Transcript Vienna vs. Chicago on Monetary Issues

Vienna vs. Chicago
on Monetary Issues
Methods, Theories, and Policies
Friday, July 31, 2009
Keynes, Friedman, and Hayek in Perspective:
Three Views of the Market Economy
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Keynes, Friedman, and Hayek in Perspective:
Perspective
A Methodological Reckoning
John Maynard Keynes
Keynes’s was the type of theorist who developed his theory after he
had developed a sense of relative magnitudes and of the size and
frequency of changes in these magnitudes.
He concentrated on those magnitudes that changed most, often
assuming that others remained fixed for the relevant period.
Allan Meltzer, Keynes’s Monetary Theory: A Different Interpretation (1988)
Further, Keynes evidently did not develop a sense of what was going
on within these macro-magnitudes and hence felt quite justified in
ignoring all such issues.
---RWG
Keynes, Friedman, and Hayek in Perspective:
A Methodological Reckoning
Milton Friedman
I believe that Keynes’s theory is the right kind of theory in its
simplicity, its concentration on a few key magnitudes, and its
potential fruitfulness.
Milton Friedman, “Keynes’s Political Legacy,”
in John Burton, ed., Keynes’s General Theory: Fifty Years On (1986)
"We're all Keynesians now …. We all use the Keynesian language
and apparatus….”;
Time Magazine (1968)
Keynes, Friedman, and Hayek in Perspective:
A Methodological Reckoning
Friedrich Hayek
The role of the economist, Hayek points out [in his Pure Theory of
Capital, 1941], is precisely to identify the features of the market
process that are “hidden from the untrained eye.”
For Hayek, The cause-and-effect relationship between central-bank
policy during the boom and the subsequent economic downturn
have a first-order claim on our attention, despite the more salient comovements in macroeconomic magnitudes that characterize the
post-downturn spiraling of the economy into deep depression.
Paraphrased from Roger W. Garrison, “Hayek and Keynes: Head to Head,”
in The Elgar Companion to Hayekian Economics (forthcoming)
Keynes, Friedman, and Hayek in Perspective:
A Methodological Reckoning
Friedrich Hayek
There may well exist better “scientific” evidence [i.e., empirically
demonstrated regularities among “key” macroeconomic magnitudes]
for a false theory, which will be accepted because it is more
“scientific,” than for a valid explanation, which is rejected because
there is no significant quantitative evidence for it.
Friedrich Hayek, “The Pretence of Knowledge,” Nobel Lecture, 1974
Keynes, Friedman, and Hayek in Perspective:
A Difference in Focus
Keynes attributes the downturn to psychological factors affecting the
investment community. His main focus, however, is on the dynamics
of the subsequent downward spiral---and on policies that will reverse
the spiral’s direction.
Friedman is dismissive of the whole issue of the cause of the
downturn, referring to it as an “ordinary,” “run-of-the mill,” “routine,”
“garden-variety” recession. His focus is on policy blunders after the
downturn and the correlation between the decrease in the money
supply and the fall in nominal GDP (i.e., in PQ).
Friedrich Hayek focuses on the policy-infected aspects of the boom
and their implications of the boom’s sustainability. He leaves it to
economic historians to detail all the policy perversities and hard
times that characterized of the subsequent depression.
Friedman’s Monetarism:
MV=PQ
with a lag of 18-30 months.
With a mild upward trend in velocity
and Output (Q) growing slowly,
the price level (P) moves with the money
supply (M).
Friedman’s Monetarism:
MV=PQ
with a lag of 18-30 months.
“Inflation is always and everywhere
a monetary phenomenon.”
Friedman’s Monetarism:
MV=PQ
with a lag of 18-30 months.
Friedman’s Monetary Rule:
Increase the money supply at a slow and steady
rate to achieve long-run price-level constancy.
Friedman’s Monetarism:
MV=PQ
But what happens within the Q aggregate
as a result of the monetary injection?
RATE OF INTEREST
with a lag of 18-30 months.
S
+ΔM
D
SAVIING (S)
INVESTMENT (D)
Friedman’s View of a Monetary Contraction
M V =( P Q )
A sharp monetary contraction puts downward
pressure on P and Q.
If P is slow to adjust, Q will fall.
Evidence shows that decreasing M is the essential
(primary, dominant) cause of the decrease in Q.
THE CASE OF THE CABBAGE-EATING MISSISSIPPI MONSTER
Austrian and Chicago Methodology in Action
Suppose that in late October of 1929, a thousand-pound monster
showed up in Mississippi. It spent the next three-and-a-half years eating
all the cabbages (and quite a few rabbits) between Jackson and
Pascagoula. By early March of 1933, the monster weighed fourthousand pounds.
Two investigators are sent to Mississippi to get a handle on the situation.
One is from Vienna, the other is from Chicago.
The Viennese investigator asks, “Where in the world did this hideous
thing come from?” [Here, I seemed to have stacked the cards against
the Austrian. It’s hard even to imagine an insightful answer to this
question—unless, of course, the monster turns out to be the unintended
consequence of some ill-conceived government-sponsored bionics
project.
THE CASE OF THE CABBAGE-EATING MISSISSIPPI MONSTER
Austrian and Chicago Methodology in Action
The Chicagoan shows up, shoves the Austrian aside, and says, “Never
mind how this thing got here, the REAL question is: How did it grow from
1000 pounds to 4000 thousand pounds? How did an ordinary, run-of-themill, garden-variety monster quadruple its weight in 40 months?
