Cagan, Phillip
A icle
Mone a ism in His o ical Pe spec i e
K edi und Kapi al
P o ided in Coope a ion wi h:
Duncke & Humblo , Be lin
Sugges ed Ci a ion: Cagan, Phillip (1976) : Mone a ism in His o ical Pe spec i e, K edi und Kapi al,
ISSN 0023-4591, Duncke & Humblo , Be lin, Vol. 9, Iss. 2, pp. 154-163,
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Mone a ism in His o ical Pe spec i e
By Phillip Cagan, New Yo k/N. Y.*
The Bullionis s e sus he An i-Bullionis s, he Cu ency School e sus
he Banking School, and now he Mone a is s e sus he Fiscalis s. Wha
jolly good spo o pa icipa e in a amous deba e. I encou ages a
lowe ing o hough and economic esea ch, no o men ion con e ences
and g an s. Pa icipan s in he o me deba es we e immo alized in
nume ous Ph. D. disse a ions and schola ly his o ies o hough [9, 16].
Alas, no one ca es abou he his o y o economic hough any mo e.
Hence we mus p o ide ou own accoun . Hence his collec ion o com-
men a ies.
Bu does any one o he han he pa icipan s ca e much abou his
deba e? Pe haps no . Ye he issues ha e a - eaching implica ions o
he conduc o policy and a e a se ious ma e . In his ca e ul e iew o
he issues, Thomas Maye la gely bypasses he his o ical an eceden s o
p esen -day mone a ism.** I belie e he an eceden s me i a en ion.
I. P o essional Opinion in he 1940s and Ea ly 1950s
No one who was no in ouch wi h he economics p o ession in he
1940s and ea ly 1950s can qui e imagine he s a e o hinking hen in
he p o ession a la ge on mone a y heo y and policy. The quan i y o
money was no conside ed impo an , indeed was ha dly wo h men-
ioning, o ques ions o agg ega e demand, unemploymen , and e en
in la ion. Pe use he jou nals o ha pe iod! The analyses may ha e
con ained an "LM" cu e, ollowing Hick's [4] amous in e p e a ion
o Keynes, bu ex ual discussions o heo y and policy in a icle a e
a icle ha dly men ioned he quan i y o money a all. Tex books in
basic economics and e en in money and banking men ioned he quan i y
heo y o money, i a all, only o hold i up o idicule. Those ex books
p oduced an en i e coho o p o essional economis s who became he
* Commen s om Anna J. Schwa z on an ea lie d a we e mos help ul.
** Vol. 8 (1975) pp. 191 and pp. 293.
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Mone a ism in His o ical Pe spec i e 155
eache s o ho des o economics s uden s. The e we e, o cou se, many
excep ions, mos no ably a he Uni e si y o Chicago and among some
eache s o mone a y economics whose in ellec ual he i age eached back
in o he 1920s. Bu i you a eled among he p o ession a la ge, men-
ion o he quan i y o money elici ed puzzled glances o disbelie o
sly smiles o condescension.
Mone a ism is a eac ion o ha ea lie inhospi able en i onmen .
Indeed, i he e had no been a ime when mos o he p o ession said
"money does no ma e ',' i would ne e ha e occu ed o anyone o say
"money does ma e " [7]. Much o he mone a is message a i s was
in ended simply o eacquain he p o ession wi h he p inciples o money
known in he 1920s, which had i s been denied and hen widely o -
go en du ing he 1930s and 1940s. Tha pu pose has now been accom-
plished, hanks no doub mo e o se e al decades o in la ion han o
he p eachings o he mone a is s. Ne e heless, now ha mone a is s
ha e come ou o he wilde ness, ew would deny hem sel -sa is ac ion
o he enewed in e es in money and mone a y policy and i s a o able
ecogni ion again in ex books.
