1. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

2. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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)

3. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 3 Chicago – the Older Generation Frank Knight 1885-1972 Jacob Viner 1892-1970 Henry Simons 1889-1946

4. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 4 Chicago – Friedman’s Generation Stigler, Friedman, Galbraith Aaron Director (1901-2004) George Stigler (1911-1991), Nobel Laureate (1980)

5. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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)

6. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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 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)

7. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

8. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

9. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 9 The Transmission Mechanism ↑M S > M D   Y,  p,  r, or other factors until M D = M S : 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: ↑M S > M D  ↓ r (long bond rate)  ↑ I

10. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

11. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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 run Anna J. Schwartz (1915- 2012 )

12. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

13. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

14. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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)

15. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

16. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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- )

17. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

18. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

19. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 19 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

20. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

21. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 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

22. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 22 The Fed’s Monetarist Experiment Replaces G. William Miller, September 1979 New monetary control strategy October 6 th 1979  monetary aggregate targeting  non-borrowed reserve control Kevin Hoover joins Fed December 10 th 1979 Credit control regime: January-June 1980 Reserve targeting abandoned 1982 Paul A. Volcker (1927- )

23. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 23 The Fed’s Monetarist Experiment: Outcome October 1979-December 1982

24. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 24 Milton and Arnold

25. Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2) 25 Thanks  The End