Real Economy Shatters Milton Friedman's Inflation Mantra

Milton Friedman has been dead for more than a decade, but his ghost still haunts us. In the 1960s, Friedman declared that inflation is “always and everywhere a monetary phenomenon” — a problem of printing too much money.

Photo Insert: Like so much of neoclassical economics, Friedman’s quantity theory of money is a mixture of two things: Dubious assumptions about human behavior and an accounting identity that makes the theory look good.

Since then, whenever inflation rears its head, you can count on someone to reanimate Friedman’s ghost and blame the government for spending too much. If only inflation were so simple, political economist Blair Fix wrote in a paper for Evonomics.

Friedman’s thinking appears plausible at first glance. Inflation is a general rise in prices. And since prices are nothing but the exchange of money, more circulating money means prices must increase. Hence, inflation is “always and everywhere a monetary phenomenon.”

Yet, this thinking falls apart on further inspection. It treats inflation as a uniform rise in prices. That’s theoretically convenient but empirically false. In the real world, inflation is wildly divergent.

At the same time that the price of apples rises by 5%, the price of cars could grow by 50%, and the price of clothing might fall by 20%, Fix also wrote in another paper for Economics from the Top Down on November 24, 2021.

Using real-world data, political economist Jonathan Nitzan debunked Friedman’s monetarist theory in the early 1990s. His work culminated in a dissertation called “Inflation As Restructuring.”

Nitzan observed price change is always “differential,” meaning there are winners and losers. The consequence is that inflation is not purely a monetary phenomenon, as Friedman claimed. Inflation restructures the social order. It is this real-world feature of inflation that is most important since it means inflation signals a change in society’s power structure.

Predictably, it is this real-world feature that mainstream economists ignore — largely because it conflicts with their tidy theory of inflation as a monetary phenomenon. Fortunately, the evidence is clear. Inflation is (and has always been) overwhelmingly differential.

Inflation is restructuring, Fix explained in “The Making of ‘Rethinking the Theoretical Foundations of Economics’” for Evonomics.

Like so much of neoclassical economics, Friedman’s quantity theory of money is a mixture of two things: Dubious assumptions about human behavior and an accounting identity that makes the theory look good. The potency of this mixture was solidified by Friedman’s famous “F-twist,” in which he argued that a theory’s assumptions are irrelevant.

All that matters, Friedman said, is that the theory makes accurate predictions. Friedman’s F-twist gets dubious assumptions off the hook. But there is still the problem of predictions. How do you ensure that your theory is consistent with the evidence?

Here, neoclassical economists have hit upon a tidy trick: Frame your theory in terms of an accounting identity. Since the identity is true by definition, any “test” of the theory will come out in your favor. When neoclassical economists test their theory of income (the theory of marginal productivity), they invoke an accounting identity.

They correlate two related forms of income (usually sales and wages) and then call one of the incomes “productivity.” Since they always find a correlation, they always “confirm” their theory of income.

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