II. The Rela i e Impo ance o Money
Indeed, mone a ism has gained such a en ion ha i s opponen s ha e
ea ed ha i migh sweep away e e y hing else. They ha e aised he
spec e ha mone a is s claim ha "only money ma e s". Tha was
ne e claimed. Wha he opponen s mis ook o such a claim, pe haps,
was he lesse one implied by some mone a is s' w i ings ha , among
he lis o in luences on agg ega e demand, money should s and a he
op. The suppo ing a gumen is ha changes in he money s ock in-
e i ably a ec agg ega e demand, albei o en slowly. The o he in lu-
ences ha e unce ain e ec s. They depend, unlike money, upon edis-
ibu i e e ec s, money illusion, o coope a i e changes in he money
s ock, in which he ne esul s can di e ma e ially om case o case.
This issue was a gued a he B own Uni e si y Con e ence on Mone-
a ism in 1974 [15]. No one he e dispu ed he impo ance o money,
and mos o he p oceedings we e de o ed o he impo ance i any o
a ach o iscal policy. The iscalis s poin ed ou ha he majo eco-
nome ic models show a la ge e ec om changes in go e nmen expen-
di u es o ax a es. Bu i is no clea how much he e ec depends
upon he Keynesian s uc u e o he models and he coope a ion o an
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156 Phillip Cagan
expanding money s ock. On a heo e ical le el iscal e ec s (wi h he
money s ock cons an ) depend upon he in e es elas ici y o he demand
o money balances (because he e ec o a go e nmen de ici on in-
e es a es which induces a mo e ac i e use o money balances is needed
o suppo an inc ease in expendi u es) and upon he ex en o which
u u e ax liabili ies o go e nmen bond in e es a e discoun ed (be-
cause go e nmen bo owing can be o se by an inc ease in axpaye s'
sa ing) [5 a]. As I poin ed ou in my published commen s a he con-
e ence [15], all his makes he magni ude o he long- un (say o e
a yea o mo e) e ec o iscal policy unce ain.1 On he p esump ion
ha he ini ial impac o a change in expendi u es om a iscal ac ion
will ake place be o e he subsequen o ses s in p i a e spending as-
socia ed wi h he inancing o he ac ion, he e ec is likely o be much
g ea e in he sho un. E en so, he sho - un e ec o a ax cu can
also be small i he public iews i as empo a y, and he size o mul-
iplie e ec s o iscal expendi u es a e unce ain in he sho un be-
cause o he a iable size and speed o associa ed o se s (no o men-
ion adminis a i e delays).
Mone a y policy p esen s almos he opposi e iming pa e n. I s e -
ec s a e delayed and, in he sho un, a iable om case o case and
unce ain. Bu i builds up o a single long- un e ec , aside om
usually mino di e ences in he manne o changing he money s ock
(open ma ke ope a ions, change in ese e equi emen s, e c.). A sus-
ained change in he money s ock ends o p oduce a p opo ional
change in agg ega e expendi u es in he long un. The e a e no impo -
an quali ica ions o o se s o he e ec o mone a y changes on ag-
g ega e demand in he long un. A change in he demand o money
balances due o accompanying changes in in e es a es is an o se , bu
i canno las o e e and is la gely a e y sho un o se . The only
quali ica ion o he p oposi ion ha changes in money will ha e in-
e i able long- un e ec s on agg ega e demand a ises when he mone a y
change is a policy esponse o ac ual o an icipa ed changes in agg ega e
demand, o in some cases policy may accommoda e he money s ock
o demand changes which ha e al eady o igina ed in o he sho - un
in luences. In hose cases he causal connec ion be ween money and ag-
g ega e demand becomes muddled, because money is hen an endogenous
1 I conside a ion is gi en o a ious weal h e ec s o iscal ac ions, e en
he di ec ion o he e ec becomes unce ain [8]. The main mone a is p opo-
si ions do no , howe e , depend upon weal h e ec s.
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Mone a ism in His o ical Pe spec i e 157
a iable and no an independen sou ce o dis u bances o he economy.
Bu he possible endogenei y o money is no denied by mone a ism. All
ha mone a ism holds is ha money should be p ope ly con olled and
ha , i i is, i can con ol agg ega e demand.
