When legend becomes fact, print the legend

I view the 1920s as a sort of golden age of macroeconomics, before Keynes ushered in the long dark night.  The standard model was similar to the AS/AD model we teach in intro textbooks.  Nominal shocks have real effects in the short run, but merely lead to higher prices in the long run.  Irving Fisher argued the business cycle was “a dance of the dollar.”  He discovered the Phillips curve.  Most economists pointed to wage and price rigidity as the cause of short run non-neutrality, the same explanation that we see in modern textbooks.  People like Fisher, Pigou, Wicksell, Cassel, Hawtrey, etc, did great work in the 1910s and 1920s.  And last but not least, there was the Keynes of the Tract on Monetary Reform (1924) and the Treatise on Money (1930.) 

Hicks (1937) argued that the only thing in the General Theory that was really new was the zero rate trap.  Otherwise it was all known to the economists of the 1920s.  But Keynes had a big ego, and wanted to claim he had revolutionized macroeconomics, rather than just dress up well known ideas in a different language.  So he grossly distorted the actual macro of the 1920s, by creating a fictional “classical” economics where the economy is always at the long run run equilibrium.  His contemporaries were outraged, but since Keynesian economics won out in the long run, modern textbook writers accepted his version of events.  Now we teach all our students a bunch of falsehoods, such as the myth that the pre-Keynesian economists had no explanation for high unemployment.  Or that MV=PY is the quantity theory of money.

Brad DeLong is quite knowledgeable about economic history, so I was surprised to see him buy into the myth of interwar “classical” economics.  He quotes this passage from the GT with approval:

The General Theory of Employment, Interest and Money: The idea that we can safely neglect the aggregate demand function is fundamental to the Ricardian economics, which underlie what we have been taught for more than a century. Malthus, indeed, had vehemently opposed Ricardo’s doctrine that it was impossible for effective demand to be deficient; but vainly. For, since Malthus was unable to explain clearly (apart from an appeal to the facts of common observation) how and why effective demand could be deficient or excessive, he failed to furnish an alternative construction; and Ricardo conquered England as completely as the Holy Inquisition conquered Spain. Not only was his theory accepted by the city, by statesmen and by the academic world. But controversy ceased; the other point of view completely disappeared; it ceased to be discussed. The great puzzle of Effective Demand with which Malthus had wrestled vanished from economic literature. You will not find it mentioned even once in the whole works of Marshall, Edgeworth and Professor Pigou, from whose hands the classical theory has received its most mature embodiment. It could only live on furtively, below the surface, in the underworlds of Karl Marx, Silvio Gesell or Major Douglas. . . .

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away. 

Ah, the old “let well enough alone” myth.  A poll in the late 1920s of 282 economists showed that 251 favored a monetary policy aimed at price level stabilization.  Isn’t that sort of like New Keynesian inflation targeting?  And of course the University of Chicago economists of the 1930s favored a combination of fiscal and monetary stimulus. 

What Keynes did was move the profession away from the idea of monetary cures for business cycles–which actually can be effective, toward the idea of fiscal cures, which (short of WWII) are almost never effective.   It would take many decades for money to be rediscovered.  Indeed the influence of Keynes was so powerful that even in 2009 there were many Keynesian economists who should have known better who suddenly announced that monetary policy couldn’t work at the zero bound, and that fiscal stimulus was needed.  Fortunately those Keynesians rediscovered money much more quickly this time, indeed within 2 years.


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70 Responses to “When legend becomes fact, print the legend”

  1. Gravatar of W. Peden W. Peden
    22. August 2011 at 14:44

    Oddly enough, I came across another old myth today when looking at an American textbook that I used in high school: the myth that Britain’s recovery in the 1930s was driven by re-armament in the run up to WWII. It said that Britain’s Great Depression bottomed out by 1932 and then Britain had a sustained recovery until WWII, but that “this was driven less by a dynamic economy and more by rearmament”.

