March 01, 2004

The Monetarist Counterrevolution: An Attempt to Clarify Some Issues in the History of Economic Thought

The Monetarist Counterrevolution

J. Bradford DeLong

April 2001; slightly revised February 2004

I. Keynesian Monetarists and Monetarist Keynesians

In 2000 I wrote an essay (DeLong, 2000) arguing that modern Keynesians are really monetarists. Even if they--we--do not really like to admit it, most of the key elements in how modern "new Keynesian" economists view the world are derived from or heavily influenced by the work of Milton Friedman.

But that essay left me unsatisfied, for it was only half of the story. Just as modern Keynesians are (in many respects) monetarists, so modern monetarists are really Keynesians--even though they like to admit it even less. They are Keynesians in the sense that they have the same profound and deep distrust in the laissez-faire market economy's ability to deliver macroeconomic stability. Moreover, they share the confidence John Maynard Keynes had that limited and strategic government interventions and policies could produce macroeconomic stability while still leaving enormous space for the operation of the market.

Thus there are no believers in true laissez-faire left, at least not as far as academic macroeconomics is concerned. The rhetoric of post-World War II monetarism held that it was a return to laissez-faire in macroeconomics. All the government had to do was to get out of the way and leave monetary policy in "neutral," and macroeconomic stabilization would be successfully achieved. But on closer inspection the "neutral" monetary policy advocated in works like Friedman and Schwartz (1963) turns out to be a policy that pre-Keynesian generations would have called extraordinarily activist on a number of levels. The laissez-faire rhetoric obscures the extraordinarily broad common ground that Milton Friedman shares with John Maynard Keynes.

This recognition has important implications for understanding the meaning and effect of the monetarist counterrevolution of the late 1960s and 1970s. The majority view of the monetarist counterrevolution was shaped while it was ongoing by Harry Johnson's Ely Lecture, "The Keynesian Revolution and the Monetarist Counterrevolution" (Johnson, 1971). Johnson saw the monetarist counterrevolution as a true intellectual revolution--one that renders the previous literature obsolete, irrelevant, and uninteresting as the post-revolutionary generation focuses on new issues and dismisses the old questions and answers as badly posed or simply incoherent. Johnson also--relatively cynically--saw the monetarist counterrevolution as the triumph not of new evidence (or a reevalution of old evidence) but as the triumph of misleading rhetoric, and was not sure that it reflected an advance in knowledge. And Johnson saw the counterrevolution as a genuine counterrevolution that would--if successful--return economists' thinking to its previous state.

I want to argue that, underneath its laissez-faire rhetoric about a non-activist, neutral monetary policy, the monetarism of the monetarist counterrevolution had been thoroughly infected by the Keynesian virus. It carried with it a way of thinking about macroeconomic policy that was as "activist" in its own way as John Maynard Keynes could have ever wished.

II. Modern Keynesians

What Today's Keynesians Believe

What do today's "new Keynesian" macroeconomists believe? Their research program is complex and hard to summarize briefly, but any list of its key ideas and premises would include the five propositions that:

--The key to understanding real fluctuations in employment and output is to understand the process by which business cycle-frequency shocks to nominal income and spending are divided into changes in real spending and changes in the price level.

-- Under normal circumstances, monetary policy is a more potent and useful tool for stabilization than is fiscal policy.

--Business cycle fluctuations in production are best analyzed from a starting point that sees them as fluctuations around the sustainable long-run trend (rather than as declines below some sustainable potential output level).

--The right way to analyze macroeconomic policy is to consider the implications for the economy of a policy rule, not to analyze each one- or two-year episode in isolation as requiring a unique and idiosyncratic policy response.

-- Any sound approach to stabilization policy must recognize the limits of stabilization policy—the long lags and low multipliers associated with fiscal policy; the long and variable lags and uncertain magnitude of the effects of monetary policy.

All five of the planks of the New Keynesian research program listed above had much of their development inside the twentieth-century monetarist tradition, and all are associated with the name of Milton Friedman. It is hard to find prominent Keynesian analysts in the 1950s, 1960s, or early 1970s who gave these five planks as much prominence in their work as Milton Friedman did in his.

Monetarist Roots of Modern Keynesianism

The importance of analyzing policy in an explicit, stochastic context and the limits on stabilization policy that result comes from Friedman (1953a). The importance of thinking not just about what policy would be best in response to this particular shock but what policy rule would be best in general--and would be robust to economists' errors in understanding the structure of the economy and policy makers' errors in implementing policy--comes from Friedman (1960). The proposition that the most policy can aim for is stabilization rather than gap-closing was the principal message of Friedman (1968). We recognize the power of monetary policy as a result of the lines of research that developed from Friedman and Schwartz (1963) and Friedman and Meiselman (1963). And a large chunk of the way that New Keynesians think about aggregate supply saw its development in Friedman’s discussions in Friedman (1970) and Friedman (1971a).

Thus a look back at the intellectual battle lines between "Keynesians" and "monetarists" in the 1960s cannot help but be followed by the recognition that perhaps "new Keynesian" economics is misnamed. We may not all be Keynesians now, but the influence of "monetarism" on how we all think about macroeconomics today has been deep, pervasive, and subtle.

The form of "monetarism" that has had a profound and deep influence on macroeconomics today was Milton Friedman's monetarism. It either emerged as a natural evolution from the old oral Chicago monetarist tradition of the Great Depression era (according to Friedman, 1974) or sprang full-grown like Athena from Milton Friedman's brain (according to Patinkin, 1972, and Johnson, 1971). This classic form of monetarism as laid out in Friedman's classic Essays in Positive Economics, Studies in the Quantity Theory of Money, A Program for Monetary Stability (see Friedman, 1953b, 1956, 1960, 1968) contained a number strands of thought that have proven remarkably durable.