Whe he o no money belongs a he op o he lis o in luences on
agg ega e demand is no a heo e ical ques ion o a gue abou , so long
as money is no bu ied in neglec a he bo om as i once was. The
ques ion is an empi ical one and will be se led by he weigh o e i-
dence. I was he impo ance o ga he ing he e idence which mo i-
a ed Mil on F iedman and Anna Schwa z o unde ake hei monu-
men al s udy o U.S. mone a y his o y [3]. They ound suppo o
hei iew ha money had been he mos impo an sou ce o dis u -
bances o he U. S. economy o e ha pe iod. I is ha d o imagine
aking s ong excep ion o hei inding, hough many do. I we ake
ano he s ep and conclude ha money will con inue o be a se ious po-
en ial sou ce o dis u bances unless p ope ly con olled, we en e in o
mone a is e i o y.
III. A Fixed Mone a y Rule
The p eceding empi ical p oposi ion abou he impo ance o money
suppo s a s ong p ima acie case o a policy o cons an g ow h in
he money s ock, he bê e noi e o he opponen s o mone a ism. I is
no en i ely a new p oposal. The immedia e an eceden was Hen y Si-
mons' ea ly a gumen s in a o o a cons an money s ock [14]2. This
has he bene i o simplici y o policy managemen and would a oid he
ho endous mis akes o policy ha p oduced de as a ing luc ua ions in
he money s ock o he pas . I has he disa an age, howe e , o no s a-
bilizing he p ice le el. Lloyd Min s p oposed ha policy con ol he
money s ock wi h a iew ins ead o s abilizing he p ice le el [10]. His
p oposal has since los i s appeal, because he p ice le el is no a sen-
si i e indica o o mone a y policy, an objec ion s eng hened by ex-
pe ience in ecen yea s. We ha e lea ned ha money a ec s p ices wi h
a long lag and ha mo emen s in p ices and ac i i y a e no closely
co ela ed in he sho un. Consequen ly, a policy o ying o s abilize
he p ice le el would no be success ul in he sho un and would en ail
subs an ial luc ua ions in mone a y g ow h.
2 See also Robe son's discussion [11] o policy iews in he 1920s.
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158 Phillip Cagan
I is na u al, he e o e, o u n back o he money s ock i sel as he
bes indica o o policy, and o p opose a cons an a e o g ow h con-
sis en wi h long- un p ice s abili y. Since he long- un end o mone-
a y eloci y changes om ime o ime, mode a e pe iodic changes
could be made in he ixed a e o mone a y g ow h o achie e ap-
p oxima e long- un cons ancy o he p ice le el.
An a gumen equen ly made agains such a p oposal is ha a dis-
c e iona y policy mus always domina e a ixed ule. I he au ho i ies
seek o s abilize he g ow h o agg ega e demand, cons an mone a y
g ow h will by chance and only occasionally be he op imal policy and
he e o e should no be speci ied be o ehand. Le he au ho i ies choose
he bes policy as hey go along; i cons an mone a y g ow h is he bes ,
i will be chosen. This is a silly a gumen and misses he poin . The
mone a is posi ion is based on he ac o ou igno ance and he mis-
akes ha a e bound o esul , whe eas he opposing a gumen assumes
op imiza ion o a known model o he economy. Once s ochas ic e ms
a e added o ep esen unce ain y, he op imal policy collapses owa d
i ual cons ancy o he policy ins umen in he sho un as he deg ee
o unce ain y inc eases. As F iedman poin ed ou [1], policy make s
mus ha e o ecas s and knowledge o he e ec s o hei ac ions ha
a e e y good indeed be o e hey can hope o educe a he han add
o he ins abili y in agg ega e demand. Maybe hey will someday, bu
who can be op imis ic?
No is ha all. Besides he e ec o s ochas ic e ms in models o e-
p esen unce ain y, he s uc u e o models en ails an unknown deg ee
o misspeci ica ion which can agg a a e policy e o s well beyond he
wo s anda d de ia ions o no mal s ochas ic e ms. In addi ion, he
kind o policy pu sued by he au ho i ies will i sel a ec he esponse
o he economy. Min s [10, p. 9 and elsewhe e] held he iew ha
public expec a ions o a cons an -p ice-le el policy would help o keep
he p ice le el s able. Unce ain, disc e iona y policies unde mine s a-
bilizing beha io by he public. Thus Benjamin Klein [5] concludes ha
he demise o he gold s anda d in he pe iod be ween he wo Wo ld
Wa s and absence o any clea commi men o s abilizing p ices has
made he p ice le el mo e ola ile han i used o be. In echnical e ms,
he inds ha changes in he p ice le el used o be eg essi e bu now
ollow a andom walk.
