John Maynard Keynes, who died in 1946, and Milton Friedman, who died last week, were the most influential economists of the 20th century. Since Friedman spent much of his intellectual energy attacking the legacy of Keynes, it is natural to consider them opposites. Their differences were, indeed, profound. But so was what they shared. More interesting, neither won and neither lost: today’s policy orthodoxies are a synthesis of their two approaches.

Keynes concluded from the great depression that the free market had failed; Friedman decided, instead, that the Federal Reserve had failed. Keynes trusted in discretion for sophisticated mandarins like himself; Friedman believed the only safe government was one bound by tight rules. Keynes thought that capitalism needed to be in fetters; Friedman thought it would behave if left alone.

These differences are self-evident. Yet no less so are the similarities. Both were brilliant journalists, debaters and promoters of their own ideas; both saw the great depression as, at bottom, a crisis of inadequate aggregate demand; both wrote in favour of floating exchange rates and so of fiat (or government-made) money; and both were on the side of freedom in the great ideological struggle of the 20th century.

If it were not for the fact that the UK and US are two nations divided by a common language, one might even call both “liberals” in the 18th and 19th century English sense of that word. But Keynes, though temperamentally a liberal, was also a pessimistic member of the upper middle classes of a declining country: he thought the survival of a measure of freedom required jettisoning large elements of 19th century orthodoxy. Friedman, a child of poor Jewish immigrants and thoroughly American, was optimistic: he hoped to restore free markets and limited government.

100 years of the US and UK consumer price inflation

To achieve this end, Friedman sought to demolish what he saw as the mistakes made by Keynes and his successors: the assumption that a fixed propensity to consume out of current income drove aggregate demand; the trust in fiscal policy as the most potent instrument in the policy armoury; the belief that changes in nominal demand would secure durable changes in real output; and confidence in the exercise of discretion by governments.

In his work of the 1950s and 1960s, Friedman took on all these propositions in turn. In a celebrated paper published in 1957 he argued that consumption depended not on current, but on permanent or long-term, income; in A Monetary History of the United States (1963), co-authored with Anna Schwartz, and a number of empirical studies co-authored with David Meiselman, he sought to reinstate the quantity theory of money, the view that a stable relationship exists between the money supply and nominal demand; and in his famous presidential address to the American Economic Association in 1968 he advanced the “natural rate of unemployment”, also known as the “non-accelerating inflation rate of unemployment” (NAIRU), in place of the trade off between inflation and output implied by the then-fashionable “Phillips Curve”.

In the 1960s, most economists regarded Friedman’s belief in the free market and rejection of Keynesian ideas as evil, misguided or, more often, both. I remember the shock when, at Oxford, I read his arguments supporting the idea of a natural rate of unemployment just after its appearance. The great inflation of the 1970s – unprecedented in peacetime – transformed the climate of opinion (see chart). So, too, did the collapse of the fixed exchange rate regime in 1971 and move to free floating, which preceded the price surge.

A new theory was required to guide this world of more or less freely floating exchange rates and soaring inflation. The answer, it was hoped, was Friedman’s monetarism – the targeting of some measure of the money supply. As chairman of the Federal Reserve, Paul Volcker tried that experiment in the US between 1979 and 1982. Margaret Thatcher’s government tried it in the UK between 1979 and the mid-1980s. In both cases inflation was crushed. But the relationship between money and nominal demand also crumbled. Keynesianism had, indeed, died. But so, too, did Friedman’s monetary rule.

From the ashes, a new orthodoxy has emerged: policy should, as Friedman argued, target a nominal variable, not a real one; that target should be the goal, inflation, not the instrument, money; central banks should be free to move the interest rate as needed to hit their target. This, then, is a regime of rules-bound discretion. Friedman would approve of the rules; Keynes would approve of the discretion. Friedman has won on the primacy of monetary policy; but Keynes has won on the rejection of the quantity theory.

Yet both have won in the most important sense. Over the past two decades, a world of fiat money has supplied modest inflation and supported stable growth. This is unprecedented. Friedman himself stated early this year that “Alan Greenspan’s great achievement is to have demonstrated that it is possible to maintain stable prices”. Thus did the great proponent of rules commend the great employer of discretion.

Are the inflation-targeting independent central bank and floating currencies “the end of history” in macroeconomic policy? I suspect not. The vagaries of floating exchange rates seem to cry out for yet another experiment in monetary integration, perhaps even a stab at a world currency.

The march of technology may even make money redundant as anything more than a unit of account.

Policy debate, too, continues. The European Central Bank may yet persuade its peers that the monetary data tell one something useful. Central banks may learn, as well, that they ignore asset prices at their peril. Even expansionary fiscal policy may again be needed, as proved the case in Japan during the deflationary 1990s.

Also uncertain is the future of the market economy. Here, too, the present position is a draw. Keynes would have worried about the destabilising consequences of the freeing of capital flows. But Friedman had to recognise that a comprehensive rolling back of the state was not on the agenda. The market has indeed been freed from many of its mid-20th century shackles. But the state commands resources and regulates economies on a scale unimaginable a century ago. Globalisation itself may yet founder.

Keynes and Friedman were the protagonists of the policy debate of the last century. But today, we can see that neither won and neither lost.

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