Thomas Mayer on Monetarism

Bronfenbrenner, Martin Article Thomas Mayer on Monetarism Kredit und Kapital Provided in Cooperation with: Duncker & Humblot, Berlin Suggested Citation: Bronfenbrenner, Martin (1975) : Thomas Mayer on Monetarism, Kredit und Kapital, ISSN 0023-4591, Duncker & Humblot, Berlin, Vol. 8, Iss. 4, pp. 473-484, https://doi.org/10.3790/ccm.8.4.473 This Version is available at: https://hdl.handle.net/10419/292749 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. 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I have accepted the invitation mainly in the hope of clarifying some of my own ideas as a by-product of considering his. II. Mayer's essay on "The Structure of Monetarism""* is a long exercise on the nature and inter-relationships of twelve propositions which he treats as comprising contemporary monetarism. The first four of these propositions — the quantity theory of money, some distinctly monetarist transmission mechanism between monetary and income changes, belief in the inherent stability of the private economy, and the unimportance of allocative (distributive) disaggregation for the explanation of short-run macroeconomic effects — he sees as necessary conditions for monetarism but offers no formal proof which might satisfy a professional logician. The other eight — including such well-known facets as preference for monetary rules, unconcern with guaranteed full employment, distrust of the Phillips curve and "incomes policies," dislike for inflationary finance — are either arguments in support of his "big four" or policy conclusions or corollaries from them, which most but not all monetarists do in fact support. The entire edifice is summarized * Kredit und Kapital, Vol. 8 (1975) pp. 190 and pp. 293. 1 M. Bronfenbrenner and Thomas Mayer > "Liquidity Functions in the American Economy." Econometrica (April, 1960.) OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 474 Martin Bronfenbrenner diagrammatically in a figure which seeks to include not only all twelve propositions but also the principal relations Mayer believes to exist between them. Any such construction is inevitably subjective, but Mayer hopes it may nevertheless be objectively helpful to his professional colleagues. III. Mayer sets monetarism against the conventional "Keynesianism" of, say, the Northern wing of the American Democratic party and its economic spokesmen. I should myself have preferred the antithesis to have been "fiscalism" without quite so much emphasis on the doctrines of the late Lord Keynes, either in the "General Theory" of 19362 or as they may have been developing in the inflationary milieu at the time of his death ten years later.3 Let us denote by pure fiscalism the doctrine that "money does not matter." This implies that 1. the economic effects of a fiscal measure are independent of the way that measure is financed, and that 2. changes in the stock of money have no effect on the level of economic activity unless embodied in a fiscal measure for introducing the new money into the economy (or withdrawing money from it). Similarly, let us denote by pure monetarism the doctrine that "only money matters." This implies that (1) the economic effects of a change in the money stock are largely independent of the methods by which the positive or negative increment is injected into or withdrawn from the economy, and that (2) fiscal policy measures have negligible effects on the economy apart from their monetary consequences. Let us also suppose, without asking embarrassing questions about measurement, that a continuum could somehow be set up, with pure fiscalists at one end (if any exist) and pure monetarists at the other (subject to the same restriction). Taxonomic exercises like Mayer's are valuable if, as I think he believes, economists tend to be bunched at the 2 Even in the depths of depression, there is room for doubt that "the economics of Keynes" was so fiscalist as "Keynesian economics" subsequently became. There doubts constitute, in part, the Clower-Leijonhufvud reinterpretation of the "General Theory", which I interpret as shifting emphasis from the shapes to the volatilities of certain crucial functions. See Axel Leijonhufvudy "Keynesian Economics and the Economics of Keynes" (New York: Oxford University Press, 1968). 