Leijonhufvud on Friedman

Before it was hijacked by Paul Krugman, Scott Sumner and I were having a friendly little argument about whether Milton Friedman repackaged the Keynesian theory of the demand for money as the quantity theory of money transmitted to him via a fictitious Chicago oral tradition, as I, relying on Don Patinkin and Harry Johnson, claim, or whether Friedman was a resolute anti-Keynesian, as Scott claims. We have been trading extended quotations from the literature to try to support our positions.

I now offer some additional quotations, all but one from Axel Leijonhufvud’s wonderful essay “The Wicksell Connection: Variations on a Theme,” published in Leijonfuvud’s volume Information and Coordination (Oxford University Press, 1981). By some coincidence, the quotations tend to support my position, but, more importantly, they shed important light on problems of interpreting what Keynes was really talking about, and suggest a way of thinking about Keynes that takes us beyond the sterile ideological debates into which we tend lapse at the mere mention of the name John Maynard Keynes, or for that matter, Milton Friedman. Of course, the main lesson that readers should take away is: read the whole essay.

Herewith are a few extracts in which Leijonhufvud comments on Friedman and his doctrinal relationship with Keynes.

Milton Friedman has emphatically denied that the elasticity of LM is at issue [in the Monetarist v. Keynesian controversies]. At the same time his use of what is basically an IS-LM structure in presenting his own theory, and his oft-repeated insistence that no theoretical issues but only questions of empirical magnitudes within this shared theoretical frame separate him from his opponents, have apparently fortified others in their belief that (whatever he says) this elasticity must be crucial. Furthermore, Friedman has himself played around with elasticities, for example in advancing the notion of a horizontal IS curve. (p. 144, fn. 22)

The troubles with keeping track of the Wicksellian theme in its Keynesian guises and disguises go far back in time. The original “Savings-equals-Investment” debate did not reach a clear-cut collective verdict. As Lipsey [“The Foundations of the Theory of National Income: An Analysis of Some Fundamental Errors”] has recently shown, confusion persists to the present day. The IS-LM framework did not lend itself too well to a sharp characterization of the question whether the excess demand for bonds or the excess demand for money governs the interest rate. It was concluded that the distinction between the Loanable Funds and Liquidity Preference hypotheses was probably either pointless or misleading and that, in either case, the issue could safely be left unresolved. Correspondingly, Hansen found, Keynes’ insistence that saving and investment determine income while money stock and liquidity preference determine the rate of interest (rather than the other way around) makes no sense once you realize that, in IS-LM, everything simultaneously determines everything.

In Hansen’s reading Keynes’ interest theory was “indeterminate” – money supply and demand could not determine the interest rate, as Keynes would have it, but only give you the LM curve, etc. This way of looking at it missed the issue of which excess demand governs the interest rate.

One is reminded of Hansen’s indeterminacy charge by Friedman’s more recent argument that Keynes’ theory suffered from a “missing equation” – and should be completed by adding an exogenously determined price level. Keynes’ theory . . . was of the dynamic-historical variety. In describing the state of the system at some point in the sequential process, such theories make use of information about the system’s initial (historical) state. Static models do not use historical information, of course, but have to have equations for all endogenous variables. Reading a dynamic-historical theory on the presumption that it is static, therefore, is apt to lead to the mistaken impression that it lacks equations and is indeterminate. (pp. 180-81 and fn. 84)

Friedman, like so many others, filters Keynes and Keynesian theory through the IS-LM model and, consequently, ends up where everyone else ends up: bogged down in the Neoclassical Synthesis, which is to say, with the conclusion that exogenous fixity of money wages was Keynes’ explanation of unemployment. His discussion is notable for a sophisticated treatment of Keynes’ demand for money function and for its sweeping endorsement of the Pigou-effect. . . . (p. 189)

I break off from the final quotation, which is just a small part of an extended discussion of Friedman, because the argument is too dense to summarize adequately, and the entire lengthy passage (pp. 187-94) has to be read to grasp its full import. But I close with one final quotation from Leijonhufvud’s essay “Schools, ‘Revolutions,’ and Research Programmes in Economic Theory,” also contained in Information and Coordination (pp. 291-345).

The most widely known “monetarist,” Professor Milton Friedman, has for a long time consistently voiced the position that “monetarists” and “(neo)-Keynesians” share essentially the same theory and that their differences all derive from contrasting hypotheses concerning certain crucial empirical magnitudes. (He has also, however, persistently denied that the issues can be defined as a “simple” matter of the magnitude of the interest-elasticity of the excess demand for money – an otherwise oft-repeated contention in the debate.) In his recent attempts to provide an explicit representation for his theory, accordingly, Friedman chose ot use the “Keynesian” so-called “IS-LM” framework as his language of formal discourse.

