Volume LVIII MARCH 1968 Number 1
THE ROLE OF MONETARY POLICY*
By MILTON FRIEDMAN**
There is wide agreement about the major goals of economic policy:
high employment, stable prices, and rapid growth. There is less agreement
that these goals are mutually compatible or, among those who regard
them. as incompatible, about the terms at which they can and
should besubstituted for one another. There is least agreement about
the role that various instruments of policy can and should play in
achieving the several goals.
My topic for tonight is the role of one such instrument-monetary
policy. What can it contribute? And how should it be conducted to contribute
the most? Opinion on these questions has fluctuated widely, In
the first flush of enthusiasmabout the newly created Federal Reserve
System, many observers attributed the relative stability of the 1920s to
the System's capacity for fine tuning-to apply an apt modern term. It
came to be widely believed that a new era had arrived in which business
cycles had been rendered obsolete by advances in monetary technology.
This opinion was shared by economist and layman alike,
though, ofcourse, there were some dissonant voices. The Great Contraction
destroyed this naive attitude. Opinion swung to the other extreme.
Monetary policy was a string. You could pull on it to stop inflation
but you could not push on it to halt recession. You could lead a
horse to water but you could not make him drink. Such theory by
aphorism was soon replaced by Keynes' rigorous and sophisticatedanalysis.
Keynes offered simultaneously an explanation for the presumed impotence
of monetary policy to stem the depression, a nonmonetary interpretation
of the depression, and an alternative to monetary policy
* Presidential address delivered at the Eightieth Annual Meeting of the American Economic
Association, Washington, D.C., December 29, 1967.
** I am indebted for helpful criticisms ofearlier drafts to Armen Alchian, Gary Becker,
Martin Bronfenbrcnner, Arthur F. Burns, Phillip Cagan, David D. Friedman, Lawrence
Harris, Harry G. Johnson, Homer Jones, Jerry Jordan, David Mciselman, Allan H.
Meltzer, Theodore W. Schultz, Anna J. Schwartz, Herbert Stein, George J. Stigler, and
2 THE AMERICAN ECONOMIC REVIEW
for meeting the depression and his offering was avidlyaccepted. If liquidity
preference is absolute or nearly so-as Keynes believed likely
in times of heavy unemployment-interest rates cannot be lowered by
monetary measures. If investment and consumption are little affected
by interest rates-as Hansen and many of Keynes' other American disciples
came to believe-lower interest rates, even if they could be
achieved, would do little good. Monetary policyis twice damned. The
contraction, set in train, on this view, by a collapse of investment or by
a shortage of investment opportunities or by stubborn thriftiness, could
not, it was argued, have been stopped by monetary measures. But there
was available an alternative-fiscal policy. Government spending could
make up for insufficient private investment. Tax reductions could undermine
The wide acceptance of these views in the economics profession
meant that for some two decades monetary policy was believed by all
but a few reactionary souls to have been rendered obsolete by new economic
knowledge. Money did not matter. Its only role was the minor
one of keeping interest rates low, in order to hold down interest payments
in the government budget, contributeto the "euthanasia of the
rentier," and maybe, stimulate investment a bit to assist government
spending in maintaining a high level of aggregate demand.
These views produced a widespread adoption of cheap money policies
after the war. And they received a rude shock when these policies
failed in country after country, when central bank after central bank
was forced to give up the pretense...