5 J. M. Keynes, "The Balance of Payments of the United States," Economic Journal (June, 1946). OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 Thomas Mayer on Monetarism 475 two ends of this continuum, with relatively few eclectics in the middle. They are less useful if, as I have come increasingly to intuit4, the distribution would be more or less even throughout the continuum (except perhaps at the two extremes) with no gaps or bald spots open for otherthan-arbitrary cuts between monetarists and fiscalists. Difficulties are compounded by at least two other considerations: 1. A fiscal measure (an expansion) is accompanied by a monetary expansion to keep interest rates down and prevent multiplier attenuation. Is the resulting income increase to be attributed to the fiscal expansion — in Hicksian terms, the shift in the IS curve — or to its monetary corollary — the shift in the LM curve?5 2. Assume that the Mundell assignment of policy tools is correct6 — fiscal policy to the internal balance and monetary policy to the external balance. Is this fiscalism or monetarism? Since Mayer is dealing with the closed economy at least 95 per cent of the time, I presume he would call Mundell a fiscalist; I am not sure of my own stand, especially for small countries with high international dependence. IV. Accepting the risk of pedantry, I wish more macroeconomists — including Mayer — would distinguish carefully between stability and volatility in describing the functions with which they are dealing. To 4 Of my own colleagues at Duke University, perhaps seven (including myself) have recently taught or written in the macroeconomics — monetary policy — fiscal policy triangle. Of these, I should classify three as decidedly more fiscalist that I, two as decidedly more monetarist, and the other as located close to myself on my hypothetical continuum. 5 In my own eclectic and unoriginal view, the answer depends on the interest-elasticities of the two functions. An inelastic IS and/or an infinitelyelastic LM leads to fiscalist answers. An infinitely-elastic IS and/or inelastic LM leads to monetarist answers. The real world of the 1970's is "just a little bit in between", although the real world of the 1930's — when Keynes9 "General Theory" was written — may indeed have conformed to fiscalism. What one might call "normative" fiscalism, however, depends not at all on the shapes of the macroeconomic functions. Whatever these shapes may be, it requires monetary policy to "validate" expansive fiscal policy by keeping nominal interest rates from rising. I am unaware of any corresponding normative monetarism. • Robert A. Mundell, "The Appropriate Use of Monetary and Fiscal Policy for Internal and External Stability", IMF Staff Papers (March, 1962). OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 476 Martin Bronfenbrenner classify the distinction, suppose that a Hicksian IS - LM model in (Y, r) space, with error terms (shift parameters) et and et may be written : IS curve rt = a — bYt + et (a, b > 0) LM curve rt = a + fiYt + et (oc < a, fi > 0) Solving for Yt, we have: v _ (a - «) + (et - et) Y' ~ bT1 This is a macrostatically stable solution by all the usual definitions I know about. (Neither IS nor LM slopes the wrong way, in other words.) But at the same time, the stable equilibrium value of Yt is highly volatile, particularly if the error terms (ety £t) are negatively correlated. Similarly, solving for the interest rate rti we derive: fi (a + et) + b (oc + st) ^ = i+p which is also stable but volatile, particularly if the error terms are positively correlated. What difference does this point make? Primarily, that the case for intervention and direct control is much stronger in unstable markets than in merely volatile ones. And secondarily, that a number of conceptually stable functions (investment functions, Phillips curves, possibly even liquidity functions) may exist but be so volatile over a wide range of shift parameters (not only economic but social and political) as to be disappointing when used for modelling, planning, tracking, and allied uses. (This, I fear, is particularly true of the once-so-promising Phillips curve with its neat unemployment — inflation trade-off.) V. Mayer's footnotes reveal a running debate with leading monetarists on the justifiability of Mayer's eight subordinate propositions. They are admittedly not logically essential to monetarism although many (probably most) monetarists accept them. Mayer's critics object to Meyer's excluding from their ranks the minority who do not accept one or more of this group of eight. OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 Thomas Mayer on Monetarism 477 Here, I think, I am on Mayer's side on Schumpeterian grounds. For in raising the Schumpeterian question, what grand "vision" of the economic process inspired the development of monetarist ideology, it is to this group that we must look, rather than to the relative abstraction and aridity of