“We Are All Monetarists Now”

4 February 2009 at 2:44 pm 4 comments

| Peter Klein |

“We are all Keynesians now,” Milton Friedman famously remarked in 1965. He meant that all mainstream macroeconomists, regardless of political persuasion, accepted the basic aggregate income-expenditure framework (and assumption of homogeneous capital) that underlies the neo-Keynesian model. How this model came to displace its predecessors, and how it remains in force today, despite the New Classical revolution and New Keynesian counterrevolution, is one of the most interesting stories of twentieth-century intellectual history. Greg Mankiw’s warm fuzzy for Bob Lucas — really a poke at Paul Krugman — is instructive in this regard. As is this anecdote shared by Steve Medema:

I was attending the small Claremont-Bologna monetary conference about a decade ago, and the participants included Friedman, Modigliani, Tobin, and Samuelson. I was sitting in a shuttle van that would take us to dinner, talking with Milton and Rose Friedman. Modigliani approached the van, saw Friedman, shook his hand vigorously, and exclaimed, “Milton, I’m a monetarist now!”

Keynesian, New Keynesian, Monetarist, and New Classical macroeconomics are variations on a theme. The capital-based macroeconomics of the Austrian school represents an entirely different approach, one I hope to blog more about soon. (See also: “Revenge of the Aggregates.”)

Update: Even Dick Armey, writing in today’s WSJ, gets it:

Keynes’s thinking was a decisive departure from classical economics, because arbitrary “macro” constructs like aggregate demand had no basis in the microeconomic science of human action. As Hayek observed, “some of the most orthodox disciples of Keynes appear consistently to have thrown overboard all the traditional theory of price determination and of distribution, all that used to be the backbone of economic theory, and in consequence, in my opinion, to have ceased to understand any economics.”

As Keynes’s Cambridge colleague Gerald Shove supposedly remarked (according to Joan Robinson), “Maynard never spent the half hour necessary to learn price theory.” Sadly, the same seems true of many of Keynes’s modern disciples.

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4 Comments Add your own

  • 1. Joe Mahoney  |  4 February 2009 at 4:41 pm

    My understanding is that “A Monetary History of the United States 1867-1960″ establishes a correlation between money and money income. Keynesians and other opponents of monetarism do not deny the existence of the correlation, but rather its interpretation.

    Monetarists claim that money causes prices: “Inflation is always and everywhere a monetary phenomenon.”

    Of course, the data are also consistent with the belief that prices cause money (by going beyond the closed-economy framework of the debate)

    No matter how large the data set and how brilliant the Friedman rhetoric (in the Classical Greek sense of the term) on monetary theory may be, it does not alleviate the econometric identification problems of multiple interpretations consistent with the data.

    The amount of sneering among macroecononomists that goes on for decades suggests that the debates go well beyond what we can know with certainty using modernist methodologies.

    Taking the con out of econometrics, we are still at the pre-science stage of making ad hoc inferences with non-experimental data that are akin to trying to learn the laws of electricity by fiddling with the radio.

    I have no vested (career) interest academically in the subject of macroeconomics. My simple question though to anyone who ventures broad statements in this field is a good one heard at most Chicago School seminars over the decades: HOW DO YOU KNOW?

  • 2. Peter Klein  |  4 February 2009 at 4:56 pm

    Joe, my point is that where one stands on that particular identification problem is a second-order difference, compared to where one stands on the levels-of-aggregation issue, the capital heterogeneity issue, etc. In other words, the differences between Keynes and Friedman are dwarfed by the differences between, say, Mises-Hayek and Keynes-Friedman.

    BTW, I think your last question is spot-on. If only we were all, in this sense, Hayekians! Remember Herbert Stein’s remarks (quoted the other day by Arnold Kling):

    1. Economists do not know very much.
    2. Other people, including the politicians who make economic policy, know even less about economics than economists do.

    Of course, given my own methodological presuppositions, I would say the problem is not that economic science is insufficiently advanced to understand macroeconomic problems, but that the macroeconomy itself is not a machine that can be fine-tuned (to use that classic Keynesian term), a car to be driven, a toy for policymakers to play with, etc., but a complex adaptive system, a social organism, an ecosystem, a spontaneous order, etc. etc. An aggregate model that ignores capital heterogeneity cannot capture this complexity in a way that is scientifically useful, no matter how many experiments we can perform, how sophisticated our econometric tools, how advanced our mathematics.

  • 3. Joe Mahoney  |  4 February 2009 at 6:23 pm

    Your comment above is edifying, Peter.
    Thank you.

  • 4. David Hoopes  |  5 February 2009 at 11:51 pm

    I thought the prescription of monetarists was that you cannot fix the economy by toying with the money supply. That the money supply should expand with an economy’s productive capacity.

    And, I think the idea that printing money more quickly than an economy grows inflates prices, also thought a monetarist’ obervation, seems most likely true.

    This going back pretty far in my education so please forgive me if it’s all jumbled.

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