History of Modern Macroeconomics
Lecture 3.1. The Background to Modern
Macroeconomics (before the 1930s)
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 (Module 2), July 2011
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Macroeconomic Issues are Old
Sir William Petty (1623-1687)
Center for the History of Political Economy
Summer School (Module 2), July 2011
2
The Distinction Between Macroeconomics
and Microeconomics is Recent
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Ragnar Frisch (1895-1973), Norwegian
economist, winner of the first Nobel
Prize in Economics
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Ragnar Frisch in Cassel Festschrift
(1933): microdynamics vs.
macrodynamics
Frisch in mimeographed lectures
(1933/34): mikroøkonomiske vs.
macroøkonomiske
Jan Tinbergen in Revue de l'Institut
International de Statistique/Review of
the International Statistical Institute
(1936): macroéconomique
J.M. Fleming in Economica (1938):
macro-economic
Ultimate source: Frisch; diffused
through early meetings of the
Econometric Society
Center for the History of Political Economy
Summer School (Module 2), July 2011
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The Slow Diffusion of the Micro/Macro
Distinction
Figure 1
The Diffusion of "Microeconomics" and "Macroeconomics"
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Percentage of All Articles
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"Macroeconomics"
10
"Microeconomics"
5
0
38
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4
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50
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62
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82
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Center for the History of Political Economy
Summer School (Module 2), July 2011
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Macroeconomics Before 1930:
Main Concerns
1.
Monetary Theory
2.
Theory of the Trade Cycle (later Business
Cycle)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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David Hume and Classical Monetary
Theory
International Quantity Theory of
Money: Principal Doctrines
 The Classical Dichotomy
 Domestic Quantity Theory
of Money (short run and
long run)
 The International SpecieFlow Mechanism
 The Independence of
Money and Finance
David Hume (1711-1776)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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The Classical Dichotomy: Hume on the
Nature of Money
“[Money] is none of the wheels of trade: it is
the oil which renders the motion of the
wheels more smooth and easy.”
David Hume “Of Money”
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Domestic Quantity Theory of Money:
Hume on the Neutrality of Money
Suppose that four-fifths of all the money in GREAT
BRITAIN to be annihilated in one night, and the nation
reduced to the same condition, with regard to specie, as in
the reigns of the HARRYS AND EDWARDS, what
would be the consequence? Must not the price of all
labour and commodities sink in proportion, and every
thing be sold as cheap as they were in those ages?
David Hume “On the Balance of Trade”
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Domestic Quantity Theory of Money:
Hume on the Short and Long Run Effects of
Money
. . . though the high price of commodities be a necessary consequence of
the encrease in gold and silver, yet it follows not immediately upon the
encrease; but some time is required before money circulates through the
whole state, and makes its effect be felt on all ranks of people. At first,
no alteration is perceived; by degrees the price rises, first one
commodity, then of another; till the whole at last reaches a just
proportion with the new quantity of specie which is in the kingdom. . .
it is only in this interval or intermediate situation, between the
acquisition of money and rise of prices, that the encreasing quantity of
gold and silver is favorable to industry. . . It is easy to trace the money
in its progress through the whole commonwealth; where we shall find,
that it must first quicken the diligence of every individual, before it
encrease the price of labor.
David Hume “Of Money”
Center for the History of Political Economy
Summer School (Module 2), July 2011
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The International Specie-Flow Mechanism
Spain imports gold  (pSpain / pEngland) ↑  demand
for English goods & gold flows into England 
pSpain↓ & pEngland ↑ until trade balanced and gold flow
stops
The gold of Spain becomes the gold of England; the
real wealth of Spain or England little changed
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Summer School (Module 2), July 2011
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Independence of Money and Finance
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Hume Ignored Financial Innovation
English gold guinea (George III, 1776)
Scottish paper guinea (Paisley Banking
Company, 1785)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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The Gold Standard Was Not Automatic
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Suspensions
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The Problem of management of paper currency
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Panic of 1797: Suspension of convertibility of Bank of
England notes into gold, 1797-1821
U.S. Civil War
Britain in World War I
Banking School (Real Bills Doctrine)
Currency School (U.K. Bank Charter Act of 1844; U.S.
National Banking Acts of 1863 & 1864)
Management of interest rates: The rules of the game
Center for the History of Political Economy
Summer School (Module 2), July 2011
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The Quantity Theory of Money:
The Equation of Exchange
Simon Newcomb
(1835-1909)

MV = PQ

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Irving Fisher

(1867-1947)
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M = money
V = velocity of
circulation (average
turnover time per dollar)
P = general price level
Q = transactions (dollars
per unit time)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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The Quantity Theory of Money:
The Cambridge Equation

M/P = kY
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M = money
P = general price level
k = fraction of income
held as money
Y = income (pounds
sterling per unit time)
Alfred Marshall (1842-1924)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Comparison of Two Approaches to the
Quantity Theory

Equation of Exchange
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Cambridge Equation
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MV = PQ
V = speed of turnover of
money
“ . . . money on the wing”
Dennis Robertson
M/P = kY
k = size of money holding
“. . . money sitting”
Dennis Robertson
Equivalence: V = 1/k if
QY
Dennis Robertson (1890-1963)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Wicksell: Cumulative Process and the
Natural Rate of Interest
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real rate of interest (rr) = nominal
rate (r) – inflation rate (P)
(Fisher)
Stable Economy: M  Y &
I and P constant at the
natural rate of interest (rN)
M > needed  ↓r below rN
 ↓ rr  ↑I & ↑ P  further
↓ rr  further ↑I & ↑ P . . .
Self-limited under gold
standard as ↑ P  gold
outflow  ↓M offsetting first
cumulative process
Not self-limiting in pure credit
economy  need for active
monetary policy
Knut Wicksell (1851-1926)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Business Cycles: Main Issues

Good and bad times alternate

Develop data
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indices (price and others)
business cycle barometers
Theory


identify patterns
are patterns regular?
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Data and Patterns: Warren Persons
Harvard Business-Cycle Barometer
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Natural Cycles
Tides – Morro Bay, California
Musical Instruments
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Wesley Clair Mitchell (1874-1948): Cycles are
Qualitatively Not Quantitatively Similar
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Cycles Have Deep Hidden Causes
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Business cycles are like
the tides, only vastly
more complex
Hierarchy of cycles:
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Kitchen (40 month)
Juglar (9-10 years = 3 
Kitchen’s)
Kondratieff (60 years = 6
 Juglar’s)
Joseph Schumpeter (1883-1950)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Clément Juglar: Credit Cycles
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Every cycle has a
proximate trigger – the
straw that breaks the
camel’s back
But cycles have a
deeper root cause – the
ebb and flow of
financial credit
Clément Juglar (1819-1905)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Cycles Have Real Causes

Jevons: business cycles
follow agricultural
cycles, which follow the
cycle of sunspots
William Stanley Jevons (1835-1882)

Henry Ludwell Moore (1869-1958)
Moore: business cycles
are closely correlated to
cycles in the orbit of
Venus
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Summer School (Module 2), July 2011
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Problem of the 1920s and 1930s
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Monetary theory is theoretically more
developed
Business cycle analysis is the premier
empirical analysis of the whole economy
How can they be brought into contact:
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Frisch
Tinbergen
Keynes
and many others
Foundation of the Econometric Society (1933)
Center for the History of Political Economy
Summer School (Module 2), July 2011
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Thanks

The End
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Summer School (Module 2), July 2011
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