Mayer's primary quartet. And if I select among the eight, I should select (1) a monetary growth rule as at least a "second best" guide to monetary policy (Mayer's # 9), (2) the corollary use of a money stock rather than an interest rate monetary target (his #8), (3) a willingness to tolerate unemployment as a cost of price disinflation (#11) coupled (after Phillips' 1958 paper)7 with rejection of the Phillips curve as a reliable trade-off indicator (# 10) and an essentially libertarian abhorrence of "suppressed inflation" and such direct controls as incomes policies, rationing, and allocations (# 12).8 VI. I might myself suggest, again on Schumpeterian grounds, one additional (ninth) member for Mayer's team of secondary propositions, raising his total to 13.9 This is the debatable proposition that the monetary authority — meaning the Federal Reserve in contemporary America — does in fact have the power, and accordingly the responsibility, to regulate the money supply. The aspect of monetarist vision involved here is that monetary mismanagement by the Federal Reserve has been and is the prime cause of the great booms and contractions of the American past and present, which have been unjustly blamed on the free enterprise system as a whole. This proposition is debatable on at least three bases, two purely domestic and the third international. 7 A. W. Phillips, "The Relation between Unemployment and the Rate of Change of Money Wages in the United Kingdom, 1861 - 1957," Economica (November, 1958). For the most influential American application, see Paul A. Samuelson and Robert M. Solow. "Analytical Aspects of Anti-Inflation Policy," American Economic Review (May, 1960). 8 A particularly apt example in Milton Friedman, "What Price Guidepost?" in George P. Shultz and Robert F. Aliber, eds. Guidelines: Informal Controls and the Market Place (Chicago: University of Chicago Press, 1966), pp. 17 to 39. 9 Of, if Mayer inclines to triakaidekaphobia, this proposition might be substituted for the preference for small models over large ones (his # 6) which seems related only tenuously to the basic monetarist insight. OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 478 Martin Bronfenbrenner 1. If M is the money stock and B the monetary base, we have:10 B M — -il"") D \ M J where die commercial banks' reserve ratio and controlled by the commercial banks themselves at least within legal limits and public's ratio of currency to total money and controlled by the public. It is the contention of numerous writers (most prominently J. G. GUYley and E. S. Shaw)11 that the Federal Reserve's control of B is inadequate to regulate M in either cyclical booms or depressions. 2. The Federal Reserve is a creature of Congress and cannot disregard current political sentiment, however wrong-headed it may be. There have been frequent attempts already, led for three decades by the expansionist Congressmen Wright Patman (D., Tex.) as Chairman of the House of Representatives Committee on Banking and Currency, to restrict particularly the system's anti-inflationary clout by limiting methods involving "tight money". (This term refers to rises in nominal interest rates and standards of credit-worthiness, "credit squeezes" on particular companies unusually dependent on borrowed funds, and pressure on savings institutions from "disintermediation", as deposits are withdrawn in search of higher interest incomes.) More recent congressional critics, such as Senator William Proxmire and Representative Henry Reuss (both D., Wis.) have been more sympathetic to monetarism in their proposals.12 10 The derivation below is based on Phillip Cagan, "Determinants and Effects of Changes on the Stock of Money, 1975 - 1960" (New York: Columbia University Press, 1965) p. 12 M = C + D (C = currency, D = bank deposits) B = C + R (R = bank reserves) Ç + R MC + DMM 1 l B C + R C_ R C, .R D C, .R / C: M M M + D'M M+D M 11 Gurley and Shaw, "Money in a Theory of Finance" (Washington: Brookings Institute, 1960). 