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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
1
Milton Friedman

Rutgers BA



Fellowship at Columbia




Milton Friedman (1912-2006),
Nobel Laureate (1976)
Henry Schultz
New Dealer
University of Wisconsin
World War II



Harold Hotelling
Chicago Graduate Study


Homer Jones (quantity
theorist)
Arthur Burns (NBER business
cycles)
Treasury
statistician
Chicago Professor 1946

replaced Viner
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
2
Chicago – the Older Generation
Frank Knight
1885-1972
Henry Simons
1889-1946
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
Jacob Viner
1892-1970
3
Chicago – Friedman’s Generation
Aaron Director
(1901-2004)
George Stigler (1911-1991),
Nobel Laureate (1980)
Stigler, Friedman, Galbraith
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
4
Friedman and Consumption



Simon Kuznets (1901-1985),
Nobel Laureate (1971)
PhD Thesis: Income
from Independent
Professional Practice
with Simon Kuznets
(1945)
 permanent-income
hypothesis
 A Theory of the
Consumption Function
(1957)
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
5
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 Function” (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)
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
6
“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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
7
“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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
8
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
9
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
10
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 run
Anna J. Schwartz (1915- 2012
)
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
11
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
12
Causal Strategy
C
E
A
D

B
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
13
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)
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
14
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
15
The Great Depression as the Test Case

Benjamin Strong
(1872-1928)

Peter Temin
(1937- )
Benjamin Strong would
have saved us from the
Great Depression
Peter Temin, Did
Monetary Forces Cause
the Great Depression
(1976)
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
16
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
17
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
18
Financial Innovation

Kaldor, “The New Monetarism” (Lloyds Bank Review
1970)




stability of velocity and 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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
19
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
20
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
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
21
The Fed’s Monetarist Experiment


Replaces G. William Miller,
September 1979
New monetary control
strategy October 6th 1979




Paul A. Volcker (1927- )

monetary aggregate
targeting
non-borrowed reserve
control
Kevin Hoover joins Fed
December 10th 1979
Credit control regime:
January-June 1980
Reserve targeting
abandoned 1982
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
22
The Fed’s Monetarist Experiment:
Outcome
Treasury Yields
20
October 1979-December 1982
Yield to Maturity (percent)
15
10-year Treasury Bond
10
5
3-month Treasury Bill
0
1971
1975
1979
1983
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
1987
23
Milton and Arnold
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
24
Thanks

The End
Economics 882 History of Modern
Macroeconomics (Spring 2013, Module 2)
25