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Milton Friedman

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. Milton Friedman. Rutgers BA Homer Jones (quantity theorist)

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Milton Friedman

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  1. History of Modern MacroeconomicsLecture 3.6 The Monetarist Counter-Revolution (1956-1982) Kevin D. HooverDepartment of EconomicsDepartment of PhilosophyCenter for the History of Political EconomyDuke University 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) 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 Economics 882 History of Modern Macroeconomics (Spring 2013, Module 2)

  4. 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)

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

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

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

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

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