Classic monetarism contained empirical demonstrations that money demand functions could retain remarkable amounts of stability under the most extreme hyperinflationary conditions (see Cagan, 1956). It analyzed the limits imposed on stabilization policy by the uncertain strength of policy instruments and the variable lags with which they took effect (see Friedman, 1953a). Its stress on the importance of policy rules and of rules that would be robust (see Friedman, 1960) has still not been adequately and fully incorporated into mainstream thought. The belief that the natural rate of unemployment is inevitably close to the average rate of unemployment (Friedman, 1968) and thus that monetary policy cannot affect the average rate of unemployment is standard in modern macro models (see Romer, 2000). Friedman and Schwartz's (1963) long narrative of the potency of monetary policy together with econometric demonstrations of the short-run power of monetary policy produced a more realistic assessment of the relative roles of fiscal and monetary policy, and started the process that has cut the multiplier down from the value of four or five that it possessed in economists' minds in 1947 to the value of maybe one and a half that it possesses in economists' minds today.

What Happened to the Label "Monetarism"?

Why then do we today talk about the "new Keynesian economists" and not about "new Monetarists economists"? I believe that the answer to this question hinges on the fact that the word "monetarism" became attached to one particular variety of monetarism. It became attached to "political monetarism"--the belief that it was easy to maintain a stable rate of growth of the money stock. and that maintaining a stable rate of growth of the money stock would solve most (if not all) of the problems of stabilization policy.

Political Monetarism argued not that velocity could be made stable if monetary shocks were avoided, but that velocity was stable. Thus the money stock became a sufficient statistic for forecasting nominal demand, and central bankers could close their eyes to all economic statistics save monetary aggregates alone. Political Monetarism argued not that institutional reforms were needed to give the central bank the power to tightly control the money supply, but that the central bank did control shifts in the money supply. The central bank was the source in its actions or in its failure to neutralize private actions of all monetary forces. Everything that went wrong in the macroeconomy had a single, simple cause: the central bank had failed to make the money supply grow at the appropriate rate.

"Political monetarism" had the advantage that it was easy for politicians to understand and could be conveyed in op-ed pieces. "Political monetarism" had the advantage that it made it easy to critique whatever economic policy was being followed by the opposition party and its central bankers. "Political monetarism" had the advantage that it made it easy to say what one would do differently.

"Political monetarism" had the disadvantage that it was not true.

"Political monetarism" crashed and burned in the early 1980s. It became clear that stable control of the money stock was not easy to obtain. It became clear that stable control of the money stock did not solve the problems of stabilization policy because the velocity of money was unstable. Indeed, Goodhart's law maintained that the better your control over any particular measure of the money stock, the more unstable its velocity would be (Goodhart, 1970). And the velocity of money turned extraordinarily unstable after 1980.

III. Modern Monetarists Are Keynesians

Speaking broadly and sketchily, business cycle theory back before the Keynesian revolution had two strands: the quantity theory strand, and the over-investment strand.

The Pre-World War II Quantity Theory of Money

The quantity theory of money goes back to David Hume. But the transformation of the quantity theory of money into a tool for making quantitative analyses and predictions of the price level, inflation, and interest rates was the creation of Irving Fisher (1911).

However, the quantity theory of money as developed by Fisher (1911) and his peers was not a useful tool for business cycle analysis. It amounted to an assertion that other things being equal--ceteris paribus--the price level would be proportional to the money stock coupled with a laundry list of what those other things might be. But it did not investigate the relationship of monetary policy and monetary shocks to the "ceteris" that were to be "paribus." And it did not engage in any significant analysis of the money supply determination process at all.

These theoretical shortcomings led other economists to become exasperated with monetarist analyses of events made by their colleagues in the monetary and financial chaos that was the immediate aftermath of World War I. This exasperation led John Maynard Keynes to write what is perhaps the most frequently quoted of his many lines, the declaration in his Tract on Monetary Reform (1923) that standard quantity-theoretic analyses were useless:

"Now 'in the long run' this [way of summarizing the quantity theory: that a doubling of the money stock doubles the price level] is probably true.... But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again..."

Most economists today would agree with Keynes. Milton Friedman certainly does. In his 1956 "The Quantity Theory of Money--A Restatement," Friedman sets out that one of his principal goals is to rescue monetarism from the "atrophied and rigid caricature" of an economic theory that it had become in the interwar period. According to Friedman, it was the inadequacies of this framework that opened the way for the original Keynesian Revolution. The atrophied and rigid caricature of the quantity theory painted a "dismal picture." By contrast, "Keynes's interpretation of the depression and of the right policy to cure it must have come like a flash of light on a dark night" (Friedman (1974)). Keynes's General Theory may not have had a correct theory of business-cycle fluctuations in employment and output, but it least it had a theory.


The second strand of pre-Keynesian business cycle theory, was, to caricature it only slightly, the over-investment theory claim that nothing could be done to avoid, moderate, or shorten depressions. One of the most striking declarations of this "liquidationist" point of view came from Herbert Hoover's Secretary of the Treasury, Andrew Mellon, who saw the Great Depression as a healthy process of macroeconomic purgation. In his memoirs Herbert Hoover (1952) wrote wrote bitterly of Mellon and the others who had advised inaction during the downslide.

This point of view was not one that originated with bankers and politicians. It was held by some of the most eminent economists of the day. I take Joseph Schumpeter's (1934) expression of it to be representative--certainly Schumpeter's is the most rhetorically powerful and analytically coherent. Schumpeter begins from the observation that the course of economic development is never smooth. Investments and enterprises are gambles on the future, made by innovative entrepreneurs who see new things to be done or new ways to produce old commodities.

