still an engineering discipline, being developed on the fly. In “Principles and Rules in Modern Fiscal Policy: A neo-classical formulation,” in 1951, Samuelson spelled out the implications for policy. Public works programs had been oversold during the Depression. The built-in flexibility of taxes and the possibility of changing tax rates to increase had been underestimated. Fiscal policy, meaning changes in taxes and government spending, were the way to deal with the business cycle. The Bureau of the Budget could manage the economy to good effect. He did not mention the Federal Reserve Board.
Work had begun to fashion a great intellectual framework. To give anything resembling a proper account of the development of the neoclassical synthesis in the ’50s and ’60s would require more time and space than I have today. Some high points include the development of the consumption function; of neo-classical public finance and growth theory; of great computer models of various sectors of the economy; of the Phillips Curve, the highly tentative trade-off between unemployment and inflation; and of Okun’s Law, a rule of thumb relating the unemployment rate to an “output gap.” Backhouse’s biography of Samuelson will make fascinating reading.
Each of these was, in its day, a thrilling development. Each deserves a story of its own. All contributed to the sense that, despite its embarrassing forecasts of post-war depression, Keynesian economics had made a series of crucial breakthroughs.
. … and Apostasy
Friedman never wrote up the precise moment when he realized that he had left the Keynesian fold. The closest he came was line in a 1967 essay about his differences with his former colleague Henry Simons and with Keynes. He wrote, “…[W]e have all of us in our personal lives had the experience of coming on a fact that suddenly illuminated an issue in a flash, showing us how wrong we had been and leading us to a fresh and very different opinion.” Instead, he described a moment of reflection that occurred while preparing the memoir he wrote with his wife, in which it was borne in on him how much a Keynesian he had once been.
He came across stenographic copy of testimony he had given to a Congressional Committee as a Treasury official, explaining why an income tax would be better than a sales tax in preventing inflation. The war was six months old. “If inflation is to be prevented, it must be neutralized by measures that restrict consumer spending. Taxation is the most important of these measures; unless it is used quickly and severely, the other measures alone will be unable to prevent inflation.” What alternatives? Price controls, rationing, control of credit, reduction in government pending or a war bond campaign. “I didn’t even mention ‘money’ or ‘monetary policy’!” he marveled, fifty years later.
A similar omission occurred about the same time when Friedman discussed a paper on “the inflationary gap” by Walter Salant, of the Office of Price Administration, in a paper printed in the June 1942 American Economic Review. When the paper was reprinted in 1953, Friedman included “additions to correct a serious error of omission in the original.” The oversight he explained “is not excused but may perhaps be explained by the prevailing Keynesian temper of the times.”
He was “cured,” Friedman said later, shortly after the end of the war.
What explains it? Only the presence of the blinders that came attached to competing thinking caps. Keynesian macro in the 1950s – Model T Keynesianism, in Samuelson’s phrase – was so tightly focused on how “autonomous spending” determined national income that it forgot about the level of prices altogether. It pushed aside the long history of financial crises and banking panics in order to focus on the interdependence of the new aggregates it had identified: consumption, investment, and government expenditure. Over the next twenty-five years, Keynesian economists gradually factored money into their models, largely in response to Friedman’s promptings, but never to his satisfaction – or he to theirs.
In 1948, Friedman’s old professor, Burns, asked him to take over the NBER project on monetary factors in business cycles. Burns sent him to Walter Stewart at Princeton, a former head of research at the Fed, who suggested an “analytical narrative.” By mid-’48, Friedman had hired Anna Schwartz, who joined the NBER as a researcher in 1941. Friedman knew a lot about business cycles. Schwartz knew a lot about the history of banking. Together they began a project that would take more than thirty years to complete – a reconnaissance whose successes and failures are examined in sympathetic and painstaking detail by J. Daniel Hammond, of Wake Forest University, in Theory and Measurement: Causality issues in Milton Friedman’s monetary economics (Cambridge, 1996).
Like the Keynesian Revolution, each thrust and parry of the Monetarist Counterrevolution makes a story good. Samuelson may have taken the first poke, a wisecrack in Foundations about the difficulty of making index numbers. It was said to be a gibe. Friedman’s eyebrow-raising declaration of independence came in a 1950 article on the quantity theory of money in the International Encyclopedia of the Social Sciences. For a time Friedman thought about writing a text on price theory, then in 1951 started the Money and Banking Workshop at Chicago instead. It turned out to be a formidable crucible for the preparation of strong views.
Friedman’s essay on “The Methodology of Positive Economics” appeared in 1953, a dense philosophical defense of Alfred Marshall and the NBER against various competing factions. These included by the enthusiasts of small general equilibrium models at MIT, proprietors of the new view of monopolistic competition at Harvard, and practitioners of axiomatic methods at the Cowles Foundation.
At every point, Friedman was dogged by suspicions elsewhere that his methods didn’t fully measure up to modern standards. The jokes multiplied: “Milton knows how to spell banana but he doesn’t know when to stop.” “I wish I could be as sure of one thing as you are of everything.” “Everything reminds Milton of Money. Everything reminds me of sex, but I keep it out of my papers.” Friedman’s friend, Gaylord Freeman, president of the First National Bank of Chicago, reported that, when he pressed the National Commission on Money and Credit to call Friedman as a witness, the staff demurred: maybe as an after-dinner speaker, but not as an expert to give testimony.