    Well, since Britain didn’t start rearming in earnest until after the 1935 election, and didn’t start borrowing for rearmament until 1937, this is obvious rubbish. Indeed, the National Government of that period is traditionally chastised for “doing nothing” and for its fiscally restrained stance. In truth, the key date in Britain’s recovery was September 1931 when we abandoned our overdeflationary parity of the £ and gold. It was the major growth of the monetary base (and more subdued growth of broad money) that led the British recovery.

    So we have our myths of the 1930s as well. Indeed, it’s a time that has generated all kinds of persistent myths e.g. appeasement was obviously stupid, fiscal policy led America out of the Depression, Hitler came to power during a time of hyperinflation, Hayek believed that the government should do nothing during downturns, Wittgenstein was a logical positivist, the Bela Lugosi “Dracula” was superior to “Nosferatu” etc.

  2. Gravatar of Martin Martin
    22. August 2011 at 15:04

    I see that you’re trying to provoke Krugman – I believe he coined the phrase ‘Dark Age of Macro’ – to respond :P?

    What does it say about the field when most of the ideas/policy prescriptions can be distilled from academic scribblers long ago? (stagnant pond/continuous stream)

    The only substantive innovations – from my brief acquaintance with the field of macro – seem to be rational expectations, EMH and to a lesser extent as it’s becoming more finance now, the CAPM.

    What would you consider the most substantive innovations in the field of monetary economics – that was not present there in the 20′s – up to now? And by substantive I mean really really new ideas.

  3. Gravatar of G Friedman G Friedman
    22. August 2011 at 15:06

    Scott and others, Can you recommend some good sources (books, papers, websites) where a non-economist can learn some sound history of economic ideas?

  4. Gravatar of Steve Steve
    22. August 2011 at 15:23

    Martin,

    That’s an easy one: NGDP targeting ;)

  5. Gravatar of W. Peden W. Peden
    22. August 2011 at 15:28

    Martin,

    There’s also the Lucas Critique, Goodhart’s Law, the Permanent Income Hypothesis (and its variants), the refutation of long business cycles, the development of free banking & monetary denationalization ideas, the natural rate of unemployment, and the anticipated/unanticipated distinction in monetary policy. Note that most of these idas were come from Lucas and Friedman.

    If there was a dark age of economic theory, we can trace its darkening period from 1936 to 1971 i.e. from the General Theory to the introduction of wage & price controls in the US and the unconstrained Keynesianism of the early 1970s. This development shows why theory matters: bad theory (income expenditure models, exogenous wages, endogenous money etc.) leads to bad policy.

  6. Gravatar of Scott Sumner Scott Sumner
    22. August 2011 at 15:55

    W. Peden, Outstanding list of myths.

    Martin, No, I’m trying to provoke DeLong. Milton Friedman said in 1974 than in 200 years macroeconomics had merely gone one derivative beyond Hume.

    G Friedman, I wish I knew. David Laidler’s books on monetary history are excellent, but they might be slightly over the head of a non-economist. You could give them a try. The first was on the quantity theory of money, and the second was on the interwar period.

    W. Peden, That’s a good list of recent improvements.

    I’d recommend Friedman and Schwartz’s Monetary History of the US, even if it is technically a history, not a history of ideas. They do discuss lots of ideas. Irving Fisher wrote a history of the Stable Money Movement.

    You should ask this question at Nick Rowe’s blog, or David Glasner’s blog. They could give you better answers.

  7. Gravatar of Andy Andy
    22. August 2011 at 16:01

    Can you explain what you mean by MV=PY not being the quantity theory of money? Do you mean that the “myth” just assumes that V is stable?

  8. Gravatar of flow5 flow5
    22. August 2011 at 16:12

    “And by substantive I mean really really new ideas”

    Yeah, this one:

    “Profit or Loss from Time Deposit Banking” — Banking and Monetary Studies, Comptroller of the Currency, United States Treasury Department, Irwin, 1963, pp. 369-386.