Sometimes these gambles will fail. The actual future that comes to pass is one in which ex post certain investments should not have been made, or in which ex post certain enterprises should not have been undertaken because they are not producing the requisite profits. The economy is left with "too much" capital given what the state of technology factor supplies, and demand turned out to be, or is perhaps left with the "wrong kinds" of capital.

The best that can be done in such a situation is to shut down those production processes and enterprises that were based on guesses about the way the future would look that did not come to pass. The liquidation of investments and businesses releases factors from unprofitable uses; they can then be redeployed to other sectors, used to produce socially useful current services (in the "too much" capital case) or alternative investment goods (in the "wrong kinds" case), and used by further waves of entrepreneurs in new gambles on a still-uncertain future. But without the initial liquidation, the redeployment and the subsequent wave of innovation and entrepreneuship cannot take place.

It follows, says Schumpeter, that depressions are this process of liquidation and preparation for the redeployment of resources. From Schumpeter’s perspective, "depressions are not simply evils, which we might attempt to suppress, but…forms of something which has to be done, namely, adjustment to…change." This socially productive function of depressions creates "the chief difficulty" faced by economic policy makers. For "most of what would be effective in remedying a depression would be equally effective in preventing this adjustment" (Schumpeter, 1934; p. 16). The process of dynamic economic growth requires that underutilized factors register their availability on markets. Policies that stimulate demand in recessions keep factors engaged in activities that do not produce value in excess of social cost. Such policies keep factor markets from registering the potential availability of productive resources for redeployment.

Is it possible to iron out the cycles, leaving an economy growing steadily on some equilibrium path rather than irregularly with rapid booms and slumps? Schumpeter (1939) thinks not, for business cycles are not "…like tonsils, separable things that might be treated by themselves." Instead, business cycles are "…like the beat of the heart, of the essence of the organism that displays them." In order for one wave of entrepreneurship to be followed by another, prospective entrepreneurs must know where and in what quantities resources available for recombination and redeployment are available. Until they can learn this, they face "the imposibility of calculating costs and receipts in a satisfactory way…[T]he difficulty of planning new things and the risk of failure are greatly increased.…[I]t is necessary to wait until things settle down…before embarking on [new] innovation."

Schumpeter thus argues that monetary policy does not allow policy makers to choose between depression and no depression, but only between depression now and a worse depression later. "Inflation…pushed far enough [would] undoubtedly turn depression into the sham prosperity so familiar from European postwar experience," claims Schumpeter (1934), but it "would, in the end, lead to a collapse worse than the one it was called in to remedy." Hence his "…analysis leads us to believe that recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of depressions undone and adds, to an undigested remnant of maladjustment, new maladjustment of its own which has to be liquidated in turn, thus threatening business with another [worse] crisis ahead."

Stimulative monetary policies, therefore, "are particulary apt to keep up, and add to, maladjustment, and to produce additional trouble for the future." Moreover, words like "stimulative" carry a special meaning in this context: if private sector actions would lead to a fall in, say, the nominal money stock, then a public sector attempt to counteract the consequences of such private-sector actions by injecting sufficient reserves to hold the nominal money stock constant would be "stimulative."

The doctrine that in the long run the Great Depression would turn out to have been "good medicine" for the economy, and that proponents of stimulative policies were shortsighted enemies of the public welfare drew many anguished cries of dissent. British economist Ralph Hawtrey scorned those who warned against stimulative policies at the nadir of the Great Depression. To call for more liquidation and deflation was, Hawtrey said, "to cry, ‘Fire! Fire!’ in Noah’s flood." Keynes (1931) tried to discredit the "liquidationist view" with ridicule. He called it an "imbecility" to argue that the "wonderful outburst of productive energy" during the boom of 1924–29 had made the Great Depression inevitable. He spoke of Schumpeter and his fellow travelers as:

"…austere and puritanical souls [who] regard [the Great Depression] …as an inevitable and a desirable nemesis on… "overexpansion" as they call it.…It would, they feel, be a victory for the mammon of unrighteousness if so much prosperity was not subsequently balanced by universal bankruptcy. We need, they say, what they politely call a ‘prolonged liquidation’ to put us right. The liquidation, they tell us, is not yet complete. But in time it will be. And when sufficient time has elapsed for the completion of the liquidation, all will be well with us again…"

Keynesian Monetarism

It is on this point that we find complete and total agreement between John Maynard Keynes and Milton Friedman. The critique of monetary policy during the Great Depression found in Friedman and Schwartz (1963) is precisely that the Federal Reserve did not do enough to stimulate the economy during the Great Depression. It injected reserves into the banking system, yes, but it did not inject enough reserves to counteract the decline in the money multiplier that took place between 1929 and 1933 that reduced the money stock and starved the economy of liquidity. As Friedman (1974) observed, the Old Chicago Monetarism of Jacob Viner, Henry Simons, and Frank Knight had stressed the variability of velocity, its potential correlation with the rate of inflation, and the instability of the money multiplier. Thus they condemned the Hoover administration government for monetary and fiscal policies that had "permitt[ed] banks to fail and the quantity of deposits to decline" that they saw at the root of America's macroeconomic policies in the Great Depression. To cure the depression they called for massive stimulative monetary expansion and large government deficits.

They (a) did not believe that the velocity of money was stable, and (b) did not believe that control of the money supply was straightforward and easy. It did not believe that the velocity of money was stable because inflation raised and deflation lowered the opportunity cost of holding real balances. The phase of the business cycle and the concomitant general price level movements powerfully affected incentives: economic actors had strong incentives to economize on money holdings during times of boom and inflation, and to hoard money balances during times of recession and deflation. These swings in velocity amplified the effects of monetary shocks on total nominal spending.

