The Quantity Theory of Money: From Locke to Keyes and Friedman.
Hammond, J. Daniel
By Mark Blaug, Walter Eltis, Denis O'Brien, Don Patinkin, Robert
Skidelsky, and Geofrrey E. Wood. Brookfield, Vermont: Edward Elgar,
1995. Pp. ix, 139. $63.95.
Yes Virginia, there may be a quantity theory, but will we know it
when we see it?
The issue tying together the six essays that comprise this book is
the identity of the quantity theory of money: its main tenets; how they
relate to monetarism; and what role the quantity theory played in early
monetary debates. Mark Blaug's introduction and his essay,
"Why is the Quantity Theory of Money the Oldest Surviving Theory in
Economics?", provide the fulcrum for considering this issue. Don
Patinkin, as commentator on the essays, devotes more attention to
Blaug's than to any of the other essays.
The particular foci for the other authors are varied. Walter Eltis
writes about John Locke, sketching his biography and summarizing the
contents of Locke's writings on money. Eltis credits Locke with the
first coherent statement of the relationship between the quantity of
money and the price level. Denis O'Brien provides a review of the
currency-banking school controversy and illustrates the danger of
ignoring adjustment to disturbances from long-run equilibrium.
O'Brien refers to the error of relying solely on long-run
equilibrium theory as the Ricardian Telescope. One is able to discern
only long-run outcomes through the telescope, missing much of what is
important.
Robert Skidelsky traces J. M. Keynes's struggle to escape
from the quantity theory. He argues that Keynes wanted to escape because
he came to view the quantity theory as inadequate for stabilization
policy. Skidelsky judges that Keynes's escape was partial. Geoffrey
Wood brings the discussion closer to the present with his argument that
conventional wisdom notwithstanding, the quantity theory was not
overturned by events of the 1980s. Wood contends that if more attention
was paid to the history of the quantity theory, mistakes of applying it
mechanically could have been avoided and it would have come as less
surprise when institutional changes upset historical relationships
between money and income.
Blaug provides the definition of the quantity theory which the
others use to determine if their subjects were quantity theorists. He
gives two versions of the definition. The first has two propositions:
(1.1) the purpose of the quantity theory is to explain the price level
and the key causal factor is the quantity of money, and (1.2) the effect
of changes in the quantity of money occur through direct and indirect
channels. The second version has three more restrictive propositions:
(2.1) causation runs from money to prices and not vice versa, (2.2)
money demand is stable, changing slowly and independently of changes in
money supply, and (2.3) the volume of transactions or real income is
determined by real forces independently of the quantity of money or
level of prices.
Proposition 2.1 is the most troublesome. What are the bounds for
concluding that causation runs only from money to prices? Does the money
stock have to be completely sealed from feedback for the quantity theory
to hold? Is their belief in this proposition required to label someone a
quantity theorist? Proposition 2.3 presents similar problems. If changes
in the money stock have any real effects does this invalidate the
quantity theory? If a person believes there is some causal power in
money over real income does this mean that the person is not a quantity
theorist? Let's see how the authors evaluate their subjects in
terms of Blaug's definition.
Eltis judges that Locke was a quantity theorist on all three
counts of one-way causation, stable and predictable money demand, and
money neutrality. O'Brien criticizes modern advocates of free
banking for using the long-run endogeneity of the money supply under the
gold standard to defend the Banking School position. He argues that some
modern mathematical renditions of classical monetary theory view matters
through the Ricardian Telescope by making the law of one price hold
continuously. O'Brien's criticism suggests that proposition
2.3 should be interpreted as holding only for the long-run but much of
what matters for understanding money, income, and prices happens away
from the long run. As O'Brien puts it, one must have a theory of
monetary control. This leads to the question, is having a theory of
monetary control a departure from the quantity theory?
Skidelsky argues that early in his career Keynes unproblematically
held to all three of Blaug's quantity theory tenets, but by the
time he wrote the General Theory had abandoned 2.3, the independence of
output from monetary factors. By then Keynes believed that output was
directly determined by changes in velocity. But Keynes never abandoned
2.1, belief in the exogeneity of money.
