THE NEW ATTACK ON KEYNESIAN ECONOMICS

FOR years, the maverick views of Milton Friedman, the towering iconoclast of U.S. economics, attracted just about as much ridicule as respect. A monetary theorist, the bald and somewhat cherubic University of Chicago professor maintains that the U.S. and many other major nations mismanage their economies. They do so, he argues, by manipulating taxes, federal spending and money supply--techniques that were formulated by Britain's John Maynard Keynes. "Keynesian economics doesn't work," says Friedman. "But nothing is harder for men than to face facts that threaten to undermine strongly held beliefs."

Those beliefs have grown stronger in the past eight years, while the U.S. economy has expanded under the vigorous application of neo-Keynesian principles. Today, when the economy is strained by inflation, Friedman's challenge commands serious attention and growing support, and is a topic of heated debate among economists, bankers and Government officials. The controversy has lifted Friedman to eminence as the leader of the so-called "Chicago school" of economic thought. Increasingly influential abroad as well as at home, he is one of the principal economic advisers to Richard Nixon. Says Paul McCracken, the incoming chairman of the Council of Economic Advisers: "In recent years, all of us have become, if not Friedmanites, at least more Friedmanesque in our thinking."

Erratic Swings. In Friedman's view, the Government has repeatedly misused its two chief weapons against recessions and inflation: fiscal and monetary policies. He contends that the Keynesians rely too much on fiscal regulators--that is, on changes in taxes and federal spending. Consequently, they underrate the influence of monetary policy, notably changes in the quantity of money in circulation. Of all the economic tools at the Government's disposal, insists Friedman, the most important and fastest-acting by far is regulation of the money supply. Over the short run, the money supply indirectly controls the growth rate of the economy; in the long run, it governs how quickly prices rise or fall.

Money supply--currency, plus checking accounts and time deposits in the nation's 14,000 commercial banks--needs to expand as population and production grow. The Federal Reserve Board controls the expansion, largely by buying or selling Government bonds. In the process, it makes adjustments for peak periods of demand, such as the Christmas shopping season, or times when the Treasury must borrow heavily to finance budget deficits. In addition, the Federal Reserve tries to use its monetary powers to moderate the ups and downs of U.S. business. But Friedman says that the board repeatedly errs in the rate at which it expands or constricts the money supply. As a result, it aggravates the swings of an economy that it is supposed to steady.

Since 1960, the money stock has changed at annual rates that have swung all the way from plus 13.5% to minus 2.8%, depending on the board's shifting opinion of the economy's needs. Such fluctuations are usually reflected in the performance of the whole economy six to nine months later. Between April 1965 and April 1966, for example, the money supply climbed at the rate of 9 1/2% a year, and the war-swollen economy began to suffer from inflation. When the Reserve Board overreacted, it slammed on the brakes too hard. Until January 1967, money supply was allowed to grow at a yearly rate of only 3.8%. The result, says Friedman, was the first-quarter slowdown that analysts dubbed the mini-recession of 1967. Since January 1967, the money supply has increased at a 9.9% annual rate, and Friedman blames today's inflation primarily on that fact. Last year he correctly predicted that, in the absence of restraint on money supply, the 10% income tax surcharge would fail to rein in the economy appreciably during 1968. Rather belatedly (and too recently to show in quarterly figures), the Federal Reserve has sharply reduced the rate of increase in money. As a result, the economy shows some signs that it is about to slow down.

Inflationary Engine. "Over the past years, the Federal Reserve has been an engine of inflation," complains Friedman. "Inflation is always and everywhere a monetary phenomenon, produced in the first instance by an unduly rapid growth in the quantity of money. I've sat in many a meeting with the Fed and argued with them. Three or four times I thought they had got the message, but every time they've strayed off the track."

For that reason, he believes that the fiercely independent Federal Reserve should be stripped of most of its powers to manipulate money. As he sees it, the board's seven governors--who now serve for 14 years--should have terms coinciding with that of the President who appoints them. Nixon recently went out of his way to ask Board Chairman William McChesney Martin to stay on, even though Friedman argues that the board under Martin has been wrong too often. Friedman now hopes that the chairman will retire before his term expires on Jan. 31, 1970. By law, Martin cannot be reappointed. Says Friedman: "It would be a very good thing if he went early."

