Irresponsible Monetary Policy Eventually Leads to an Increase in the Natural Rate of Unemployment

As Bellante and Garrison (1988) remind us, Friedman acknowledges that irresponsible monetary policy would eventually lead to an increase in the natural rate of unemployment. Two of Friedman’s papers (1976 and 1977) suggested the potential existence of a positively sloped Phillips curve. But in neither case did Friedman reconsider his model of dynamic monetary theory in light of his empirical work. 

In his Nobel lecture, Friedman acknowledged that additional research was needed to resolve the inconsistency between the monetarist Phillips curve and empirical data. He anticipated that this “third stage” of the research into the relationship between inflation and unemployment would only be successful if a way was found to incorporate political factors:

In recent years, higher inflation has often been accompanied by higher not lower unemployment, especially for periods of several years in length. A simple statistical Phillips curve for such periods seems to be positively sloped, not vertical. The third stage is directed at accommodating this apparent empirical phenomenon. To do so, I suspect that it will have to include in the analysis the interdependence of economic experience and political developments. It will have to treat at least some political phenomena not as independent variables—as exogenous variables in econometric jargon—but as themselves determined by economic events—as endogenous variables [. . .]. The third stage will, I believe, be greatly influenced by a third major development—the application of economic analysis to political behavior, a field in which pioneering work has also been done by Stigler and Becker as well as by Kenneth Arrow, Duncan Black, Anthony Downs, James Buchanan, Gordon Tullock, and others. (1977, p. 470)

In my doctoral thesis (Ravier, 2010), I called this “Friedman’s dilemma” because Friedman observed an empirical reality his own analytical framework was unable to explain. Friedman observes a positively sloped Phillips curve and a long-term effect of monetary stimulus which is not neutral in real terms. Both are inconsistent with his own theories. Instead he provides evidence confirming the work of Robert Lucas (1973) and, more recently, William Niskanen (2002). Robert Mulligan (2011) has demonstrated the connection between Niskanen’s article and Austrian business cycle theory.

—Adrián O. Ravier, “Dynamic Monetary Theory and the Phillips Curve with a Positive Slope,” Quarterly Journal of Austrian Economics 16, no. 2 (Summer 2013): 172-173.