Information and expectations in policy-making: Friedman’s changing approaches to macroeconomic dynamics

Abstract

The paper shows how Friedman gradually came to incorporate the expectations formation process in his account of macroeconomic disequilibria. It is shown that Friedman's early Monetarism relies on slowly adjusting prices and wages, mainly because of long-term contracts. When he first addressed the expectations issue in his work macroeconomic dynamics Friedman actually considered static expectations. In the mid-1960s his anticipationist critique of the Phillips curve led Friedman to place at the centre of the analysis the idea that private agents progressively adjust their forecasts to a new informational environment. Nevertheless, adaptive expectations involve backward-looking behaviour regarding the price structure, without taking account of the probable effect of discretionary policy on the economy in the future; hence economic agents make systematic forecasting errors. Friedman eventually considered forwardlooking behaviour in the 1970s but stopped short of fully embracing the rational expectations approach to economic policy. In Friedman's later Monetarism there is an echo of Friedman's early joint work with Savage regarding attitudes towards risk based on the subjective probability approach. But this is the residual outcome of a very lengthy process.

Evolution of expectations models in economic thought

“…When he first addressed the expectations issue in his work on macroeconomic dynamics, Friedman actually considered static expectations. In the mid-1960s his anticipationist critique of the Phillips curve led Friedman to place at the centre of the analysis the idea that private agents progressively adjust their forecasts to a new informational environment, i.e., they form adaptive expectations [12]. David Laidler (2006) [13] in his essay "Milton Friedman and the Evolution of Macroeconomics", by citing Philip Cagan (2000) [14], "accuses" Friedman to have picked the idea of adaptive expectations in 1952 from conversations with A. W. Phillips.…”