In my opinion, there are “hard core” differences between the two theories and ones, moreover, that the “IS-LM” framework will not help us define. Not only are these differences at the “cosmological” level not accurately represented by the models used, but they will also lead to divergent interpretations of empirical results. (pp. 298-99, fn. 10)

The last paragraph, I suspect, probably sums up not just the inconclusiveness of the debate between Monetarists and Keynesians, but also the inconclusiveness of the debate about whether Friedman was or wasn’t a Keynesian. So be it.


13 Responses to “Leijonhufvud on Friedman”

  1. 1 Bill Woolsey August 13, 2013 at 8:17 pm

    Good contribution.


  2. 2 Tom August 13, 2013 at 9:19 pm

    “Friedman, like so many others, filters Keynes and Keynesian theory through the IS-LM model and, consequently, end up where everyone else ends up: bogged down in the Neoclassical Synthesis.”

    It seems to me that the IS LM model, so beloved of many neo-Keynesians and Monetarists marks the complete separation with Wicksell and the nature of credit disequilibrium that Wicksell’s followers were particularly interested in. As highlighted in diagram 1, Fisher and Friedman were mostly uninterested in this issue due to their focus on quantity theory. The 1937 debate between Ohlin, Robertson, Hawtrey vs Keynes (Alternative theories of the rate of interest) emphasises Keynes’ departure from Wicksell too (as did the GT). To me the more interesting argument is not the similarities between Keynes and Friedman on this point but why the Wicksell Connection has been lost and credit disequilibrium mostly ignored (with the exception of Laidler and Leijonhufvud)


  3. 3 Ray Newton August 14, 2013 at 2:19 am


    First let me assert that I did not open dialogue with this website because I had nothing better to do, I am very active in the financial markets. It is as addictive to me as golf is to a golfer, or fishing to an angler. It is my sport.

    I have no personal vendetta with you, any poster, or even the long past economic theorists to whose names, here, require such constant reference, and their works subjected to such analytic profound discussion.

    My objective is merely to draw attention to those who come here looking for economic enlightenment, to question just how useful it all is, in the real world, once the necessary requirements have been fulfilled to acquire that diploma to hang in the office, or wherever and that proclaims one now fit to apply one’s profession to the world – for better, or for worse. (Why is it that those upon whom the highest office is bestowed appear, at least to the naive, always choose the latter)

    Here are some things to think about. Mr B. Bernanke and his predecessors (long list of them) have all gone through the academic mill, most of them at the most prestigious institutes. Now, if all those theories had any real substance in formulating a sound economic policy, just where did it go wrong? I mean, do you think they all suffered a mental relapse once they had reached a position most budding economists hardly dare dream to attain?

    Let us look at the opening paragraph of the latest offering: –

    “…Before it was hijacked by Paul Krugman, Scott Sumner and I were having a friendly little argument about whether Milton Friedman repackaged the Keynesian theory of the demand for money as the quantity theory of money transmitted to him via the Chicago oral tradition, as I, relying on Don Patinkin and Harry Johnson, claim, or whether Friedman was a resolute anti-Keynesian, as Scott claims. We have been trading extended quotations from the literature to try to support our positions…..”

    I ask a simple question – what does it matter? Will arriving at either a negative, or positive, conclusion help us to save our world from economic mismanagement of such ’empirical magnitude’ (borrowed from Leijonhufvud, don’t quite know what it means but it sounds erudite) that we are now experiencing and are almost certainly committed to endure for many years to come – along with our children not yet born?

    Then if we wade through the whole account, we arrive at the summing up in the last paragraph. Personally, I read that first, as I was taught, for that is usually where the essence is revealed. David also acknowledges this.

    I quote: “The last paragraph, I suspect, probably sums up not just the inconclusiveness of the debate between Monetarists and Keynesians, but also the inconclusiveness of the debate about whether Friedman was or wasn’t a Keynesian. So be it.”

    I know Tom, and most, if not all, who contribute here will either not see, or agree with, my point. However,
    ” The Moving Finger writes; and, having writ, Moves on: nor all thy Piety nor Wit, shall lure it back to cancel half a Line, nor all thy Tears wash out a Word of it…..”

    I wish you all well.


  4. 4 Ray Newton August 14, 2013 at 3:03 am

    I deliberately did not include this above, because I understand the way to eat an elephant is one bite at a time.

    Might I suggest that you try to imagine that you have been gifted with the ‘eureka’ touch and brought forth an economic ‘theory’ that would supplant all others and would bring it to the level of ’empirical’ standing of a Newtonian (no, not this Newton) ‘law’.

    I know it is stretching the imagination to the limit, but go along with me, so far. I ask you the question – Do you think it would be accepted by those in the position to bestow such an honour?

    Have you not considered the possibility that what so many, and many who should know better, view as economic mismanagement, has a contrived purpose with an ulterior motive for which it would be deemed ‘highly efficient’ management. One that permits the man at the helm to retain his job and enjoy the rewards of office, and the pats on the back from those who put him there, his compensation for ” suffering the slings and arrows of outrageous fortune’, from those whose suffering is more profound.


