Milton Friedman was the most influential economist of the 20th century and his work will continue to have effect as long as humans engage in economic activity. It is, therefore, appropriate that as we celebrate the 100th anniversary of his birth, we remember his impact in Canada and worldwide.
Professor Friedman had a broad view of the applicability of economic analysis. He was a path breaker in its application in many areas of human activity ranging from the organization of schools and professional licensure to the conduct of monetary policy and the possibility of using tax-and-spending policy to manage the level of national economic activity. He was both an academic and a high-profile public educator. His work was disseminated in Newsweek and other popular publications, in his books, and through a globally watched TV series that showed how economic policy ideas could both create and destroy wealth and prosperity.
Most aspects of economic life in Canada bear the mark of this courageous thinker’s insights. It is impossible to do credit to his ideas here, but two policies are relevant to key international issues of 2012 and give an indication of Professor Friedman’s impact.
Most adult Canadians can remember something of the economic chaos produced in the early 1980s by the dramatic increase, and then collapse, of interest rates and the rate of inflation. Essentially, this episode was a by-product of the failure by the world’s central bankers to pay attention to Friedman’s conclusion from exhaustive historical research that "inflation is always and everywhere a monetary phenomenon." It followed from that conclusion that the Bank of Canada and its counterparts around the world bore a singular responsibility for the inflationary explosion and its catastrophic impact on employment, income, and economic welfare.
Canada learned very quickly from this experience and was an early adopter of monetary policy based on Friedman’s principles. In the 1970s, the Bank of Canada had started doing research that laid the groundwork for the conversion to a new look in the conduct of policy. By the time John Crow took the reins in 1987, the Bank took the confident and appropriate stance that the then-spendthrift policies of the Mulroney government should not be financed by the Bank of Canada because of the inevitable inflationary consequences. While the on-going and sometimes acrimonious conflict between the government of the day and the Bank proved to be career limiting for John Crow, his insistence on the Friedman approach to policy was triumphant.
All subsequent governors have adhered strictly to a policy of monetary control based on inflation targeting. Moreover, that policy is the subject of an explicit agreement between the Bank and the Government of Canada, following a recipe developed by Friedman disciple Don Brash when he was Governor of the New Zealand Reserve Bank. The consequence of this history at the Bank, directly attributable to Milton Friedman, was that Canada has had top-notch inflation performance for a quarter century—incomparably better than the world average, distinctly better than the rest of the developed world, and even better than the United States.
Canada was able to outperform in the control of inflation because it had the power to adopt a truly independent monetary policy. And that ability could only be had if Canada followed another policy course advocated by Friedman: flexible exchange rates. Incredibly, the eventual adoption of flexible exchange rates can be traced back to a conversation that Professor Friedman had with then-Deputy Governor of the Bank of Canada, Donald Gordon, in 1948.
Professor Friedman reported the conversation in a keynote address to a conference organized by the Bank of Canada in November 2000 to mark 50 years of floating exchange rates. He related that what occasioned the conversation was the struggle by Gordon and other officials in the Canadian government to deal with the country’s persistent trade deficit. Friedman notes that when he suggested flexible exchange rates it was apparently the first time Gordon had heard the idea. Two years later, the Canadian government floated the exchange rate, and so it has remained with few lapses.
Of course the policy of a floating exchange rate has been considerably criticized by those, including some of my colleagues at the Fraser Institute, who have felt that we would have fared better with a common Canada/US currency. Called the Amero, in imitation of the Euro, such a common currency would eliminate any uncertainty about the future exchange rate between Canada and the United States. Consequently, they argue, capital investment and therefore productivity would be improved. The Euro’s current dilemmas illustrate some of the reasons Milton Friedman advised Canada to opt for floating rates and independent monetary policy rather than pegging to or pursuing currency union with the US dollar.
When, at that same Bank of Canada Conference in 2000, Milton Friedman was asked about the future of the Euro, he said:
"I think the euro is in its honeymoon phase. I hope it succeeds, but I have very low expectations for it. I think that differences are going to accumulate among the various countries and that non-synchronous shocks are going to affect them. Right now, Ireland is a very different state; it needs a very different monetary policy from that of Spain or Italy… On purely theoretical grounds, it’s hard to believe that it’s going to be a stable system for a long time…
"You know, the various countries in the euro are not a natural currency trading group. They are not a currency area. There is very little mobility of people among the countries. They have extensive controls and regulations and rules, and so they need some kind of an adjustment mechanism to adjust to asynchronous shocks—and the floating exchange rate gave them one. They have no mechanism now.
"If we look back at recent history, they’ve tried in the past to have rigid exchange rates, and each time it has broken down. 1992, 1993, you had the crises. Before that, Europe had the snake [the first attempt at European monetary cooperation in the 1970s], and then it broke down into something else. So the verdict isn’t in on the euro. It’s only a year old. Give it time to develop its troubles."
It is highly unfortunate for the European countries that they did not pay more attention to these piercing insights and that Milton Friedman is no longer here to hold them to account.