The same poin is de eloped u he wi h he new idea o " a ional
expec a ions" [6, 12, 13]. I he public bases economic decisions on ex-
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Mone a ism in His o ical Pe spec i e 159
pec a ions o med a ionally, ha is, wi h all he a ailable in o ma ion
and economic knowledge, hey will ake in o accoun wha is announ-
ced o known abou go e nmen and cen al bank policy. The con-
sequences a e ema kable and in iguing. The s anda d "Phillips Cu e"
is e ical ( ha is, no adeo exis s be ween in la ion and unemploy-
men ), and mone a y policy has no e ec on ou pu and employmen
bu only a ec s p ices.
Such models based on a ional expec a ions should no be aken as
accu a e desc ip ions o economic beha io , bu i is an empi ical ques-
ion whe he hey a e wo se app oxima ions o eali y especially oday
han a e he a ious econome ic models on which disc e iona y policy
p oposals a e based. These econome ic models de i e "op imal" dis-
c e iona y policies o ade o in la ion and unemploymen ; hey a e
able o do so because hey a e based on lags and ad hoc mechanical o -
mula ions o expec a ions by he public which a e dis inc ly i a ional
in e ms o he models hemsel es.3
Bu he ecen wo k on a ional expec a ions, hough consis en wi h
he mone a is adi ion, goes beyond i . Mone a ism is no based on a-
ional expec a ions and does no equi e hem.
Indeed, a mone a is in good s anding need no oppose all disc e ion-
a y mone a y policy. I migh be bene icial in pa icula ci cums ances.
The mone a is iew is a he ha disc e iona y mone a y policy has
no been bene icial o e -all in he pas , ha i s pe o mance in he
u u e canno by assump ion be aken as bene icial wi hou ques ion,
and ha in any e en disc e ion should be qui e limi ed and unde aken
wi h cau ion. (Keeping mone a y g ow h easonably cons an gi es he
au ho i ies plen y o do, so ixed mone a y g ow h is a om a "pas-
si e" policy.)
Mone a is s and hei opponen s disag ee on he deg ee o economic
s abili y o be achie ed wi h a policy o cons an o nea cons an mone-
a y g ow h. The mone a is s say he esul ing s abili y — no longe
dis u bed by domes ic mone a y in luences — will p obably be he bes
a ainable and "good enough", whe eas he opponen s say "no good
enough" and hink hey know how o do be e . This issue goes o he
hea o he deba e and does no appea capable o being se led o
3 As one who helped o popula ize mechanical expec a ions in a s udy o
hype in la ions done long ago be o e expec a ions en e ed empi ical models a
all, I welcome wo k on a ional expec a ions as an app op ia e an ido e.
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160 Phillip Cagan
e e yone's sa is ac ion by he kind o e idence so a a ailable. We
need expe ience wi h cons an mone a y g ow h. Ge man policy has
mo ed in ha di ec ion and, unde p odding om Cong ess, so has he
U. S. Fede al Rese e. Pe haps he u u e will b ing he needed e iden-
ce, bu i should be unde s ood ha easonably cons an mone a y
g ow h, s a ing in he mids o apid in la ion and wo ld economic
diso ganiza ion, needs mo e han a ew yea s o demons a e i s bene-
icial e ec s.
Deba es end o accen ua e ex eme iews. I should be emphasized,
he e o e, ha mone a is s do no claim ha easonably cons an mone-
a y g ow h (and i s necessa y co olla y, eely loa ing exchange a es)
will p oduce a millenium ee o dis u bances o he economy and o luc-
ua ions in economic ac i i y. They claim only ha economic ins abili y
will be much less han in he pas . Mone a is s may di e among hem-
sel es whe he some disc e iona y mone a y policy and sho - un a ia-
ions in mone a y g ow h could, unde good managemen , be bene icial
and wo h ying. Gi en he lags in mone a y e ec s, howe e , disc e-
iona y mone a y policy will ou pe o m a policy o cons an g ow h a
bes mode a ely, and wo se esul s a e a eal dange .
