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Center for the History of Political Economy Summer School June 2014 1 History of Modern Macroeconomics Lecture 3.6 The Monetarist Counter-Revolution (1956-1982) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University

Center for the History of Political Economy Summer School June 2014

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Milton Friedman Rutgers BA Fellowship at Columbia Homer Jones (quantity theorist) Arthur Burns (NBER business cycles) Fellowship at Columbia Harold Hotelling Chicago Graduate Study Henry Schultz New Dealer University of Wisconsin World War II Treasury statistician Chicago Professor 1946 replaced Viner Milton Friedman (1912-2006), Nobel Laureate (1976) Center for the History of Political Economy Summer School June 2014

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Page 1: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June 2014 1

History of Modern MacroeconomicsLecture 3.6 The Monetarist Counter-

Revolution (1956-1982)

Kevin D. HooverDepartment of EconomicsDepartment of Philosophy

Center for the History of Political EconomyDuke University

Page 2: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 2

Milton Friedman Rutgers BA

Homer Jones (quantity theorist)

Arthur Burns (NBER business cycles)

Fellowship at Columbia Harold Hotelling

Chicago Graduate Study Henry Schultz

New Dealer University of Wisconsin World War II

Treasury statistician

Chicago Professor 1946 replaced Viner

Milton Friedman (1912-2006), Nobel Laureate (1976)

Page 3: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 3

Chicago – the Older GenerationFrank Knight 1885-1972

Jacob Viner 1892-1970Henry

Simons 1889-1946

Page 4: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 4

Chicago – Friedman’s Generation

Stigler, Friedman, Galbraith

Aaron Director (1901-2004)

George Stigler (1911-1991), Nobel Laureate

(1980)

Page 5: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 5

Friedman and Consumption

PhD Thesis: Income from Independent Professional Practice with Simon Kuznets (1945)

permanent-income hypothesis

A Theory of the Consumption Function (1957)Simon Kuznets (1901-

1985), Nobel Laureate (1971)

Page 6: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 6

Key Works in Friedman’s Revival of the Quantity Theory

of Money “A Monetary and Fiscal Framework for Economic Stability” (AER 1948)

Methodology: “The Marshallian Demand Curve” (1948) “The Methodology of Positive Economics” (1953)

“The Quantity Theory of Money – A Restatement” (1956)

The History of Money (with Anna J. Schwartz): The Monetary History of the United States (1963) Monetary Statistics of the United States: Sources,

Methods (1970) Monetary Trends in the United States and the

United Kingdom (1982)

Page 7: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 7

“The Quantity Theory of Money – A Restatement” – 1

Cambridge Quantity Equation: MV = pY Causal claims:

long run theory of price short run theory of nominal income money at deep level independent of V, p, Y

endogenous (e.g., gold standard or accommodation)

exogenous (e.g., fixed policy rule) V independent of M, p, Y

Classical dichotomy

Page 8: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 8

“The Quantity Theory of Money – A Restatement” – 2

Downplays causal formulation Allergic to causal formulations see Hoover, "Milton Friedman’s Stance:  The

Methodology of Causal Realism,” in Mäki, editor, The Methodology of Positive Economics: Milton Friedman’s Essay Fifty Years Later (2009)

Quantity theory as a theory of money demand (= 1/V) V not constant nor infinitely malleable stable function of a few variables

Page 9: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 9

The Transmission Mechanism

↑MS > MD Y, p, r, or other factors until MD = MS: whatever it takes

more specifically, through asset yields investment (including consumer durables)

pace Patinkin: little emphasis on real-balance effects

the “black box” cf. Keynes on transmission:

↑MS > MD ↓r (long bond rate) ↑I

Page 10: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 10

The Pragmatic Impulse

Legacy of institutionalism “Marshallian” method in action:

don’t get bogged down in unmeasurable details

choose categories for greatest illumination

Transmission mechanism: complex process, impossible to detail precisely, long and variable lags simple policy rules

Page 11: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 11

The History of Money

The Monetary History of the United States, 1867-1960 (1963) – short run

Monetary Statistics of the United States: Sources, Methods (1970) – data

Monetary Trends in the United States and the United Kingdom (1982) – long runAnna J. Schwartz (1915-

