Milton Friedman

Economics 882 History of Modern Macroeconomics (Spring 2013,

Module 2) 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


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)


Module 2) 3

Chicago – the Older GenerationFrank Knight 1885-1972

Jacob Viner 1892-1970

Henry Simons

1889-1946


Module 2) 4

Chicago – Friedman’s Generation

Stigler, Friedman, Galbraith

Aaron Director (1901-2004)

George Stigler (1911-1991), Nobel Laureate

(1980)


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)


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)


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


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


Module 2) 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


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


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 runAnna J. Schwartz (1915-

2012 )


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


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


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)


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


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- )


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


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


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


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


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


Module 2) 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- )


Module 2) 23

The Fed’s Monetarist Experiment: Outcome

Treasury Yields

0

5

10

15

20

1971 1975 1979 1983 1987

Yie

ld t

o M

atu

rity

(p

erce

nt)

3-month Treasury Bill

10-year Treasury Bond

October 1979-December 1982


Module 2) 24

Milton and Arnold


Module 2) 25

Thanks

The End

Milton Friedman

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