Wood asks whether modern monetarists should be seen as quantity
theorists, and answers "yes." He does so by comparing Friedman
and Schwartz's views with Hume and Thornton, whom he presumes were
quantity theorists. The implication of his argument is that Blaug's
propositions 2.1 and 2.3 should not be taken in a strict sense for
understanding the economy or identifying quantity theorists. Money is
not nor should it be expected to be strictly exogenous. Money's
effect on output is only temporary, but output is not strictly
independent of money and the price level.
Wood confronts head on an issue that Blaug opens in his
introduction--what makes a monetarist? Blaug acknowledges some
difficulty in pinning this down, but suggests several beliefs or
characteristics, including preference for monetary policy with the money
supply as the policy target, preference for rules over discretion, and
crucially, neutrality of money.
Blaug makes the historiographic argument that a person's
views on historical issues are colored by their views on contemporary
issues and vice versa. He argues that monetarists are likely to find
quantity-theory precedents for monetarism in the past, while Keynesians
(or non-monetarists) are likely not to find them. With regard to the
book's authors, Blaug associates Eltis and Wood with monetarism and
O'Brien, Skidelsky and himself with Keynesianism or non-monetarism.
I find the taxonomy in this book problematic. Let's consider
Milton Friedman. Friedman considers himself a quantity theorist. There
has been debate about this, but certainly Friedman is a monetarist if
anyone is. In 1958 Congressional testimony Friedman summarized the
tentative findings from his monetary research project as follows:
The direction of influence between the money stock and income and
prices
is less clear-cut and more complex for the business cycle than for
the
longer movements.... Thus changes in the money stock are a
consequence as well as an independent cause of changes in income
and
prices, though once they occur they will in their turn produce
still
further effects on income and prices. This consideration blurs the
relation between money and prices but does not reverse it. For
there is
much evidence . . . that even during business cycles the money
stock plays
a largely independent role. This evidence is particularly direct
and
clear for the deep depression periods [1, 179].
Let's consider if Friedman was a quantity theorist in the
1950s by comparing the evidence in this statement with Blaug's
definition. Friedman's statement is incompatible with proposition
2.1. He flatly states that he thinks causation runs in both directions
between money and income and prices. It is equally clear that his
statement is incompatible with 2.3, for he states that money influences
real income. So taking Blaug's definition of the quantity theory as
given, we would conclude that in the 1950s Friedman was not a quantity
theorist.
Was he a monetarist when he made this statement? Blaug says that
the monetarist contributors to this book emphasize money's
neutrality while the Keynesians emphasize the short-run non-neutrality
of money. On this criterion it looks as if Friedman is more a Keynesian
clan monetarist, for he emphasizes money's non-neutrality.
Something is out of kilter when Milton Friedman appears to be
neither a quantity theorist nor a monetarist. No doubt part of the
problem is simply that taxonomy is very difficult in dealing with the
history of ideas. Blaug's insight that views on current issues
influence interpretations of historical issues is to the point. Put
differently, doctrines evolve over time as they are tested and applied
in different circumstances. There is good reason to think that something
essential from the past remains in contemporary versions of old
doctrines, but it is far from a trivial exercise to extract that
essence.
Yet my suspicion is that a more particular reason explains why
Friedman does not fit Blaug's definitions of the quantity theory
and monetarism. This is that Blaug defines the quantity theory by
peering through what we might call the Neoclassical Telescope. The
Neoclassical Telescope transforms ideas into propositions suitable for
formal mathematical modeling. It transforms more-or-less questions into
either/or questions. Thus we have the stark dichotomy between exogenous
money and endogenous money, and between money neutrality and
non-neutrality. Causation either runs from money to nominal income or
the other way, but not both ways. Money is either neutral or
non-neutral. Friedman's summary of his findings that is quoted
above is singularly inappropriate for viewing through the Neoclassical
Telescope. It reflects his method of investigating relations between
money, income, and prices--a method that became increasingly atypical
within neoclassical economics through the period that he was developing
what came to be called monetarism.
Reference
[1.] Friedman M. "The Supply of Money and Changes in Prices and
Output," in The Relationship of Prices to Economic Stability and
Growth, pp. 241-56. 85th Cong., 2nd. sess, Joint Economic Committee
Print, 1958. Reprinted in M. Friedman, The Optimum Quantity of Money.
Chicago: Aldine, 1969, pp. 171-87.