  5. 5 Luis August 14, 2013 at 12:16 pm

    As I said some days ago (and mr. Glasner doesn’t comment it) Friedman was a very follower of Wicksell’s Natural Interest Rate. You can see it in http://www.aeaweb.org/aer/top20/58.1.1-17.pdf, the most famous Friedman’s piece of 1968
    From which I take only one paragraph:

    Thanks to Wicksell, we are all acquainted with the concept of a “natural”rate of interest and the possibility of a discrepancy betweenthe “natural”and the “market”rate. The preceding analysis of interestrates can be translated fairly directly into Wickse]lian terms. The mon-etary authority can make the market rate less than the natural rate only by inflation. It can mnake the market rate higher than the naturalrate only by deflation. We have added only one wrinkle to Wicksell-the Irving Fisher distinction between the nominal and the real rate ofinterest. Let the monetary authority keep the nominalmarket rate for atime below the natural rate by inflation. That in turn will raise thenominal natural rate itself, once anticipations of inflation become wide-spread, thus requiring still more rapid inflation to hold down the mar-ket rate. Similarly, because of the Fisher effect, it will require notmerely deflation but more and more rapid deflation to hold the marketrate above the initial “natural”rate.
    i don’t know if in any other occasion Friedman broke with this fundamental (and misconceaved) idea, that is certainly for me a definitive barrier between Keynes and the monetarism. The NRI is truly incompatible with the Liquidity Trapp.


  6. 6 Luis August 14, 2013 at 12:28 pm

    … Obviously, the Natural Rate is determined by real saving and investment, which is perhaps a Great contradicction with Friedman monetarism. I don’t know, really.


  7. 7 Blue Aurora August 14, 2013 at 8:55 pm

    I like your references to Axel Leijonhufvud (sp?). Although this debate over intellectual history may essentially result in status quo antebellum, as far as I’m concerned David Glasner, your view on Milton Friedman is more than just supportable and debatable.

    However, there is a little unresolved matter involving Ulrich Bindseil that I’d like resolved, please.



  8. 8 Tas von Gleichen August 17, 2013 at 5:54 am

    No way that Friedman was an Keynesian.


  9. 9 David Glasner August 28, 2013 at 9:24 am

    Bill, Thanks.

    Tom, You are right that the Monetarists and many of the Keynesians became disconnected from the Wicksellian ideas that deeply influenced Keynes. But in his debt-deflation theory, Fisher actually reconnected, either intentionally or inadvertently, reconnected with many of those ideas.

    Ray, Thanks for sticking around as long as you did, and sorry to disappoint. I guess my expectations for what a blog like this can accomplish are a lot less grandiose than yours.

    Luis, Thanks for reminding me of Friedman’s discussion of the Wicksellian natural rate. I now find it extremely oversimplified and inadequate for exactly the same reason that his discussion of the natural rate of interest is inadequate and oversimplified, namely that it implicitly assumes that the natural rate is invariant with respect to the macroeconomic state of the economy.

    Blue Aurora, Thanks. Sorry to take so long to respond to your question about the Bindseil book, but I have never seen it. In looking at it briefly on Amazon, I found it to be very interesting and worth a closer reading, but that doesn’t mean that I will actually read it any time soon.

    Tas, Well I say, let’s take him at his word. He said “we are all Keynesians now and none of us are Keynesians any more.” So, go figure.


  10. 10 Blue Aurora August 30, 2013 at 4:16 am

    David Glasner: Well, at least you finally got around to answering my question on Ulrich Bindseil’s book. And I understand perfectly – unfortunately, we have only so much time in this world.


  11. 11 Tom August 30, 2013 at 2:10 pm

    David, you are right that Fisher connected to a limited extent in Debt and deflation theory, however, Fisher rarely referred to Wicksell’s work directly (even in Booms and Depressions there is only 1 reference to an earlier piece from Wicksell). Wicksell’s theory is far more nuanced than Fisher’s ideas in Debt and Deflation. Moreover, the error in Wicksell’s work on price stability was central to Fisher’s thesis, an error that David Davidson pointed out to Wicksell. (George Selgin has done some excellent work on this). As such I think Leijonhufvud’s framing of the problem is still valid.


  12. 12 David Glasner August 31, 2013 at 7:52 pm

    Tom, I agree generally agree with your assessment of Fisher’s monetary theory. He made many important contributions, but there were also significant gaps and the debt-deflation theory only partially filled the gap. On Wicksell, I agree that he overestimated price stability as a criterion for overall macro-stability, but the critique of his work by Davidson and the Austrians was not fully correct either insofar as it failed to see that in principle the condition for macro-stability is correct anticipation of the future price level, not stability or deflation equal to real growth.


  1. 1 Noted for August 17, 2013 Trackback on August 17, 2013 at 7:31 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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