Archive for the 'Friedman' Category

Next Entries »

Friedman and Schwartz on James Tobin

Published April 15, 2012 Friedman , monetary theory 19 Comments

Nick Rowe and I, with some valuable commentary from Bill Woolsey, Mike Sproul and Scott Sumner, and perhaps others whom I am not now remembering, have been having an intermittent and (I hope) friendly argument for the past six months or so about the “hot potato” theory of money to which Nick subscribes, and which I deny, at least when it comes to privately produced bank money as opposed to government issued “fiat” money. Our differences were put on display once again in the discussion following my previous post on endogenous money. As I have mentioned many times, my view of how banks operate is derived from one of the best papers I have ever read, James Tobin’s classic 1963 paper “Commercial Banks as Creators of Money,” a paper that in my estimation would, on its own, have amply entitled Tobin to be awarded the Nobel Prize. If you haven’t read the paper, you should not deny yourself that pleasure and profit any longer.

A few months ago, I stumbled across the PDF version of one of the relatively obscure follow-up volumes to the Monetary History of the US that Friedman and Schwartz wrote: Monetary Statistics of the US: Estimates, Sources, Methods. Part one of the book is an extended discussion about the definition of money, presenting various historical definitions of money and approaches to defining money. I think that I read parts of it when I was in graduate school, perhaps when I took Ben Klein’s graduate class monetary theory. As one might expect, Friedman and Schwartz spent a lot of time on discussing a priori versus pragmatic or empirical definitions of money, arguing that definitions based on concepts like “the essential properties of the medium of exchange” (title of a paper written by Leland Yeager) inevitably lead to dead ends, preferring instead definitions, like M2, that turn out to be empirically useful, even if only for a certain period of time, under a certain set of monetary institutions and practices. In rereading a number of sections of part one, I was repeatedly struck by how good and insightful an economist Friedman was. Since I am far from being an unqualified admirer of Friedman’s, it was good to be reminded again that despite his faults, he was a true master of the subject.

At any rate, on pp. 123-24, there is a discussion of definitions based on a concept of “market equilibrium.”

Gramley and Chase, in a highly formal analysis of monetary adjustments in the shortest of short periods (Marshall’s market equilibrium contrasted with his short-run and long-run equilibriua), discuss the definition of money only incidentally. Yet their analysis qualifies for consideration along with the analyses of Pesek and Saving, Newlyn, and Yeager because, like the others, Gramley and Chase believe that far-reaching substantive conclusions about monetary analysis can be derived from rather simple abstract considerations and like, Newlyn and Yeager, they put great stress on whether the decisions of the public can or do affect monetary totals. That “the stock of money” is “an exogenous variable set by central bank policy,” they regard as one of the “time-honored doctrines of traditional monetary analysis.” They contrast this “more conventional view” with the “new view” that “open market operations alter the stock of money balances if, and only if, they alter the quantity of money demanded by the public.

In a footnote to this passage, Friedman and Schwartz add the following comment (p. 124).

In this respect [Gramley and Chase] follow James Tobin, “Commercial Banks as Creators of ‘Money.'” . . . Tobin presents a lucid exposition of commercial banks as financial intermediaries with which we agree fully and which we find most illuminating. His analysis, like that of Pesek and Saving, Newlyn, and Yeager, and as we shall note, Gramley and Chase, demonstrates that emphasis on supply considerations leads to a distinction between high-powered money and other assets but not between any broader total and other assets. Unlike Gramley and Chase, Tobin explicitly eschews drawing any far-reaching conclusions for policy and analysis from his quantitative analysis.

Then on p. 135, Friedman and Schwartz in a critical discussion of the New View, of which Tobin’s paper was a key contribution, observed:

This approach is an appropriate theoretical counterpart to an analysis of changes in income and expenditure along Keynesian lines. That analysis takes the price level as an institutional datum and therefore minimizes the distinction between nominal and real magnitudes. It takes interest rates as essentially the only market variable that reconciles the structure of assets supplied with the structure demanded.

In a footnote to this passage, Friedman and Schwartz add this comment.

