Monetarism in Historical Perspective

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, h ps://doi.o g/10.3790/ccm.9.2.154 This Ve sion is a ailable a : h ps://hdl.handle.ne /10419/292761 S anda d-Nu zungsbedingungen: Die Dokumen e au EconS o dü en zu eigenen wissenscha lichen Zwecken und zum P i a geb auch gespeiche und kopie we den. Sie dü en die Dokumen e nich ü ö en liche ode komme zielle Zwecke e iel äl igen, ö en lich auss ellen, ö en lich zugänglich machen, e eiben ode ande wei ig nu zen. So e n die Ve asse die Dokumen e un e Open-Con en -Lizenzen (insbesonde e CC-Lizenzen) zu Ve ügung ges ell haben soll en, gel en abweichend on diesen Nu zungsbedingungen die in de do genann en Lizenz gewäh en Nu zungs ech e. Te ms o use: Documen s in EconS o may be sa ed and copied o you pe sonal and schola ly pu poses. You a e no o copy documen s o public o comme cial pu poses, o exhibi he documen s publicly, o make hem publicly a ailable on he in e ne , o o dis ibu e o o he wise use he documen s in public. I he documen s ha e been made a ailable unde an Open Con en Licence (especially C ea i e Commons Licences), you may exe cise u he usage igh s as speci ied in he indica ed licence. h ps://c ea i ecommons.o g/licenses/by/4.0/ 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. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 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 OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 156 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. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 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. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 158 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- OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 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. OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 160 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- OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15 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 OPEN ACCESS | Licensed unde CC BY 4.0 | h ps://c ea i ecommons.o g/abou /cclicenses/ DOI h ps://doi.o g/10.3790/ccm.9.2.154 | Gene a ed on 2023-01-16 13:33:15