  9. Gravatar of W. Peden W. Peden
    22. August 2011 at 16:16

    Andy,

    MV = PY is a definition of national income (like Y = C + G + I + (X-M)) whereas the quantity theory of money is a theory about the dynamics of an economy based on (1) looking at desired vs. actual quantities of money, (2) long-run money neutrality, (3) money exogeneity, (4) a Fisherian analysis of interest rates, (5) viewing money as a part of a wide and heterogenous portfolio of assets.

  10. Gravatar of JTapp JTapp
    22. August 2011 at 16:24

    W Peden:
    “the development of free banking & monetary denationalization ideas”– would you really say these were the idea of Lucas and Friedman? I mean Bagehot is citing others’ free banking ideas back in 1873.

  11. Gravatar of Dave Dave
    22. August 2011 at 16:36

    I’m learning lots here http://www.youtube.com/watch?v=KWUG1n1jEJI

  12. Gravatar of W. Peden W. Peden
    22. August 2011 at 16:37

    JTapp,

    Note the quantifier “most”.

    I’d date the modern free banking movement to firstly Friedman the Younger (1973), then Hayek (1977), then of course the modern champions White & Selgin.

  13. Gravatar of bill woolsey bill woolsey
    22. August 2011 at 16:44

    Peden:

    Friedman the younger? Can you give a more complete citation?

  14. Gravatar of W. Peden W. Peden
    22. August 2011 at 16:54

    Bill Woosley,

    Better yet, I can give you the text-

    http://daviddfriedman.com/The_Machinery_of_Freedom_.pdf

    - though as I read it, I notice that Friedman was predated by Lawrence R. White, who can therefore be fairly called the father of modern free banking theory.

  15. Gravatar of bill woolsey bill woolsey
    22. August 2011 at 17:18

    David Friedman has a short article that was put out by Cato, Gold, Paper, or is there a Better Money.

    http://www.cato.org/pubs/pas/pa017.html

    He was my instructor in undergraduate money and banking and advisor to our campus libertarian club at Virginia Tech. I started as an orthodox Rothbardian. I suppose I got the contents of that article orally. A good bit of my current thinking is embedded in that short article.

    I had read Machinery of Freedom before taking his class, but I was still a Rothbardian — 100% Reserve Gold Standard. Believe it or not, we covered “fractional reserve banking is fraud” in the class.

  16. Gravatar of W. Peden W. Peden
    22. August 2011 at 17:24

    Bill Woosley,

    I am very grateful for that Friedman article and envious of your undergraduate experience. I went to a university where “libertarian” wasn’t even a dirty word- it wasn’t even a word, at least in politics; that said I did go to university with someone who claimed to be Milton Friedman’s grandson.

  17. Gravatar of JTapp JTapp
    22. August 2011 at 17:31

    Bill,
    Why is it that Rothbardians don’t see any problem with deflation, but feel inflation is always immoral? The standard Keynesian treatment of the late 1800s seems to be “there was deflation due to expanding population and lack of increasing gold supply causing farmer defaults on loans, bank failures, and populist anger.” Rothbard, on the other hand, seems to rarely mention how deflation can be harmful and seems to rarely mention why there was populist anger at that time. He takes the natural decline of prices when you have a constant money supply as a good thing and not accompanied by any necessary downturn in the business cycle. Rothbard & Mises recognize that certain prices are sticky– the central bank can initially boost output without dramatically raising prices, and I see a Phillips curve in Mises’ descriptions of 1920s Germany. But yet they seem to neglect that the same issues apply when prices fall. Can you please point me to something that explains the dichotomy? Thanks.

  18. Gravatar of bill woolsey bill woolsey
    22. August 2011 at 17:35

    David Friedman wrote the first edition of the Machinery of Freedom in 1973, and Larry White wrote the first edition of Free Banking in Britain in 1984. (Maybe Friedman added the stuff about free banking in later editions.) I know I read both books soon after they came out.

    By the way, back to Sumner’s original point… Yeager’s “The Keynesian Diversion,” is very good on this subject as well. He cites some standard pre-depression texts that describe monetary
    disequilibrium.