It did not believe that controlling the money supply was easy because fractional-reserve banking in the absence of deposit insurance created the instability-generating possibility of bank runs. The fear by banks that they might be caught illiquid could cause substantial swings in the deposit-reserves ratio. The fear by deposit holders that their bank might be caught illiquid could cause substantial swings in the deposit-currency ratio. And together these two ratios determined the money multiplier. Thus the overall level of the money supply was determined as much by these two unstable ratios as by the stock of high-powered money itself. And the stock of high-powered money was the only thing that the central bank could quickly and reliably control.

The worry that control of the monetary base was insufficient to control the money stock was to be dealt with, in Friedman's (1960) Program for Monetary Stability, by reforming the banking system to eliminate every possibility of fluctuations in the money multiplier. Shifts in the deposit-reserve and deposit-currency ratios would be eliminated by requiring 100% reserve banking. Shifts in the deposit-reserve ratio then become illegal. Banks can never be caught illiquid. And in the absence of any possibility that banks will be caught illiquid, there is no reason for there to be any shifts in the deposit-currency ratio either.

Shifts in the velocity of money in response to cyclical bursts of inflation and deflation that amplified fluctuations in the rate of growth of the money stock would be eliminated by the constant-nominal-money-growth rule. Without cyclical fluctuations in the money stock and in inflation, there would be no cause of cyclical fluctuations in the velocity of money. Thus banking system reform and Federal Reserve reform would eliminate the monetary causes of the business cycle, and would make both the money supply and the velocity of money stable.

It is important to recognize that in its proper context--that of the pre-World War II version of the quantity theory and the pre-World War II over-investment theory--this is a very Keynesian vision of macroeconomic policy.. As Robert Skidelsky puts it in his three-volume biography of John Maynard Keynes, Keynes's key contribution was not to find a middle way between "laissez-faire and central planning... conservatism and socialism" but a genuine Third Way that achieved the benefits each traditional pole of politics had claimed but had never been able to deliver. Keynes saw the market economy as having two great flaws: first, that demand for investment was extraordinarily and pointlessly volatile as business leaders and investors attempted the hopeless task of trying to pierce the veil of time and ignorance, and, second, that the fluctuations in the wage level that classical economic theory relied on to bring the economy back into balance after such an investment fluctuation either did not work at all or worked too slowly to be relevant for economic policy. (No, I am not going to be drawn into the debate about "unemployment disequilibrium.") But if these problems could be fixed, Keynes believed, then the standard market-oriented toolkit of economists was worthwhile and relevant once more.

And this is exactly Friedman's position. The tools used are a little different--rather than Keynes's focus on investment plus government spending, Friedman focuses on the banking system and the money stock. But in each case the vision is one of powerful and strategic but focused and limited government intervention and control of a narrow section of the economy, in the hope that the merits of laissez-faire can flourish in the rest of the economy.

IV. Conclusion

My conclusion is simple. Much of the history of macroeconomic thought is often taught as the rise and fall of alternative schools. Monetarists tend to write of the rise and fall of Keynesian economics--its rise during the Great Depression, and its fall in the 1970s under the pressure of stagflation and the theoretical critiques of Friedman, Phelps, Lucas, Sargent, and Barro. They tend to see this as the rise "interventionism" and then its decline and replacement by a more hands-off view that holds that monetary policy should be "neutral." Keynesians write of the rise and fall of monetarism--its rise during the monetarist counterrevolution, its fall as the instability of velocity and the money multiplier became clear, and its replacement by the modern "new Keynesian" paradigm.

Neither story appears to me to give an accurate or even a particularly useful vision of how it really happened. The fall of monetarism as a political doctrine was coupled with the victory of "monetarist" ideas and ways of thinking in the mainstream: that was the point of DeLong (2000). And what Friedman and Schwartz (1963) would call a "neutral" hands-off monetary policy during the Great Depression--one that kept the nominal money stock fixed--would have been condemned by pre-World War II over-investment theorists as extraordinarily interventionist. Indeed, it would have been. Between 1929 and 1933 the Federal Reserve raised the monetary base by 15% while the nominal money stock shrunk by a third. The position of Friedman and Schwartz (1963) is that the Federal Reserve should have injected reserves into the banking system much, much faster. Sometimes to be "in neutral" requires that you push the pedal through the floor.


Philip Cagan (1956), "The Monetary Dynamics of Hyperinflation," in Milton Friedman, ed. (1956), Studies in the Quantity Theory of Money (Chicago: University of Chicago Press).

J. Bradford DeLong (2000), "The Triumph [?] of Monetarism," Journal of Economic Perspectives.

Irving Fisher (1911), The Purchasing Power of Money (New York: Macmillan).

Milton Friedman (1953a), "The Effects of a Full-Employment Policy on Economic Stability: A Formal Analysis," in Essays on Positive Economics (Chicago: University of Chicago Press: 1953), pp. 117-132.

Milton Friedman (1953b), Essays on Positive Economics (Chicago: University of Chicago Press).

Milton Friedman (1956), "The Quantity Theory of Money—A Restatement," in Studies in the Quantity Theory of Money (Chicago: University of Chicago Press: 0226264068), pp. 3-21.

Milton Friedman (1968), "The Role of Monetary Policy," American Economic Review 58:1 (March), pp. 1-17.

Milton Friedman (1960), A Program for Monetary Stability (New York: Fordham University Press: 0823203719).

Milton Friedman (1970), "A Theoretical Framework for Monetary Analysis," Journal of Political Economy 78:2 (April), pp. 193-238.

