1. Center for the History of Political Economy Summer School June 2014
History of Modern Macroeconomics Lecture 3.6 The Monetarist Counter-Revolution ( ) 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

2. 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 ( ), Nobel Laureate (1976)
Center for the History of Political Economy Summer School June 2014

3. Chicago – the Older Generation
Frank Knight
Jacob Viner
Henry Simons
Center for the History of Political Economy Summer School June 2014

4. Chicago – Friedman’s Generation
Aaron Director ( )
George Stigler ( ), Nobel Laureate (1980)
Stigler, Friedman, Galbraith
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 ( ), Nobel Laureate (1971)
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)
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
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
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
Center for the History of Political Economy Summer School June 2014

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

11. Center for the History of Political Economy Summer School June 2014
The History of Money
The Monetary History of the United States, (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 ( )
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
Center for the History of Political Economy Summer School June 2014

13. Center for the History of Political Economy Summer School June 2014
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
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:
“greenbacks”
gold standard
Federal Reserve under gold standard (discount policy dominates)
off domestic gold standard
Treasury fixes short and long interest rates (1945 on Bretton Woods agreement)
Federal Reserve “bills only” policy (open-market operations and interest-rate policy dominates)
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
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
( )
Peter Temin
( )
Center for the History of Political Economy Summer School June 2014

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

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

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

20. Center for the History of Political Economy Summer School June 2014
Monetarism
Origins of the term obscure:
oral tradition: due to Karl Brunner ( )
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
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
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 ( )
Center for the History of Political Economy Summer School June 2014

23. The Fed’s Monetarist Experiment: Outcome
October 1979-December 1982
Center for the History of Political Economy Summer School June 2014

24. Center for the History of Political Economy Summer School June 2014
Milton and Arnold
Center for the History of Political Economy Summer School June 2014

25. Center for the History of Political Economy Summer School June 2014
Thanks 
The End
Center for the History of Political Economy Summer School June 2014