The Chicagoan’s answer, of course, is: it was all those cabbages. (He
couldn’t get good data on the rabbits.) The correlation between cabbage
consumption and weight gain leaves not doubt the issue.
Do we suspect that data availability is what led The Chicagoan to his
conclusion? And that the lack of hard data pertaining to the monster’s
origins caused him to be dismissive of questions about where the thing
came from? These and related suspicions are what underlie the
message in Hayek’s Nobel address on “The Pretense of Knowledge.”
Friedman’s View of a Monetary Contraction
M V =( P Q )
A sharp monetary contraction puts downward
pressure on P and Q.
If P is slow to adjust, Q will fall.
Evidence shows that decreasing M is the essential
(primary, dominant) cause of the decrease in Q.
The equation of exchange is so near and
dear to Milton Friedman’s heart that he
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The equation of exchange is so near and
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Gribouillis économiques
C. parody to the popular Y.M.C.A.
D. vanity license plate number.
GREG MANKIW’S BLOG
Random Observations for Students of Economics
September 16, 2006:
Curious question from Mankiw:
“How can you identify my car?”
Gregory Mankiw
Former Chairman
Council of Economic Advisors
George W. Bush Administration
mvpy writes:
You know, I hate to spoil things, but I must say, I think Milton
Friedman has a better plate. This is from an article I came across:
"Years ago, trying to find the Friedman’s apartment in San
Francisco, I knew I was in the right location when I spotted a car
with a license plate that read “MV = PT."
A. Delaique writes:
Milton Friedman's license plate was MV = PQ, not MV = PT.
Picture here : http://gribeco.free.fr/article.php3?id_article=12
Anonymous writes:
That's pretty ridiculous..
Canée writes:
I love economists.
Friedman’s Monetarism:
MV=PQ
with a lag of 18-30 months.
“Inflation is always and everywhere
a monetary phenomenon.”
Vienna vs. Chicago
on Monetary Issues
Monetarist Conclusions
Depend on a Constant
Or Near-Constant Velocity
Inflation (a rising CPI)
The Money Supply (M1)
--from J. Bradford DeLong’s “The Triumph of Monetarism?”
Journal of Economic Perspectives, Winter 2000.
The velocity of
money became
unstable after 1980.
Friedman’s policy
rule lost its velocity
anchor.
The Federal Reserve
abandoned moneysupply targeting in
favour of interestrate targeting.
Friedman’s Monetarism:
MV=PQ
with a lag of 18-30 months.
The Irony of Monetarism:
The monetary rule that allows the economy to
perform at its laissez-faire best presupposes a
critical piece of intervention (Regulation Q) that
makes the money supply operationally definable.
Friedman’s Monetarism:
MV=PQ
with a lag of 18-30 months.
Greenspan: “We don’t know what money
is, anymore.”
…which explains why the Federal Reserve
switched from money-supply targeting to
interest-rate targeting in the early 1980’s
Vienna vs. Chicago
on Monetary Issues
The Implementation of the Monetary Rule
Requires Fixed and Known
Commercial-Bank Operating Ratios
Vienna vs. Chicago
on Monetary Issues
How Did Friedman Account for
the Long and Variable Lag between
Monetary Expansion and a Rising Prices?
Friedman accounts for the M-P lag of 18-30 months:
Holders of cash will…bid up the price of assets. If the extra
demand in initially directed at a particular class of assets,
say, government securities, or commercial paper, or the
like, the result will be to pull the prices of such assets out
of line with other assets and thus widen the area into
which the extra cash spills. The increased demand will
spread sooner or later affecting equities, houses, durable
producer goods, durable consumer goods, and so on,
thought not necessarily in that order…. These effects can
be described as operating on “interest rates” if a more
cosmopolitan [i.e., Austrian] interpretation of “interest
rates” is adopted than the usual one which refers to a small
range of marketable securities.
Milton Friedman (1969 [1961]), “The Lag Effect in Monetary Policy,” in Miltion
Friedman, The Optimum Quantity of Money and Other Essays, Chicago: Aldine.
“The key feature of this process [during which interest rates
are low] is that it tends to raise the prices of sources of both
producer and consumer services relative to the prices of the
services themselves…. It therefore encourages the
production of such sources and, at the same time, the direct
acquisition of the services rather than of the source. But
these reactions in their turn tend to raise the prices of
services relative to the prices of sources, that is, to undo the
initial effects on interest rates. The final result may be a rise
in expenditures in all directions without any change in
interest rates at all; interest rates and asset prices may
simply be the conduit through which the effect of the
monetary change is transmitted to expenditures without
being altered at all….”
Milton Friedman (1969 [1961]), “The Lag Effect in Monetary Policy,” in Miltion
Friedman, The Optimum Quantity of Money and Other Essays, Chicago: Aldine.
“It may be … that monetary expansion induces someone
within two or three months to contemplate building a
factory; within for or five, to draw up plans; within six or
seven, to get constructions started. The actual construction
may take another six months and much of the effect on the
income stream may come still later, insofar as initial goods
used in construction are withdrawn from inventories and only
subsequently lead to increased expenditure by suppliers.”
Milton Friedman (1969 [1961]), “The Lag Effect in Monetary Policy,” in Miltion
Friedman, The Optimum Quantity of Money and Other Essays, Chicago: Aldine.
Vienna vs. Chicago
on Monetary Issues
Friedman’s Plucking Model
Vienna vs. Chicago
on Monetary Issues
Methods, Theories, and Policies
Friday, July 31, 2009