Milton Friedman (1971a), "A Monetary Theory of Nominal Income," Journal of Political Economy 79:2 (April), pp. 323-37.

Milton Friedman (1974), "Comments on the Critics," in Robert J. Gordon, ed. (1974), Milton Friedman’s Monetary Framework: A Debate with His Critics (Chicago: University of Chicago Press: 0226264076).

Milton Friedman and David Meiselman (1963), "The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897-1958," in Stabilization Policies (Englewood Cliffs: Prentice-Hall).

Milton Friedman and Anna J. Schwartz (1963), A Monetary History of the United States (Princeton: Princeton University Press).

Charles Goodhart (1970), "The Importance of Money," Quarterly Bulletin of the Bank of England (June), pp. 159-98.

Robert J. Gordon, ed. (1974), Milton Friedman’s Monetary Framework: A Debate with His Critics (Chicago: University of Chicago Press: 0226264076).

Seymour Harris (1934), "Higher Prices," in Douglass Brown et al., Economics of the
Recovery Program (New York: McGraw-Hill, 1934).

Herbert Hoover (1952), Memoirs (New York: Macmillan).

Harry Johnson (1971), "The Keynesian Revolution and the Monetarist Counterrevolution," American Economic Review 61 (May), pp. 1-14.

John Maynard Keynes (1923), A Tract on Monetary Reform (London: Macmillan).

John Maynard Keynes (1936), The General Theory of Employment, Interest, and Money (London: Macmillan).

Don Patinkin (1972), "Friedman on the Quantity Theory and Keynesian Economics," Journal of Political Economy.

Lionel Robbins (1934), The Great Depression (London: Macmillan).

David Romer (2000), Advanced Macroeconomics 2nd ed. (New York: McGraw-Hill).

Joseph Schumpeter (1934), "Depressions," in Douglass Brown et al., Economics of the
Recovery Program (New York: McGraw-Hill, 1934).

Joseph Schumpeter (1939), Business Cycles (New York: Macmillan).

Posted by DeLong at March 1, 2004 11:54 AM | TrackBack


Extremely well done.

Much of the conservative swing in economic thinking is based, to no small extent, in a generation of economicists who had finally learned the tools of the Keynesian revolution well enough to direct them at ends other than ameliorating the Great Depression and its aftermath - the problems facing the post-war generation were more conservative problems - how to manage an engine already built. This is true not only of Friedman - but of Mundell as well.

It is also far from the first time I've heard an economist say that the longer time goes on, the more Keynes and Friedman look the same - that each seems to be a special case of the other. For one it was "both Keynes and Friedman felt that economic policy had to be no more intellectually capable than the people who run it." And hence economics in the positive mode was a search for the creation of policy rules which could be adhered to.

What strikes me about political monetarism is that it puts the burden and the blame on the central bank, which is neither elected nor accountable, and away from elected officials. The monetary climate is like the weather. This isn't, in point of fact entirely true, but it is, as you say, easy to say.

The other point of your essay which should be more widely absorbed is that while in polemics economics seems "liberal" versus "conservative", in genuine policy and economic thinking, there is a much wider and omnivorous search for equations and ideas that work. That good economic thinking is good economic thinking, and the ability to apply ideas to the problems at hand is much less a factor of the politics of the origin of the idea, and much more the quality of the idea itself. Monetarism and Keynesianism both retain their appeal simply because they are engines of a solution - the open the way to those "flashes of light" which are the start of a solution.

Posted by: Stirling Newberry on March 1, 2004 12:28 PM


O.K., Brad, this is real economics, valuable economics, and I commend you. (Though you might have made the simple point that modern monetarists are obviously Keysians because they think in terms of macro-economic models: did not Keynes introduce this way of thinking into the world?)

Part of what we're left with is the conclusion that monetary policy is an art not a science -- for the simple reason that the factors that influence money supply (new forms of credit, especially) are always changing. Only someone who has an intuitive feel for these emergent forms can keep the car on the road, so to speak.

You might have mentioned that a big part of the reason the whole stagflation, phillips curve way of thinking went by the board has a lot to do with the fading of the labor unions. It's a whole lot easier to deal with the downward stickiness of wages in a mildly inflationary environment, without a lot of COLA's hanging around. Does this mean good liberals should favor, or not favor, a resurgence of organized labor in the private sector?

If we favor, then how do we deal with the COLA problem in the future if it arises?

And if we don't favor, then how are the laboring classes to make their voices heard in the political arena. How do they protect their share of the economic pie?

The latter question is particularly urgent now, since free trade theory -- and I mean orthodox free trade theory, Heckscher-Ohlin theory -- predicts labor's share of the pie will decline in our current trading environment (ie, with gigantic poor countries like China and India).

When is the economics profession going to come clean about this? After it completely destroys the reputation of the field?

You really ought to draw Krugman and Samuelson in on this discussion.

In the meantime you can rest assured that there is broad agreement in the land as regards the field of macro-economics.

Posted by: Luke Lea on March 1, 2004 12:40 PM


"After it completely destroys the reputation of the field?"

Economics, because it describes the behavior of biological entities tends to follow the same pattern - growth followed by collapse. So, yes, when there is a complete and total meltdown, there will be a search for new solutions.

It has generally been this way in the past, and by Adam Smith's rule that the people who win the last round of economics tend to run the next round, entirely logical. After all, those with the most economic voice are the winners of the previous competition, and will, probably, keep doing whatever got them there until it fails.

Hence "It works. Until it doesn't".

As for the solution, the solution is glaringly obvious and has been for some time: if the world wants, as it should, for the labor pools of India and China to come on line, then it is going to have to slash the cost of a middle class life style relative to inputs, or slash the level of middle class life style. Or some combination of the above.