Friedman's main point is that the Reserve Board should simply let the money supply grow at a constant rate of about 5% a year, in line with the real growth of the nation's output of goods and services. An increasing number of experts agree with him. Last summer the congressional Joint Economic Committee urged the Federal Reserve to expand the money supply no less than 2% and no more than 6% a year. Last week 40 out of 71 economists who responded to a survey by a House subcommittee urged the Reserve Board to increase the money stock steadily and moderately. But the Federal Reserve's economists disagreed. Though there are Friedman fans at the Federal Reserve Bank of St. Louis, he has few if any supporters elsewhere in the system or on the board itself.

Deceptive Indicator. Nobody disputes Friedman's impressive scholarship. His 808-page A Monetary History of the United States 1867-1960 (written in collaboration with Anna Schwartz and published in 1963) is the definitive work in its field. In it, he points out that every U.S. recession in the past century but one (1869-70) has been preceded by a decline in the growth of the money supply.

Popular impression to the contrary, Friedman notes, interest rates are often a deceptive indicator of the real monetary situation. When the money supply grows rapidly, for example, rates do fall, but only for a few months. As the money works its way through the economy, spending and incomes rise. This has a multiplying effect. Consumers further increase their demands, and businessmen respond by expanding .their plants and building their inventories. With that comes a spurt in the demand for loans, and interest rates shoot up--as they have been doing lately. According to Friedman's analysis, when the Federal Reserve boosted its discount rate to 5 1/2% last month -- the highest level in 39 years--it only validated his theory. "The delayed effect of monetary expansion is to raise interest rates," says Friedman, "and this is reinforced when you have inflation."

Out with Orthodoxy. Friedman's critics hold that his theory is too simplistic to guide complex economies. They believe that by calling for an inflexible system of monetary growth, he would deprive policymakers of their discretionary powers to adjust money to meet changing conditions. But even such an opponent as M.I.T.'s Paul Samuelson pays Friedman a barbed compliment. "Strong ideology drives out the weak," he says, paraphrasing Gresham's law, "and Friedman has the strongest ideology around."

The son of immigrants from the old Austro-Hungarian Empire, Friedman, now 56, worked his way through Rutgers and won a postgraduate scholarship in economics to the University of Chicago. Except for a World War II interval as a tax expert in Washington and a few years of teaching elsewhere, he has been at Chicago ever since. A frequent public speaker, he has written or been co-author of 13 books on economics. He was Barry Goldwater's chief economic adviser in 1964.

Though foes often depict him as an arch conservative, Friedman's wide-ranging views fit no orthodox niche. Beyond pure economics, he originated the guaranteed-income plan known as the "negative income tax" as a substitute for today's ineffective welfare system. He advocates an end to the draft in favor of a well-paid Army of volunteers (see TIME ESSAY, p. 25), and his thinking helped lead Nixon to the same stand. In the field of education, Friedman would have the Government give parents vouchers that would pay for their children's tuition in any school--public, private or parochial. That would not only switch the Government subsidy from the institutions to the students but force inferior schools to improve or lose their customers.

In international monetary affairs, Friedman contends that today's system of fixed exchange rates should be scrapped and that currencies should be free to fluctuate in value. That way, weak currencies would be penalized with instant if minor devaluations. Balance of payments problems would automatically disappear, along with the onerous controls and taxes imposed to try to solve them. Few policymakers accept such a radical proposal, but support is increasing for the related idea of permitting currencies to fluctuate within a "band" of 3% to 5% of their par value. Thus Friedman may not gain all of what he wants, but he stands to get a good deal of it.

In a sense, Friedman is like a Paris designer whose haute couture is bought by a select few, but who nonetheless influences almost all popular fashions. Richard Nixon's economists will not accept all of Milton Friedman's money-supply theory. They will, however, pay much more attention to monetary policy --and relatively less to taxes and Government spending. In that way, they hope to ease the economy onto a steadier, less inflationary course.

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