It is instructive that economists who adopt this general view write as if the monetary authorities could determine the real and not merely the nominal quantity of high-powered money. For example, William C. Brainard and James Tobin in setting up a financial model to illustrate pitfalls in the building of such models use “the replacement value of . . . physical assets . . . as the numeraire of the system,” yet regard “the supply of reserves” as “one of the quantities the central bank directly controls (“Pitfalls in Financial Model-Building,” AER, May 1968, pp. 101-02). If the nominal level of prices is regarded as an endogenous variable, this is clearly wrong. Hence the writers must be assuming this nominal level of prices to be fixed outsider their system. Keynes’ “wage unit” serves the same role in his analysis and leads him and his followers also to treat the monetary authorities as directly controlling real and not nominal variables.

But there is no logical necessity that requires the New View so elegantly formulated by Tobin to be deployed within a Keynesian framework rather than in a non-Keynesian framework in which some monetary aggregate, like the stock of currency or the monetary base, rather than M1 or M2, is what determines the price level. The stock of currency (or the monetary base) can function as the hot potato that determines (in conjunction with all the other variables affecting the demand for currency or the monetary base) the price level. Denying that bank money is a hot potato doesn’t require you to treat the price level “as an institutional datum.” Friedman, almost, but not quite, figured that one out.

A New Version of My Paper (With Ron Batchelder) on Hawtrey and Cassel Is Available on SSRN

Published March 29, 2012 Cassel , Friedman , gold standard , Hawtrey , Keynes , monetary history , monetary policy , monetary theory 7 Comments

It’s now over twenty years since my old UCLA buddy (and student of Earl Thompson) Ron Batchelder and I started writing our paper on Ralph Hawtrey and Gustav Cassel entitled “Pre-Keynesian Monetary Theories of the Great Depression:  Whatever Happened to Hawtrey and Cassel?”  I presented it many years ago at the annual meeting of the History of Economics Society and Ron has presented it over the years at a number of academic workshops.  Almost everyone who has commented on it has really liked it.  Scott Sumner plugged it on his blog two years ago.  Scott’s own very important work on the Great Depression has been a great inspiration for me to continue working on the paper.  Doug Irwin has also written an outstanding paper on Gustav Cassel and his early anticipation of the deflationary threat that eventually turned into the Great Depression.

Unfortunately, Ron and I have still not done that last revision to make it the almost-perfect paper that we want it to be.  But I have finally made another set of revisions, and I am turning the paper back to Ron for his revisions before we submit it to a journal for publication.  In  the meantime, I thought that we should make an up-to-date version of the paper available on SSRN as the current version (UCLA working paper #626) on the web dates back to (yikes!) 1991.

Here’s the abstract.

A strictly monetary theory of the Great Depression is generally thought to have originated with Milton Friedman.  Designed to counter the Keynesian notion that the Great Depression resulted from instabilities inherent in modern capitalist economies, Friedman’s explanation identified the culprit as an inept Federal Reserve Board.  More recent work on the Great Depression suggests that the causes of the Great Depression, rooted in the attempt to restore an international gold standard that had been suspended after World War I started, were more international in scope than Friedman believed.  We document that current views about the causes of the Great Depression were anticipated in the 1920s by Ralph Hawtrey and Gustav Cassel who warned that restoring the gold standard risked causing a disastrous deflation unless an increasing international demand for gold could be kept within strict limits.  Although their early warnings of potential disaster were validated, and their policy advice after the Depression started was consistently correct, their contributions were later ignored and forgotten.  We offer some possible reasons for the remarkable disregard by later economists of the Hawtrey-Cassel monetary explanation of the Great Depression.

Was Milton Friedman a Closet Keynesian?

Published March 16, 2012 Friedman , Keynes , monetary theory 40 Comments

Commenting on a supremely silly and embarrassingly uninformed (no, Ms. Shlaes, A Monetary History of the United States was not Friedman’s first great work, Essays in Positive Economics, Studies in the Quantity Theory of Money, A Theory of the Consumption Function, A Program for Monetary Stability, and Capitalism and Freedom were all published before A Monetary History of the US was published) column by Amity Shlaes, accusing Ben Bernanke of betraying the teachings of Milton Friedman, teachings that Bernanke had once promised would guide the Fed for ever more, Paul Krugman turned the tables and accused Friedman of having been a crypto-Keynesian.

