14 October 1976

THIS YEAR’s ECONOMICS PRIZE TO AN AMERICAN

The Royal Swedish Academy of Sciences has decided to award the 1976 Prize in Economic Sciences in Memory of Alfred Nobel to

Professor Milton Friedman, University of Chicago, Illinois, USA,

for his achievements in the fields of consumption analysis, monetary history and theory, and for his demonstration of the complexity of stabilization policy.

Milton Friedman’s name is chiefly associated with the renaissance of the role of money in inflation and the consequent renewed understanding of the instrument of monetary policy. He has given us the terms “money matters” or even, “only money matters”, with the emergence of monetarism as a Chicago school. This strong emphasis on the role of money should be seen in the light of how economists – usually advocates of a narrow interpretation of Keynesian theory – have, for a long time, almost entirely ignored the significance of money and monetary policy when analyzing business cycles and inflation. As far back as the beginning of the fifties, Friedman was a pioneer in the well-founded reaction to the earlier post-Keynesian one-sidedness. And he succeeded – mainly thanks to his independence and brilliance – in initiating a very lively and fruitful scientific debate which has been going on for more than a decade. In fact, the macro-econometric models of today differ greatly from those of a couple of decades ago as far as the monetary factors go – and this is very much thanks to Friedman. The widespread debate on Friedman’s theories also led to a review of monetary policies pursued by central banks – in the first place, in the United States. It is very rare for an economist to wield such influence, directly and indirectly, not only on the direction of scientific research but also on actual policies.

Friedman has carried out a number of studies, which, scientifically speaking, are both original and weighty, in support of his analysis of the role of money. His empirical studies of the relationship between increases in the supply of money and the consequent changes in incomes and prices are thus founded on a new formulation of the theory of demand for money or liquid resources. His findings on the comparatively great relevance of the quantity theory in explaining developments is, in fact, built on the premise that the demand for money is in fact very stable.

From the purely scientific point of view, Friedman’s other achievements are of greater interest than his monetary analysis. Of primary importance here is his re-fashioning of the theory of consumption based on the hypothesis that “the permanent income” and not year-to-year income is the determining factor when assessing total consumption outlay. He makes the extremely valuable distinction between the temporary and more permanent incomes of households; Friedman has demonstrated that a much greater proportion of the former type of income is saved than the latter.

Another of the important contributions has been studies of “lags” appearing in all areas of economic policy. It was Friedman who coined the terms “observation-lag”, “decision-lag” and “effect-lag” to express a fundamental problem somewhat neglected earlier – and that is, the right timing for stabilization measures during a business cycle. Friedman has demonstrated how both prolonged “effect-lags” and those of varying lengths – of changes in the supply of money, for example – can have a destabilizing effect. The conclusion he draws for economic policy from these findings has been the subject of lively debate, and, to put it briefly, is that monetary policy should be simplified and that its goal should be to ensure a long-range stable growth rate of the supply of money. This view has been accepted to some extent by a few leading central banks.

Friedman was the first to demonstrate that the accepted assumption of a simple trade-off between unemployment and the rate of inflation was only a temporary phenomenon; on the longer term (more than five years), no such trade-off exists. Unemployment below a structural level of balance thus leads, according to Friedman’s theory, to a cumulative increase rate in prices and wages mainly on account of the destabilizing influence exerted by expectations. Modern ideas about the factors determining wage structures are very much based on Friedman’s hypotheses on the importance of expectations of inflation.

At the beginning of the fifties, Friedman was a pioneer among those recommending the reorganization of the international monetary system based on free rates of exchange. He studied the theory of the problem but also used empirical studies to assess how such a system could be made to work. Friedman was among those who first realized – and could explain – why the Bretton Woods System with relatively fixed rates of exchange was bound to break down sooner or later.

His major work, A Monetary History of the United States,1867 – 1960, is regarded as one of Friedman’s most profound and also most distinguished achievements. Most outstanding is, perhaps, his original and energetically pursued study of the strategic role played by the policy of the Federal Reserve System in sparking off the 1929 crisis, and in deepening and prolonging the depression that followed. The critics agree that this is a monumental scientific work which will long stimulate the re-examination of the course of events during this epoch.