  19. Gravatar of marcus nunes marcus nunes
    22. August 2011 at 18:09

    And there is also Yeager´s
    “A cash balance interpretation of the depression” (1956):
    http://www.jstor.org/pss/1054532

    Scott:
    “left, right, jab” and “knockout”!

  20. Gravatar of Bonnie Bonnie
    22. August 2011 at 18:39

    G Friedman:

    Milton Friedman wrote a few books that a non-economist can understand:

    “A Monetary History of the United States, 1867-1960″
    “Money Mischief: Episodes in Monetary History”
    “The Great Contraction, 1929-1933: (New Edition) (Princeton Classic Editions)”
    “The Optimum Quantity of Money”

    I learned quite a bit from reading his material, and it gave me a good background for understanding Scott Sumner’s views. If I had to pick just one, it would probably be “Money Mischief.”

    I also look at cato.org, heritage.org, plus the links on this site to other economist bloggers that Scott follows. There’s some free stuff you can get on the Kindle too, like the “Wealth of Nations” by Adam Smith, and some stuff by Frédéric Bastiat. You might even be able to get stuff by Marx there for free too; I don’t have much interest to read that stuff, so haven’t looked.

    Another way I learned a smattering of economic history was through study of US history itself because it’s helpful to know a little about how economic ideas were put into practical (sometimes) application. There’s some stuff about economics in Lincoln’s writings when he talks about the sub-treasury (which I think the bill for it was actually signed by Pierce), but I think I learned the most when studying Ulysses S. Grant who was president during “resumption”, Woodrow Wilson who was president when the Federal Reserve came into being, and Harding/Coolidge who dealt with the depression in 1921-22. A short cut you can take in this approach is to download the State of the Union addresses that approximately correspond to dates in history that are important to economics (you can get most of them on Kindle for free or a very small charge); and you can get a rich view of the how and why certain things were being done, or the president was in want of them being done.

    I haven’t gotten to FDR yet, not in depth anyway. I have been avoiding it. His “Fireside Chats” boggle my mind. I can’t grasp the golden thread of logic when he discusses central planning and I have to force myself to read it. They can be downloaded for free on the Kindle as well.

    Others that I follow:
    Thomas E. Woods Jr.: tomwoods.com – an economic historian of the Austrian flair – he has a lot of stuff, including videos, on his website that I found easy to understand. He is very active in politics though, and you have to sort through a bit of propaganda to get to the good stuff.
    Art Laffer: supply-sider

  21. Gravatar of W. Peden W. Peden
    22. August 2011 at 18:48

    G. Friedman,

    I would also recommend “Money Mischief” as a good introduction to monetarist thinking. Other good introductions to economics are Mankiw’s “Principles of Economics”. Henry Hazlitt’s “Economics in One Lesson” is a good deflator of some basic fallacies and a good introduction to good economic logic in the Bastiat tradition. Partha Dasgupta’s “Economics: A Very Short Introduction” is a very broad and accessible introduction to the fundamentals of economics.

    Mark Skousen’s “The Making of Modern Economics” is an exceptionally good whistle-stop tour through the history of economics.

  22. Gravatar of John Papola John Papola
    22. August 2011 at 19:03

    Scott,

    Am I reading you right? Are you saying that WWII ended the depression due to fiscal stimulus? Seriously?

    I guess some myths are deeper rooted than others.

  23. Gravatar of Will Will
    22. August 2011 at 19:41

    G. Friedman-

    I agree that Skousen’s “Making of Modern Economics” is a whistle-stop through the history, but I cannot agree that it is exceptionally good. It is excellent as a basic “who’s who” of the big names, but quite superficial in its treatment of non-Austrians between 1890 and 1930. In particular I don’t think it does justice to Fisher and the other 10s and 20s economists Scott was making reference to (though it is good on the Chicago school in the 30s).

    Unfortunately, I don’t have a better recommendation. For an exposition of the quantity theory, I don’t think you can beat Hume’s 250-year-old essay.