12 The belated rise of "monetarist" criticism of the Federal Reserve within Congress itself lends some support to monetarist reproaches against Federal Reserve "fleeing where no man pursueth" in connection with past ineptness. OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 Thomas Mayer on Monetarism 479 3. Under a regime of fixed exchange rates and unregulated short-term capital movements, the power of any country's monetary authority is circumscribed by the tendency to international equality of interest rates. Monetary expansionism, lowering short-term rates at home, is thus counteracted by capital outflows, and vice versa. During the 1960's, moreover international aspects of monetary control have been exacerbated for the United States by the rise of the Eurodollar market. This market has become a vehicle for foreign banks, including foreign branches of American banks, to create dollar deposits on a large scale by loans subject neither to reserve nor to reporting requirements, so that the Federal Reserve can only estimate more or less inaccurately the total volume of the dollars outstanding and overhanging the American money market. It is obviously difficult to regulate a quantity when one does not know with adequate precision what that quantity is! The basis of scepticism regarding monetarism is summarized by a "Wall Street Journal" editorialist:13 "[A]fter so much government manipulation over so many years, private commerce has become exceedingly adroit in switching to money imports and substitutes, chiefly trade credit and credit cards, both of which are sources of liquidity" i. e., of autonomous changes in velocity. VII. Three random comments on Mayer's exposition of individual propositions and I close: During the Great Depression, for example, and under the gold standard, Friedman and Schwartz deny that the fear of gold drains constituted a rational explanation for Federal Reserve phobia against expansionary openmarket operations. Milton Friedman and Anna J. Schwartz, "The Great Contraction, 1929 - 1933", (Princeton: Princeton University Press, 1965), pp. 103 to 110. 13 Jude Wanniski, "The Mundell-Laffer Hypothesis — A New View of the World Economy", Public Interest (Spring, 1975), p. 28 n., citing Professor Robert Mundell. — More generally, the monetarist theory of the international balance of payments seems itself inconsistent with any notion of over-riding power in the hands of domestic monetary authorities. This is because it sees a balance of payments deficit (surplus) as primarily a manifestation of an excess supply of (demand for) money, and an avoidance of the authority's authority. See Donal Kemp, "A Monetary View of the Balance of Payments", Federal Reserve Bank of St. Louis Review (April, 1975) and sources cited, (including Professor Mundell). OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36 480 Martin Bronfenbrenner 1. On that alleged "black box" — the transmission mechanism between monetary changes and the real economy — Mayer should perhaps have spelled out in more detail what he thinks monetarists believe that process to be, or if indeed they seem to him hopelessly divided among themselves. To me, any explanation must involve the proposition, resting on Pigou and Keynes effects, that money changes effect real variables through price-level changes separately from and in addition their effects through interest changes both nominal and real. If so, it is important "whether one formulates the analysis in terms of M or in terms of r", since the effects, despite substantial overlaps, are significantly different. It is easy to criticize monetarist coyness in deciding between the Mu M2, ..., Mn concepts of money (I have seen n values as high as 7). But the critics owe Professor Friedman in particular the concession of mentioning his belief (unconfirmed, to the best of my knowledge) that all Mthe ratios would be sensibly constant but for such constraints as the ban on interest payments on demand deposits and the "Regulation Q" interest ceilings on savings deposits. I likewise have questions about Mayer's sentence: "An increase in the real stock of money lowers the imputed real interest rate on money balances" (italics his) as a part of the transmission process, unless indeed this statement implies a rise in the price level.14 2. It may involve no more than my inflated ego to point out the existence of a compromise proposal (of my own)15 midway between the Friedman - Shaw constant monetary growth rule (Mayer's proposition 14 In personal correspondence, Mayer has clarified my difficulty here. By "imputed real interest rate" he means what I would call the marginal utility of an increment to real balances. I do not think that our difference is more than verbal. 15 M. Bronfenbrenner, "Monetary Rules: A New Look", J. L. E. (October, 1965). — If we write the standard equation of exchange as: MV = pY = pN n , whence log M + log V = log p + log N -}- log 7i d log M + d log V = d log p + d log N + d log n dM dV = dp ,dN du M V ~~ p N n Gm + Gv = Gp + Gn + Gn the expression in the text follows, if Gp = 0, i e., if price-level stability is maintained. OPEN ACCESS | Licensed under CC BY 4.0 | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/ccm.8.4.473 | Generated on 2023-01-16 13:32:36