QandO

March 02, 2004

The legacy of Monetarism
Posted by Jon Henke

Recently, I suggested to a friend - an economist - that Monetarism is not separate school of economic thought any longer, so much as it is a subset of Keynesianism; a refinement of Keynesianism, if you will. I fear my suggestion was unconvincing, but I find I'm not alone. Brad DeLong argues along the same lines in this lengthy post....

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.

That, it seems to me, is an advantage over the more doctrinaire economic schools, such as the austrian school. DeLong concludes...

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.

It can be boiled down to this, I think: Keynesianism + Monetarism = Neo-Keynesianism.

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