  24. Gravatar of Liberal Roman Liberal Roman
    22. August 2011 at 19:44

    “I view the 1920s as a sort of golden age of macroeconomics, before Keynes ushered in the long dark night. ”

    Wow, that’s your quote for Bartlett’s Book of Quotations.

  25. Gravatar of Ron T Ron T
    22. August 2011 at 19:53

    Yes, indeed the 1920 were the golden age of econ. No better testament than the flourishing economy of 1928-1938. In the same way 1970-2008 was the golden age of neoclassical macro, which led to the Great Moderation, belief that the business cycle was conquered and all wrinkles can be ironed out by monetary policy, aided by the strangest idea of them all: that the Fed controls the money supply, contrary all evidence. Sigh.

    http://bilbo.economicoutlook.net/blog/?p=7554
    http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

  26. Gravatar of Richard A. Richard A.
    22. August 2011 at 20:58

    “When legend becomes fact, print the legend”

    From John Ford’s, The Man Who Shot Liberty Valance.
    http://www.youtube.com/watch?v=ZF42ZaWKPro

  27. Gravatar of TGGP TGGP
    22. August 2011 at 22:26

    I don’t believe you ever linked to your bepress reaction to Delong here.

    I dimly recalled that one of last week’s topics, Casey Mulligan, favorably cited some pre-General Theory work by Keynes. He summarized A Tract on Monetary Reform with “In contrast [to the general theory], this book is easy to understand, with some elegant passages describing basic tenets of economics such as the fact that printing money, printing government debt, and levying taxes are really all the same thing — the government’s taking purchasing power from the people.” I would be irked at his (admittedly brief) description of printing money as merely a form of taxation, but Milton Friedman says the same thing in this video. After his passing, Krugman lamented that Friedman the popular writer made stronger claims and with less rigor than Friedman the academic economist. Like a lot of people I didn’t take kindly to that description, but thinking back perhaps it would have been better if in his days as inflation-fighter he regularly reminded supporters of the dangers of deflation and the occasional necessity of monetary expansion. Keynes himself supposedly told his friend Hayek (who incidentally had caused Keynes to abandon some of his earlier monetary thought) that if inflation ever got out of hand he would whip the “Keynesians” in line, but unfortunately he died not too long afterward.

  28. Gravatar of Lorenzo from Oz Lorenzo from Oz
    22. August 2011 at 23:42

    TGGP On Friedman warning about deflation: possibly, though he probably thought that everyone knew that deflation was bad and it did not seem much of a prospect from 1955 to 2006. 50 years is a powerful long time in policy debate.

    Besides, the problem now is not so much that people think that deflation is good as the widespread delusion that we are hovering on the brink of a major inflation breakout. I know my “Austrian” friends have been expecting hyperinflation for years now: a fear I think is mad and is one of the reasons I am unkeen on Austrian analysis.

  29. Gravatar of Kevin Donoghue Kevin Donoghue
    23. August 2011 at 00:52

    This strikes me as a better appraisal:

    As an economics student, I enjoyed Keynes’s flashes of wit and purple prose, but I labored through or skimmed his elaborate discussions of methodology. As a middle-aged economist with a couple of hundred papers behind me, and with some experience of the “struggle of escape” involved in producing a new economic theory, I read the book from a very different perspective – and with a sense of awe. Parts of the book that once seemed tedious are, I now understand, part of a titanic effort to rethink economics, an effort whose success is demonstrated by the fact that so many of Keynes’s radical innovations now seem obvious. To really appreciate The General Theory, one needs a sense of what Keynes had to go through to get there.

    Read the whole thing (then read the whole book):

    http://www.pkarchive.org/economy/GeneralTheoryKeynesIntro.html

  30. Gravatar of Martin Martin
    23. August 2011 at 01:30

    W Peden,

    “There’s also the Lucas Critique, Goodhart’s Law, the Permanent Income Hypothesis (and its variants), the refutation of long business cycles, the development of free banking & monetary denationalization ideas, the natural rate of unemployment, and the anticipated/unanticipated distinction in monetary policy. Note that most of these idas were come from Lucas and Friedman.”