We are going to come to a stable solution to the current problem one way or another, and protectionism is simply an attempt by those doing well in the present to delay the day of reckoning long enough for them to win the death bet. If the solution sets which are emerging are unappealing, then it is time to get busy on others.

Posted by: Stirling Newberry on March 1, 2004 12:47 PM


"As for the solution, the solution is glaringly obvious and has been for some time: if the world wants, as it should, for the labor pools of India and China to come on line, then it is going to have to slash the cost of a middle class life style relative to inputs, or slash the level of middle class life style. Or some combination of the above."

The troublesome part of this quote begins in the phrase "if the world wants". Ah, the devil is in the details. Who gets to determine what the "world" wants? A "world" govt? How is that constituted and who sets it up? What characterizes a member of such a "world" whose opinion is worth taking into account? Does this club you are calling "the world" admit only CEO's as members? How about American CEO's and the aspiring Indian middle-class, who live like kings (well they have servants!) on 6K/year? And so on.

You hit the nail on the head, globalization is a political issue. But that's all you do: hit the nail. A global political entity which could address the consequences of globalization is nowhere visible, even in dreams. That means we will rely on our old standby, nationalism, to deal with these tensions. The nationalist response to a devastated middle-class will be protectionist.

Posted by: camille roy on March 1, 2004 01:13 PM


Uh, look guys, don't get me wrong. I think there are ways of dealing with this problem -- though they are far from obvious, and are not protectionist.

They have to do with progressive consumption taxes and wage subsidies, things that economists know something about, but are refusing to focus on, because first it means acknowledging that they were less than forthright -- above all Samuelson, godfather of the profession -- when they sold free trade to the nation a decade ago.

It is a major embarassment that won't go away, but just keeps getting bigger and bigger ... and bigger. I mean, look at the lines on that chart Brad posted earlier today.

Posted by: Luke Lea on March 1, 2004 01:23 PM


First, get a visual on this:

Instead, imagine two (2) L-curves, one blue
and one opposite red, fighting each other up
and down the football field, just as we all are.
My sale is your loss, my tenure is your T.A. job.
We're all fighting up the field, hoping to score,
even though common logic suggests that only
1:100 will cross the goal line. Maybe 1:1000,
considering all the foreign investors on the field.

Now a compassionate, sustainable economic
policy would state that we should give the most
traction to those born or lost at the 10-yard line.
After all, it's at that end of the field where all the
social dysfunction are found, and the economic
dyslocations, the emergency health care, the
pimps, drug pushers, prostitutes, the numbers
rackets, pull-tabs, lottos, all the vultures that add
nothing to the value of society, and only magnify
a social welfare burden on police and health care.

By 'aiding' those people, we would actually ADD
to the value of the economy in greater productivity.
Common sense and brute force logic suggests that
only a trickle UP economic system in fully sustainable,
and that "trickle-down" is just the pleasant-faced lie,
ol' Grandfather Ronald shaking his head, "Well...."

Don't piss on my back and tell me that it's raining.

As poor folks scrabble towards a median income
at the 50-yard line, their traction 'aid' should give
way to a taxation braking action. Given our GDP
of $11,252,000,000,000, and about 156,000,000
employed Americans, that 50-yard line should be
at somewhere around $72,128 per 40-hour worker.

After $75,000, Fed taxes should gradually increase
towards some real, but sustainable personal goal, say
$1,000,000 per year, after which, taxes would ramp
up sharply. The result of this policy would be a whole
lot more middle class people, more middle class economic
and social activities, more recreational and social benefits,
whether people receive minimum wage and partial welfare,
or whether taxes are used for public works, IT and medical
research, free education, health care and emergency services,
or however it's done, a redistribution of wealth as traction
given back to those most burdened by their position in life.

Of course, that was the 1950's, long ago, and far away.
You remember those days of shangrai la, American flags,
Moms and apple pie, a chicken in every pot and a car in
every garage. For near a decade, we almost had it made.
Now Mom turns tricks on the side, Costco sells the pies,
and any thinking American would fly his flag upside down.

So let's look at today. Our current economic policy gives
absolutely no traction to those at the 10-yard line. Study
after study shows most people at that half of the field
are forever trapped in wage slavery, the rising costs of
goods and services, the huge (as percent of income)
fees, user and sales taxes, plus all the pimps, hustlers,
loan sharks, furniture rentals, labor agencies, rackets,
lottos, booze and drugs that prey upon them.

They are hopeless, and well they should be. Doomed
by circumstances, like landless English common men
at the height of the Industrial Revolution. Steal, or die!

At the very far end of the field, of course, it's a hay day!
Whoo-hoo!! Capital gains taxes shaken off, and once
they near their goal line, an absence of estate taxes
means the wealthy's children and children's children
forever inhabit sky-boxes far above the ragged turf.
They are our new American Royalty. All hail Caesar!

With that kind of $ incentive, no wonder there are so
many, many thieves in high places. Corruption is king!

But cashflow has to come from somewhere, even with
growing M-3 and foreign investment. As more and more
wealthy leap across the goal line into a life of unending
investment riches, those ROI's have to be extracted
from those still struggling up the field, those being pulled
slowly backward by a great sucking sound, those 3rd
world'rs trying to grasp the next rung above starvation.

Ultimately, ours won't be a game of football at all,
Keynesian, Monetarist or other. The game, having
been founded on that one structural flaw of holding
back the poor, and giving the rich all the traction,
can't be analyzed as a closed 'economic' system.
The notion of economics as science is a delusion.
The invisible hand of the market is clearly visible,
it's a highly-leveraged political puppet string.