The truth, although nobody on the right will ever admit it, is that Friedman was basically a Keynesian — or, if you like, a Hicksian. His framework was just IS-LM coupled with an assertion that the LM curve was close enough to vertical — and money demand sufficiently stable — that steady growth in the money supply would do the job of economic stabilization. These were empirical propositions, not basic differences in analysis; and if they turn out to be wrong (as they have), monetarism dissolves back into Keynesianism.

Krugman is being unkind, but he is at least partly right.  In his famous introduction to Studies in the Quantity Theory of Money, which he called “The Quantity Theory of Money:  A Restatement,” Friedman gave the game away when he called the quantity theory of money a theory of the demand for money, an almost shockingly absurd characterization of what anyone had ever thought the quantity theory of money was.  At best one might have said that the quantity theory of money was a non-theory of the demand for money, but Friedman somehow got it into his head that he could get away with repackaging the Cambridge theory of the demand for money — the basis on which Keynes built his theory of liquidity preference — and calling that theory the quantity theory of money, while ascribing it not to Cambridge, but to a largely imaginary oral tradition at the University of Chicago.  Friedman was eventually called on this bit of scholarly legerdemain by his old friend from graduate school at Chicago Don Patinkin, and, subsequently, in an increasingly vitriolic series of essays and lectures by his then Chicago colleague Harry Johnson.  Friedman never repeated his references to the Chicago oral tradition in his later writings about the quantity theory, e.g., his essay on the quantity theory of money in the International Encyclopedia of the Social Sciences.  But the simple fact is that Friedman was never able to set down a monetary or a macroeconomic model that wasn’t grounded in the conventional macroeconomics of his time.

Friedman was above all else a superb applied price theorist who wound up doing a lot of worthwhile empirical work and historical on monetary economics, but his knowledge of the history of monetary theory seems to have been pretty much confined to whatever he learned from his teacher Lloyd Mints’s book, A History of Banking Theory in Great Britain and the United States and probably from a classic book, Studies in the Theory of International Trade, by Jacob Viner, another one of Friedman’s teachers at Chicago  That’s why when Friedman finally published an article in two part in the Journal of Political Economy in the early 1970s entitled “A Theoretical Framework for Monetary Analysis,” the papers pretty much flopped, and are now almost completely forgotten (but see here).  Actually Friedman’s intellectual forbears were really W. C. Mitchell and Friedman’s teacher at Columbia Arthur Burns from whom Friedman was schooled in the atheoretical, empirical approach of the old NBER founded by Mitchell.

But Krugman is not totally right either.  Although Friedman obviously liked the idea that the LM-curve was vertical, and liked the idea that money demand is very stable even more, those ideas were not essential to his theoretical position.  (Whether the stability of the demand for money was essential to his position would depend on whether Friedman’s 3-percent growth rule for the money supply is central to his thought.  Although Friedman obviously loved the 3-percent rule, I don’t think that objectively it was really that important to his intellectual position, his sentimental attachment to it notwithstanding.)  What really mattered was the idea that, in the long run, money is neutral and the long-run Phillips Curve is vertical.  Given those assumptions, Friedman could argue that ensuring reasonable monetary stability would lead to better economic performance than discretionary monetary or fiscal policy.  But Friedman, as far as I know, never actually considered the possibility of a negative equilibrium real interest rate.  That’s why, when we look for guidance from Friedman about the current situation, we can’t be completely sure what he would have said.  His comments on Japan suggest that he would have indeed favored quantitative easing.  But inasmuch as he did not explicitly advocate inflation, supporters and opponents of QE can make a case that Friedman would have been on their side.  My own view is that the argument that Friedman would have supported QE is not one of the five or even ten strongest arguments that could be made on its behalf.

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

Archives

Enter your email address to follow this blog and receive notifications of new posts by email.

Join 665 other subscribers
Follow Uneasy Money on WordPress.com