    I’d file most of those ideas under either expectations in economics or rational expectations in the case of Lucas. They seem to be more the application of a principle, than a principle itself. This is not to say that applications of principles have not contributed to our understanding.

    I am however more thinking along the lines of coming up with the QTM rather than ‘merely’ applying it. The former is a research paradigm and the latter is the actual research.

    CAPM tells us that systemic risk and return are related in equilibrium and that any departure from it is a profit opportunity.
    The EMH tells us something about the information content of prices.

    Regarding Free Banking: I don’t know where to place it. It’s ‘radical’ as a policy proposal, but is it radical in terms of economics or is it the radical application of economics?

    If let’s say a 1000 years from now, historians of thought would have to put some order to economic ideas over the centuries before and after us, how would they go about it?

    Perhaps they’ll just file this century under “expectations”, for Keynes these were exogenous and everything after Keynes, New Classical Macro included, was to make these expectations endogenous to the system studied?

  31. Gravatar of W. Peden W. Peden
    23. August 2011 at 03:04

    Martin,

    Those may be applications of principles in economics, but they required the revivification of those principles after the long dead night of Keynesianism.

    “If let’s say a 1000 years from now, historians of thought would have to put some order to economic ideas over the centuries before and after us, how would they go about it?”

    It’s very hard to say. In the 1980s, the History of Economic Thought course at Bristol didn’t even cover Keynes, instead opting to focus on Walras. The history of any discipline is necessarily selective and likely alien to contemporaries- philosophers of 1851 would be amazed that David Hume is famous today and shocked that William Hamilton is not.

    It’s worth noting, I think, that contemporary quantity theory work (at least the stuff that focuses on asset prices and broad money) is a definite improvement on the most currency-focused theories of yore.

    TGGP,

    I suspect that Friedman just never suspected that deflation would ever be a problem again or would ever have a significant political constituency in the way that inflation does.

  32. Gravatar of Morgan Warstler Morgan Warstler
    23. August 2011 at 04:45

    “Regarding Free Banking: I don’t know where to place it. It’s ‘radical’ as a policy proposal, but is it radical in terms of economics or is it the radical application of economics?”

    I think it is obvious that the politicians being elected will be forced to accept a digital version of Free Banking.

    Something like BitCoin will come on like Google and Twitter.

    It will have a known numbered supply, but be infinitely divisible. And it will not be anonymous. Thereby, removing all boogie men from the equation.

    Ultimately, the chain of custody of a digital unit: Martin – Morgan – Scott – Peden is too easy to keep track of, and this means it can’t be stolen or lost, and it can be taxed.

    The stock market PROVES this is coming.

    I also suspect we’ll soon see some kind of personal currency, based on hours (correlated to some unit X – like dollars), and backed by reputation and committed float.

    So when I trade Sumner 3 of my hours for his 5 hours, I can quickly throw his 5 hours up on an exchange – until I or someone else wants to make use of them. Scott should even be able to buy them back.

    Whenever you get too far into a hole with consumption, you basically work like a dog to get those

    I can’t really look at Internet tech without seeing this a obvious.

    Time is money, and people will be given easier and easier ways of trading their hours with larger and larger groups of people in forced honesty systems.

  33. Gravatar of Ron T Ron T
    23. August 2011 at 04:59

    Yes, indeed the 1920 were the golden age of econ. No better testament than the flourishing economy of 1928-1938. In the same way 1970-2008 was the golden age of neoclassical macro, which led to the Great Moderation, belief that the business cycle was conquered and all wrinkles can be ironed out by monetary policy, aided by the strangest idea of them all: that the Fed controls the money supply, contrary all evidence.

    http://bilbo.economicoutlook.net/blog/?p=7554
    http://www.federalreserve.gov/pubs/feds/2010/201041/201041pap.pdf

  34. Gravatar of Lee Kelly Lee Kelly
    23. August 2011 at 06:00

    I highly recommend Yeager’s “New Keynesians and Old Monetarists.”