2012)

Page 12: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 12

The Monetary History of the United States, 1867-1960

Goal 1. Establish causal dominance of money in the short run

Goal 2. Document effective policy

Page 13: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 13

Causal Strategy

C E A B D F

If relationship of A to B stable under variations in C and D, but not under variations in E and F, then A B

Page 14: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 14

Money Causes the Real Economy and Prices

Careful documentation of stability of quantity equation under changes in money supply regime: 1867-1879 “greenbacks” 1879-1914 gold standard 1914-1933 Federal Reserve under gold standard

(discount policy dominates) 1933-1941 off domestic gold standard 1942-1953 Treasury fixes short and long interest rates

(1945 on Bretton Woods agreement) 1953-1960 Federal Reserve “bills only” policy (open-

market operations and interest-rate policy dominates)

Page 15: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 15

Effective Strategy: Monetary Control

Endogenous and exogenous regimes gold standard (= exchange-rate target) real-bills doctrine monetary target

Tight money supply control 100% reserve requirements no feedback rules target M not r or real quantities

Page 16: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 16

The Great Depression as the Test Case

Benjamin Strong would have saved us from the Great Depression

Peter Temin, Did Monetary Forces Cause the Great Depression (1976)

Benjamin Strong (1872-1928)

Peter Temin (1937- )

Page 17: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 17

Econometric Battles

On the relative efficacy of monetary and fiscal policy Commission on Money and Credit:

Friedman and Meiselman on stability of V Ando, Brown, Solow, and Kareken on the relative lags

of monetary and fiscal policy and on timing artifacts The “St. Louis Equation”:

Anderson and Jordan long lags money predicts GDP better than Federal

expenditures

Page 18: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 18

Causality Debate Tobin, “Money and Income: Post Hoc Ergo

Propter Hoc?” (QJE 1970) theoretical models in which M does not cause p with

M leading p theoretical models in which M does cause p with p

leading M timing misleading Kaldor: “money does not cause Christmas”

Friedman’s reply: invariance not timing Granger-causality tests:

Sims, “Money, Income, and Causality” (AER 1972) later work

Page 19: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 19

Financial Innovation Kaldor, “The New Monetarism” (Lloyds Bank

Review 1970) stability of velocity an artifact example of the Irish bank strike

Hester, “Innovation and Monetary Control” (Brookings Papers, 1981) and the financial innovations of the 1970s and 1980s

Friedman’s elastic definition of money money = whatever asset has the most stable

velocity Fed’s stable: MB (“high-powered money”), M1, M1A,

M1B, M2, M3, L

Page 20: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 20

Monetarism

Origins of the term obscure: oral tradition: due to Karl Brunner (1916-

1988) oldest reference in JSTOR and the OED: H.

Aaron “Structuralism versus Monetarism: A Note on Evidence” (Journal of Development Studies 1967)

Common by 1970 Harry Johnson: “Monetarist Counter-

revolution” to Keynes, 1971

Page 21: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 21

Monetarism as a Player: 1970s

Accumulating evidence Stagflation: the acceptance of the natural

rate hypothesis and Friedman’s Phillips curve mythology

Policy skepticism and rules The New Classical Macroeconomics: reflected

glory of Monetarism Mark II The role of the regional Federal Reserve

Banks Sidebar: Mrs. Thatcher and monetarism

Page 22: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 22

The Fed’s Monetarist Experiment

Replaces G. William Miller, September 1979

New monetary control strategy October 6th 1979 monetary aggregate

targeting non-borrowed reserve

control Kevin Hoover joins Fed

December 10th 1979 Credit control regime:

January-June 1980 Reserve targeting

abandoned 1982

Paul A. Volcker (1927- )

Page 23: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 23

The Fed’s Monetarist Experiment: Outcome

Treasury Yields

0

5

10

15

20

1971 1975 1979 1983 1987

Yie

ld to

Mat

urity

(per

cent

)

3-month Treasury Bill

10-year Treasury Bond

October 1979-December 1982

Page 24: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

2014 24

Milton and Arnold

Page 25: Center for the History of Political Economy Summer School June 2014

Center for the History of Political Economy Summer School June

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Thanks

The End