Mathematics in this case is meaningless. Hindcast.
Ignoring higher-order variables and curve-fitting with
a lead sap. That's precisely why all the economists'
predictions are so wrong. Not even the right sign !

In essence, what we're re-creating is a neo-Mayan culture
of blood sacrifice, of Sun-God elites, of walled compounds
amid complete squalor, endless upward flow of tribute and
taxes and first born children, an utter indentured servitude.

And then the only thing left for the economists to do is to
mark that relentless passage of goods and services on
soft clay tablets for some future age, where they'll shake
their heads and laugh at our incredible folly.

That is, if this neo-American culture leaves anything of
tilth or leaf or breath of air to sustain that future age.

Posted by: Delgard Tellas on March 1, 2004 01:26 PM


Perhaps you mentioned the following points, but I missed them:

1) That Friedman is a Keynesian is most clearly seen in his portfolio analytic approach to understanding velocity and money demand.

2) New Keynesians are essentially monetarists who disagree with Friedman on two important points about how the economy operates:
a) the stability of velocity
b) the flexibility of wages and prices.
The disagreement is based not on any theoretical differences but on observation. Portfolio theory can reaonably well generate unstable velocity. Why wages &/or prices are not flexible is not well understood, i.e., there is no satisfactory and widely accepted set of optimizing models that generate them. But this current lack is no reason to ignore them.

Posted by: paul on March 1, 2004 01:34 PM


I've been writing on the long history of economic policy in overview over at as part of the American Thermidor series, I hope you will take the time to read it. The next post is on the rise of Reganonomics - the previous ones dealt with, in order the energy deficit, FDR's creation of an asset based money system and the fall of Keynesian economics in the 1970's.

But for people to come to solutions, they have to be looking for them. Right now most people are not looking for solutions, but instead, to keep their home value high, keep their old job, avoid paying taxes, or avoid worrying about politics 99% of the time and then voting on what they see on one debate and some commercials. One of the reasons disasters are so often required before people come to solutions is that disaster is what marvelously focuses people's mind on the real problem. It might be unfortunate that this is so, but, generally, it is.

Posted by: Stirling Newberry on March 1, 2004 01:34 PM


"Thus there are no believers in true lessez-faire left"?

But what about your favorite whipping boys, the
"clown show"? I guarantee that many of them believe
in a strict, pre-Depression, no-government-intervention
in-economic-policy-ever mindset. (Or at least say they do,
inasmuch as they comprehend them) How much does it
matter what the consensus of the professional economists
is when the policy implementers don't know what it is
and furthermore don't care?

The hard right has no interest in intellectual rigour.
They feel comfortable espousing long-discredited theories in
many, many fields. They have enjoyed a lot of
political success as a result. If you don't think there
is any such thing as a true believers, you haven't talked
to many of the Republican staffers on Capitol Hill.
They may not know what they are talking about, but they
are the ones with their hands on the wheel.

Posted by: dave on March 1, 2004 01:41 PM


Terrific time for a terrific post.


Posted by: anne on March 1, 2004 01:56 PM


Godammit! Another bum rap for the long run!

Many researchers in probability, math and physics (myself included) have tried to make a career distinguishing the short run from the long run, or small scale from large scale.

Sniff. Nobody pays any attention.

Posted by: CSTAR on March 1, 2004 01:57 PM


"It is a major embarassment that won't go away, but just keeps getting bigger and bigger ... and bigger. I mean, look at the lines on that chart Brad posted earlier today."

There is something that is even simpler: some commodity, or commodities, is/are mispriced, and the solution is to price it correctly. Once this happens, incentives will get people to do what is appropriate.

Posted by: Stirling Newberry on March 1, 2004 01:58 PM


"How much does it
matter what the consensus of the professional economists
is when the policy implementers don't know what it is
and furthermore don't care?"

Given the size of the deficit, this is not the case. The people running the Executive branch clearly believe in lots of intervention in the market place - to the tune of billions of dollars. They may say they are are against government intervention, but then, they said they were against deficits too.

Watch what people do, not what they say.

Posted by: Stirling Newberry on March 1, 2004 02:00 PM


Posting it here instead of a journal, so you can edit it for a journal?

Posted by: big al on March 1, 2004 02:53 PM


"Even if they - we - do not really like to admit it, most of the key elements in how modern 'new Keynesian' economists view the world are derived from or heavily influenced by the work of Milton Friedman....

"All five of the planks of the New Keynesian research program listed above had much of their development inside the twentieth-century monetarist tradition, and all are associated with the name of Milton Friedman. It is hard to find prominent Keynesian analysts in the 1950s, 1960s, or early 1970s who gave these five planks as much prominence in their work as Milton Friedman did in his....

"The form of 'monetarism' that has had a profound and deep influence on macroeconomics today was Milton Friedman's monetarism....

Pretty good. Without the word "liar" appearing once I thought for a moment I was caught back in a time warp. Pleasantly so.

And, hey, can I quote this the next time some smarty pants newspaper columnist writes: Milton Friedman's monetarism was a misguided, naive doctrine that has not stood the test of time ... and Milton has admitted it! ;-)

Posted by: Jim Glass on March 1, 2004 03:02 PM


Brad: Does anyone (at least within economics) seriously disagree with your account of history? It seems pretty obviously close to the truth to me.

Posted by: Walt Pohl on March 1, 2004 04:35 PM


For an alternate view:


Posted by: Stirling Newberry on March 1, 2004 05:35 PM


Brad, can you expand at some point on the lines
"Shifts in the deposit-reserve and deposit-currency ratios would be eliminated by requiring 100% reserve banking. Shifts in the deposit-reserve ratio then become illegal. Banks can never be caught illiquid."

