Thursday, August 15, 2013

The MANetarist

There has been an interesting argument happening in the economics blogosphere about whether Friedman was a Keynesian or not. Participants included Glasner, Krugman and Sumner. I'm not really going to weigh in on the debate ... ah, who am I kidding. Friedman is to Keynesians what a manarchist is to anarchists. I'd like to coin the term manetarist for economists who apply economic theory in order to reinforce conservative priors. In this way, Friedman tried to re-purpose Keynesian economics (and the quantity theory of money) in order to have the government be the root cause of the Great Depression and advocate limited government macroeconomic stabilization. [As an aside, I think it is telling that neither Friedman nor his defender Sumner have real mathematical models.]

There is one thing I thought was particularly egregious. Krugman's 1998 paper on liquidity traps has a graph in it on page 155; he says the "basic facts [in the graph] underlie two influential views of the Depression". Instead of showing the graph starting in 1929, I will create its analog starting in 2008. The graph plots the Monetary Base and the M2 Aggregate as an index referenced to 2008 vs time:

In the original graph starting in 1929, M2 falls, only to return to 100 in 1939, but is essentially similar to the graph above.

Krugman's "two influential views" of the depression-era data mentioned above are both monetarist views (probably since he is writing in 1998 and bringing back the idea of a liquidity trap). I believe this graph underlies two more disparate views: Keynes and Friedman's approach to economics.

Keynes' analysis said: Look at the graph: MB rose which ISLM (not actually Keynes, but Hick's shorthand version of Keynes' arguments) says should generate a boost in aggregate output and lower the interest rate, but the interest rate is low, therefore liquidity trap. Or, more concisely, here is information that doesn't work with prior model, so modify model with a new effect.

Friedman's analysis said: Look at the graph: MB rose, but monetarism, so notice M2 didn't rise enough. Or, less concisely, here is information that doesn't work with prior model so use different information that confirms prior model. 

Now, of course, Friedman later abandoned M2 because he really didn't have a good reason to use it in the first place except to hold on to his priors. If you normalize to any given year except during the Great Depression or the Great Recession, M2 and MB roughly track each other. To me, that is strong evidence that these periods represent a new effect, and not just that you should use one measure or the other. [As an aside, M2 includes money created by fractional reserve banking and it seems to me that the lending involved should be closely tied to interest rates, hence involve an interest rate model.]

If you get down to it, Keynes was about new ideas while Friedman was about old ideology.


  1. Krugman has a little more on the role of reserves (in the monetary base) today

    Also, I didn't want to make it seem like the basic idea of the monetary base controlling the price level itself was ideological; it is a relatively good first order approximation. I talk about it some here ...

    ... and will talk about it more in the next post.

  2. This Krugman post is also relevant

    However, the information transfer view does not rely on these mechanisms (e.g. dollars are close substitutes for treasuries) and instead says we have so many "bits" (dollars) out there to measure the information transfer that additional bits aren't going to help.


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