Chicago and monetary economics

Conference: Living the Legacy: Chicago Economics through the Years

Client: The Becker Friedman Institute for Research in Economics at the University of Chicago

Was there really a monetarist Chicago tradition of monetary economics that emerged in the 1930s? Yes, indeed, asserted David Laidler, Professor Emeritus at the University of Western Ontario, in this session. The “details, nature and influence” of the tradition evoked widespread debate, Laidler acknowledged, but “the only person who questioned its existence was Harry Johnson—“and he was just wrong,” said Laidler.

This panel aimed to get to the bottom of a well-known argument that arose in the 1960s when Friedman claimed that monetarist thinking was in place at the University of Chicago in the 1930s, well before his research brought it to the fore in the 1950s and 1960s. Critics, including UChicago professor Harry Johnson (1959–77) and lecturer Donald Patinkin, PhD’47. (1947–48), objected, going so far as to accuse Friedman of “scholarly chicanery” for the claim.

Laidler and panelists Hugh Rockoff and George Tavlas soundly backed Friedman and summoned evidence that early monetarist ideas were in fact prominent at Chicago.

The Chicago tradition’s central market-focused message was built around the quantity theory of money. It argued that given appropriate monetary rules, it was possible for a laissez-faire economy to function.

Laidler stressed that even arguing that this kind of economy was possible—not just desirable—is an important point. By 1930, in the midst of the Great Depression, the question was not whether there was something better than capitalism, but whether capitalism was possible at all. Laidler noted that by then people were already trying various forms of totalitarianism. “So this simple proposition that this (approach) could work is very, very important in the history of economic thought,” he said.

Laidler laid out three propositions that characterized the Chicago tradition in the 1930s: first, the great contraction of 1929 to 1933 was a collapse of the role of the Federal Reserve, not a collapse of capitalism; second, the immediate cure for this was vigorous monetary and fiscal expansion; and, third, the system should be at 100 percent money to protect the stability of price levels. (“One hundred percent money” or “narrow banking” is when commercial banks are required to hold Federal Reserve monetary liabilities equal to their total checkable deposits.)

Milton Friedman later modified and extended this point of view through his work in the 1950s, and summarized it in his American Economic Association presidential address, “The Role of Monetary Policy.” in March 1968. In the aftermath of the Great Depression, many believed the fatal flaw in the economy was the laissez-faire approach, but Friedman grew to believe the fatal flaw was in monetary mechanisms. He concluded that essentially, the role of monetary policy was to generate price stability.

Friedman’s approach was basic continuity of the Chicago tradition, Laidler said, noting that it was a minority opinion at the time. A few others outside the University of Chicago shared it, such as Laughlin Currie at Harvard University. (In the final panel of the conference, professor emeritus Lester Telser pointed out that Currie’s monetarism and explanations for the Depression preceeded Friedman’s by decades but Friedman never acknowledged them.)

But these ideas were not universally accepted at Chicago, either. Most notably, Jacob Viner refused to sign The Chicago Plan, 1933 public memorandum from his colleagues recommending steps to shore up the ailing economy. The Chicago history, Laidler concluded in an accompanying paper, is “very untidy.”

Rockoff, professor of economics at Rutgers University, focused on the founding role Henry Simons, a quantity theorist, played during the 1930s and early 1490s in this emerging Chicago tradition. Simons held that fiscal policy, not monetary policy, was the answer to the problems of the Great Depression and that the government’s federal debt management policies were very important to the economy overall.

The key to understanding Simons’ approach is that he held a very broad definition of what defined money, Rockoff noted. Simons argued that it should include a wide range of instruments, including commercial paper, bonds, treasury notes, bank deposits. For Simon, each, had a varying degrees of “moneyness.” Simons believed that fiscal policy worked because, in the end, it really was a sort of monetary policy.

Rockoff argued that Simons’ most enduring contribution to monetary economics was his ideas about the benefit of using rules over discretion. Simons argued that there had to be rules for the economy, including monetary rules, for private enterprise systems to function effectively. He also advocated for the price rule because he believed there were so many new monies around. These monies were going to change, argued Simons, so the economy couldn’t be controlled and a stable framework couldn’t be created just by controlling currency and deposits.

“The best Simons said you can do in the absence of any fundamental reforms,” Rockoff explained, “is try to aim at price stability by aiming at any variables you can control.”

Friedman later argued for rules vs. discretion as well, yet there is a large transition from Simons’ view to Friedman’s, Rockoff argued. Most notably, Friedman had a strong interest in empirical research while Simons was skeptical of empirical economics all together.

George Tavlas, Bank of Greece, concluded the panel by scrutinizing the scholarly uproar when in a prominent lecture, Johnson accused Friedman of exaggerating the evidence for an early Chicago tradition. At the heart of this criticism was the debate percolating between the Chicago tradition and the Keynesian approach most typified by Harvard economists at the time and led, in part, by Patinkin, then at Hebrew University. They argued that Friedman’s work really derived from Keynesian preference theory.

Tavlas reviewed the evidence and concluded that Friedman was in the right. “The particular way the Chicago quantity theory approach of the early 1930s was articulated left it less vulnerable to the Keynesian revolution in other academic centers Chicago economists,” he stated, adding, “It’s notable that three major critiques of Keynes were written by Chicagoans.”

In particular, work by Paul Douglas put forth the idea that fiscal deficits could be used to generate increases in money supply. A 1931 book by Douglas and Aaron Director also put forth a money supply growth rate rule.

The evidence is clear that there was a distinct Chicago quantity of money movement, Tavlas concluded, although important work in this vein was also being pursued elsewhere. “And there is a distinct, unmistakable, and revealing connection between this work and Friedman’s but it’s not the Friedman of the 1960s; it’s the Friedman of the late 1940s.”

–Jennifer Roche | LINK to Original

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