Friedman sought other channels. The Volker Foundation – the business philanthropy that had funded the Mont Pelerin Society nine years before – began a series of summer programs in 1956 with a series of lectures that Friedman gave at Wabash College. Five years later, carefully edited by his wife, the Lectures appeared as Capitalism and Freedom, published by the University of Chicago Press. By the time its fortieth anniversary edition appeared, the book had sold more than half a million copies in English alone. The couple named the summer house they built in 1966 “Capitaf,” for the stream of royalties the book provided.
Then, finally, A Monetary History of the United States: 1867-1960, appeared. Friedman and Schwartz’s tome is 860 pages long, but it doesn’t look anything like Foundations of Economic Analysis. Instead of differential equations there are fold-out charts depicting data; instead of models, narrative. The epigraph was from Marshall instead of Gibbs:
Experience in controversies such as these brings out the impossibility of learning anything from facts till they are examined and interpreted by reason; and teaches that the most reckless and treacherous of all theorists is he who professes to let facts and figures speak for themselves, who keeps in the background the part he has played, perhaps unconsciously, in selecting and grouping them, and in suggesting the argument post hoc ergo propter hoc.
The main argument of the book had to do with the quantity theory of money – with Friedman and Schwartz’s analysis of the relationship between money and income in two very different eras of bank regulation, first under the National Bank Act, then under the Federal Reserve Act, an ostensibly dry topic that nevertheless precipitated a sharp controversy among macroeconomists. Among economic historians and others interested in the broader issues, however, attention gradually turned to Chapter Seven, the 200-pages account of monetary policy in the Great Depression, which the authors titled “The Great Contraction.” Bungling by the Federal Reserve, the authors asserted, had been at the heart of the Great Depression. The details deemed relevant were sensational; the impulsive tightening in 1928 designed to pierce a stock market bubble; the death of Benjamin Strong; four distinct waves of banking panic, beginning in 1930, each more serious than the last; confusion among the Federal Reserve banks, tightening reserves when they should have been easing. It was a very different interpretation fron the standard Keynesian analysis. The authors concluded,
The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than any inherent instability of the private economy. A governmentally established agency – the Federal Reserve System – had been assigned responsibility for monetary policy. In 1930 and 1931, it exercised this responsibility so ineptly as to convert what otherwise would have been a moderate contraction into a major catastrophe.
The chapter was, in fact, a bombshell. Quite aside from the libertarian rhetoric, “The Great Contraction” proposed a new master narrative of events. In essence, it was picking up the thread of Henry Thornton and Walter Bagehot, though without emphasizing the lineage. Clark Warburton, economist for the Federal Deposit Insurance Corporation, had observed as much in 1939. So had Lauchlin Currie, the aide to Marriner Eccles who in the early 1950s had been forced into exile in Colombia after he was accused of having been a Soviet spy.
Now, because the extraordinary care Schwartz had exercised in assembling the data, there was some hope of actually getting to the bottom of at least some of the issues of the Great Depression. The challenge to the standard Keynesian interpretation was now fully posed. The assessment would, of course, take time.
Almost none of this was visible to the outside world. Friedman and his wife had taken off the year 1962-63 to go around the world. The word “monetarism” wouldn’t be coined until 1968.
When John F. Kennedy defeated Richard Nixon, in 1960, his chief economic adviser was Paul Samuelson. Samuelson declined to go to Washington, but the Council of Economic advisers Kennedy appointed was the very cream of the New Economics: Walter Heller, James Tobin and Kermit Gordon, with Robert Solow and Kenneth Arrow among the senior staff. From the first, the task was “to get the country moving again.: The economics of the New Frontier is a story for some day. But by 1962 the administration’s accomplishments were sufficient for the president to boast of them in a famous commencement speech at Yale:
What is at stake in our economic decisions today is not some grand warfare of rival ideologies which will sweep the country with passion but the practical management of a modern economy. What we need is not labels and clichés but more basic discussion of the sophisticated and technical questions involved in keeping a great economic machinery moving ahead.
The boom of the 1960s rolled on. By 1965, Time magazine put John Maynard Keynes on its cover, eighteen years after his death. Keynes had almost been named its “Man of the Year,” edged out, by William Westmoreland, commander of the growing US forces in Vietnam. From a distance of thirty years, Robert Lucas, who had been a young econometrician at the time and who would later win a Nobel Prize, looked back at what had been the conventional wisdom then:
For the applied economist, the confident and apparently successful application of Keynesian principles to economic policy which occurred to the United States in the 1960s was an event of incomparable significance and satisfaction. These principles led to a set of simple quantitative relationships between fiscal policy and economic activity generally, the basic logic of which could be (and was) explained to the general public and which could be applied to yield improvements in economic performance benefiting everyone. It seemed an economics as free of ideological difficulties as say, applied chemistry or physics, promising a straightforward expansion of economic possibilities. One might argue as to how this windfall should be distributed, but it seemed a simple lapse of logic to oppose the windfall itself. Understandably and correctly, non-economists met this promise with skepticism at first; the smoothly growing prosperity of the Kennedy-Johnson years did much to diminish these doubts.
The Time cover had struck a chord. A few months later, Osborne Elliott, editor of Newsweek, phoned Friedman, Samuelson and Henry Wallich, of Yale, to ask each to write rotating columns for the magazine. Samuelson would be the “New Deal liberal.” Friedman would represent the “free enterprise” wing. Wallich would write from “the radical middle.”
As it turned out, the Wallich column didn’t last very long.