To me this looks something like solving the energy crisis by saying "assume we have cheap fusion reactors that generate no radiocative byproducts..." and then going on to talk about wholly irrelevant problems of distribution and such.
Isn't our whole system based on credit which flows from fractional reserve banking? And won't removing fractional reserve banking therefore destroy the system as it currently exists, not just in minor tax-code-change ways, but as in taking us back to the way things were done in 1400AD?

Posted by: Maynard Handley on March 1, 2004 06:04 PM


Trying again, Meltzer on monetarism, has a section on Keynesianism versus Monetarism

Posted by: Stirling Newberry on March 1, 2004 06:08 PM


You might want to change this from a long article to a shorter, more simplified article for the rest of us. I'm not saying that you have to re-define exactly "monetarist" with other, more suitable names, but that will be entirely up to you.

I remember reading here that Keynes made big time bucks around the Great Depression. Just what was the method he used- that would say a heckuva lot more about smarts, that is, what smarts he published and what smarts he kept to himself.

I'm just listing a few chapter titles for the booklet for your consideration:, thanks again to the movie "Smoke Signals."

1. We was framed.

2. How did we set ourselves up to be framed?

3. As we start hearing various economists put in their 2 cents about the economy, how will we know the good ones from the bad ones? What good economist-type noises should we be looking for and which ones should we avoid?

4. What steps can we take to keep ourselves from getting framed again?

Posted by: woodturtle on March 1, 2004 10:50 PM


Great posts, all! And for a change there were no conservatarians posting about how great it is that they're rich and everybody else isn't...

Posted by: non economist on March 1, 2004 10:50 PM


"there are no believers in true laissez-faire left, at least not as far as academic macroeconomics is concerned."

Do you intend by this that Austrians are not academic, or that they're not economists? Or both?

Posted by: Cap'n Arbyte on March 1, 2004 10:53 PM


good read, thanks!

Posted by: Mats on March 2, 2004 03:29 AM


when the storm is long past the ocean is flat again

The storm is has never passed and the oceans have never been flat

consequently, free trade doesn't work; never has, never will, for it is nothing more than the political screwing of those who in the short run face foreign competition.

Posted by: John on March 2, 2004 06:32 AM


when the storm is long past the ocean is flat again

The storm has never passed and the oceans have never been flat

consequently, free trade doesn't work; never has, never will, for it is nothing more than the political screwing of those who in the short run face foreign competition.

Posted by: John on March 2, 2004 06:32 AM


Great essay. But don't you sell Irving Fisher a little bit short? I understand it wasn't your main point, but his thinking in the depression years offered some important material for an anti-liquidationist position: not just the debt-deflation argument, but also his now somewhat quaint-seeming attempts to increase money velocity by finding a way to tax monetary holdings. I don't know whether this was any part of the material with which Friedman was working but it is a similar example of how the basic quantity theory points could promote "interventionism" in the depression context.

Posted by: David M. Woodruff on March 2, 2004 07:27 AM


Hi Brad,

I'm having a little trouble following this sentence. Does it mean that economic shocks two main effects are in business activity and inflation rates?



--The key to understanding real fluctuations in employment and output is to understand the process by which business cycle-frequency shocks to nominal income and spending are divided into changes in real spending and changes in the price level.

Posted by: Adrian Spidle on March 2, 2004 10:02 AM


Yep. It is, for Friedman, an accounting device to divide up "shocks to nominal income and spending" into two components. What Uncle Milton is saying is that sometimes when spending drops (or rises), prices drop (or rise) and employment remains the same, and sometimes prices stay the same and it is employment that drops (or rises). And that the key mystery is to understand when which will happen.

Posted by: Brad DeLong on March 2, 2004 11:50 AM


Keynesianism and monetarism have one thing in common: they both are structural approaches to economic forecasting. The real conterrevolution, I think, happened with the advent of non-structural forecasting, when some researchers decided to study the economy, as Sims and Sargent put it, "without pretending to have too much a priori theory"...

Posted by: Nikolai Chuvakhin on March 2, 2004 12:30 PM


"free trade doesn't work; never has, never will, for it is nothing more than the political screwing of those who in the short run face foreign competition."

John, apparently that is why China's GNP (and average per capita income) has been growing since they decided to put socialism in the mausoleum and join the WTO. And this is why North Coreans will live happily ever after, since their great leader opted for autarchy and protectionism.

And apparently this is why we in Europe have millions of jobs newly created (still not enough, but much better than nothing) by the "Single European Market", i.e. by opening up all the "national" markets (and the watchdogs of the Commission and the European Court of Justice are really after even the most hidden trace of remaining protectionsm and impediments to free trade).

Posted by: gerhard on March 3, 2004 04:08 AM


I have fond memories of teaching principles of
macro in the early 80's and focusing on the
fiscal versus monetary policy debate. Doctrinaire Keynesians believed in fiscal policy
and doctrinaire monetarists denied that fiscal
policy mattered at all. Friedman's permanent
income hypothesis is thus viewed as an attack on the Keynesian view that consumption arises out of
disposable income.

To say that we are all monetarists now is correct
in the sense that neo-Keynesians accept that monetary policy is a potent and flexible policy
tool. But our present debate over the failure of the Bush FISCAL POLICY to provide the correct
bang for the buck is not anything the monetarists would have had any truck with.

Monetarism Version 1 taught that only money matters. Monetarism Version 2 taught that only
unanticipated money matters. I suspect Brad
does a disservice to Laidler et al by labeling
them "Political Monetarists."

Posted by: malcolm on March 3, 2004 06:01 AM


Great post. Much appreciated.

Posted by: andrew on March 3, 2004 09:34 AM


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