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Carney Do It?
October 2013


Most economists are left-wing or at any rate left of centre in political outlook. They dislike Milton Friedman's theories, and his straightforward enthusiasm for a free-market capitalist economy. However, the vast majority of them accept that one of Friedman's works — his December 1967 presidential address to the American Economic Association — was among the most influential contributions to their subject in the 20th century. 

In that address Friedman repudiated the Keynesian claim that monetary policy could reduce the rate of unemployment on a permanent basis. He acknowledged that, over a period of a few years, an increase in the rate of growth of the quantity of money could boost demand and output, and so lower unemployment relative to what it might otherwise have been. But suppose that the rate of unemployment were pushed beneath what he termed "the natural rate". The result would be not a high and stable rate of inflation, but ever-accelerating and hence unsustainable inflation. 

The natural rate was determined by underlying structural characteristics of the labour market and the economy, and could not be changed by tinkering around with interest rates, open-market operations or any kind of monetary gimmickry. In Friedman's words, while "there is always a temporary trade-off between inflation and unemployment, there is no permanent trade-off". It followed that "the monetary authority" should not use its control over nominal quantities, such as the quantity of money, "to peg a real quantity" such as "the rate of unemployment". 

Friedman's argument had massive importance for policy, particularly in Thatcherite Britain. Government attempts to combat unemployment should focus on the economy's structural aspects or, in the phrase that was fashionable in the 1980s, on "the supply side". They should not use monetary policy and certainly not "Keynesian demand management" by manipulating fiscal policy. A notably effective presentation of this viewpoint (in a speech entitled "Thatcherism in practice") was given by Nigel Lawson, as Financial Secretary to the Treasury, to a Zurich audience in 1981. The gnomes loved it, and it was one of the reasons for the surge in international financial confidence in Britain achieved at that time. 

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