IV. Is a Disc e iona y Fiscal Policy Needed?
Mone a is s a e accused o claiming ha iscal policy has no e ec .
No so. The de ense o hose e ec s h own up by iscalis s is in espon-
se o a di e en mone a is a gumen , namely ha he p e e ence gen-
e ally gi en o iscal o e mone a y policy as a means o mode a ing
economic luc ua ions is a mis ake, and ha he o de o p io i y should
be e e sed. Fiscal measu es, pa icula ly expendi u es such as unem-
ploymen compensa ion, ob iously do ha e sho - un e ec s, and no h-
ing in mone a is hough opposes hei use o pu poses o sho - un
s abiliza ion, especially in iew o he long lags o mone a y policy.
F iedman o one has poin ed o he bene icial au oma ic e ec s o he
go e nmen budge o sho - un s abiliza ion and p oposed ha i be
nondisc e iona y [2]. One migh also se iously con empla e an ac i e
disc e iona y iscal policy. I see no basic con lic o such a iew wi h
mone a ism on a heo e ical le el.
The ca ch is he iscal pe o mance in p ac ice. He e mone a is s a e
skep ical o a eco d which iscalis s glo i y. As mone a is s sump up ou
expe ience wi h iscal policy, decisions o change he le el o go e n-
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Mone a ism in His o ical Pe spec i e 161
men expendi u es ha e adminis a i e lags jus as long as he "ou side"
lag o mone a y policy, while cyclical changes in ax a es, on which
iscal s abiliza ion in he U. S. has been o ced o concen a e, ha e un-
ce ain e ec s on consump ion expendi u es. Because o o ecas ing e -
o s, he o e -all con ibu ion o he s abiliza ion o mild business cycles
is open o ques ion. In se e e, p olonged ecessions he con ibu ion is
mo e likely o be bene icial and is widely accep ed. Tax changes o
s abiliza ion pu poses, howe e , a e di icul o con ol in a democ acy
because o hei e ec s on he dis ibu ion o income. The consequence
is he well known p e e ence o elec ed go e nmen s o cu s a he
han inc eases and he pe sis ence o de ici s when hey a e no ap-
p op ia e. Pe haps he managemen p oblems o iscal policy a e no
insupe able. Ye hey a e o midable.
As a i s s ep, he mone a is p oposals o mone a y policy should
be ino ensi e o a wide ange o economis s including neo-Keynesians
who migh ne e heless doub he deg ee o success o be achie ed wi h
s able mone a y g ow h alone. Whe he a disc e iona y iscal policy,
despi e he isks, is also desi able depends upon how unsuccess ul a
mone a is policy would be. The mone a is posi ion is ha , a e se -
e al yea s o easonably s able mone a y g ow h, disc e iona y iscal
changes would no be needed as a s abiliza ion ins umen .
V. Concluding Rema k
As is e iden om he abo e discussion, mone a ism in my iew is
mo e a se o p oposi ions abou policy and abou he empi ical esea ch
o suppo hem han a pa icula heo e ical model o he economy.
The co e o he mone a is iew is ha money is e y impo an and
ha easonably s able mone a y g ow h should be he cen e piece o
s abiliza ion policies.4
Re e ences
1. Mil on F iedman, The E ec o a Full-Employmen Policy on Economic
S abili y: A Fo mal Analysis, in his Essays in Posi i e Economics, Chicago,
1953. — 2. Mil on F iedman, A Mone a y and Fiscal F amewo k o Economic
S abili y, Ame ican Economic Re iew, June 1948, 245—64, ep in ed in his
4 To a oid misunde s anding I should add ha his is a policy o an
economy al eady on i s desi ed pa h. I we s a a o he desi ed pa h, as
wi h he in la ion o 1975—76, we can only app oach he desi ed pa h
g adually.
11 K edi und Kapi al 2/1976
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