  35. Gravatar of Scott Sumner Scott Sumner
    23. August 2011 at 06:04

    Andy, MV=PY is merely a definition of a ratio called velocity–it’s not a theory at all.

    Bonnie and others, Thanks for all that information on monetarism.

    John, Just to be clear I am not arguing that American involvement ended the depression. The Depression ended between mid-1940 and late 1941, an 18 month period of very rapid growth. The US was not fighting yet, but was involved in a big arms buildup.

    Thanks Liberal Roman.

    Ron, You said;

    “Yes, indeed the 1920 were the golden age of econ. No better testament than the flourishing economy of 1928-1938. In the same way 1970-2008 was the golden age of neoclassical macro, which led to the Great Moderation, belief that the business cycle was conquered and all wrinkles can be ironed out by monetary policy, aided by the strangest idea of them all: that the Fed controls the money supply, contrary all evidence. Sigh.”

    I was talking about economic theory, not policy. Sigh.

    But if you insist on talking policy, then yes, the 1920s were far better policy than the 1930s. In case you didn’t notice, the Fed abandoned any sort of even crude attempts at price level targeting after Strong died in 1928.

    You might also want to read Friedman and Schwartz’s monetary history of the US. And what happened after the dollar was devalued in 1933 (industrial production rose 57% in 4 months.)

    Richard, Yes, great movie.

    TGGP, Good points. The Tract is basically a monetarist work.

    Kevin, Krugman thinks it’s innovative because he know little of the history of thought in macro (which is obvious from reading his blog.) So he takes Keynes at face value when Keynes claims to be innovative.

    In any case, Keynes was flat our wrong about the “classicals”; indeed the entire idea of classical macroeconomics is pretty much a myth. Actual “classical” econ was invented near the Great Lakes during the 1970s and 1980s.

  36. Gravatar of Scott Sumner Scott Sumner
    23. August 2011 at 06:05

    Thanks Lee Kelly

  37. Gravatar of Kevin Donoghue Kevin Donoghue
    23. August 2011 at 06:38

    Well Scott, if Keynes wasn’t an innovator, perhaps you can tell us who got ahead of him with such concepts as the consumption function, effective demand and the liquidity-preference theory of interest-rates? I have some sympathy for those who say his original ideas were wrong, at least when they bring arguments to support that claim. But if you really believe the GT wasn’t innovative, where’s the literature you have in mind? Pigou said that what Keynes did was new and (contrary to your assertion) so did Hicks and many others. Maybe they were all wrong. But the burden of proof is on you I think.

  38. Gravatar of Scott Sumner Scott Sumner
    23. August 2011 at 06:51

    Kevin, My comment about Hicks was accurate–read his famous 1937 article.

    Obviously Keynes came up with a different framework, but the essence of what is different all revolves around the zero rate trap. It seems to me (and some others) that the other components of the GT were ideas discussed by previous economists (consumption depends on income, money demand depends on interest rates. etc)

    I’m probably biased as I don’t think his model is very good. BTW, I agree with those who say IS/LM is the essence of his theroretical innovation–and I hate IS/LM.

    My real point here is that Keynes was wrong in accusing others of being blind to the problem of demand shortfalls creating business cycle.

  39. Gravatar of Kevin Donoghue Kevin Donoghue
    23. August 2011 at 09:38

    Scott, let me just remind you that we’ve been over this ground before:

    http://www.themoneyillusion.com/?p=1328#comment-3143

    Have a good time in Italy.

  40. Gravatar of George Selgin George Selgin
    23. August 2011 at 10:05

    There’s a risk that in countering the “Keynes vs. the Classics” myth another will be erected in its place, according to which the consensus in the 20s was built around the Fisher-Cassel price-level stabilization norm. But while such a consensus may have prevailed in the U.S. (where the survey Scott cites was taken), in general (as I argue here) the price-level-stability view had a very strong rival in the “productivity norm” favoring stability of a factor price index. This fact should be considered of particular importance in this forum, because the productivity norm represents a version of NGDP targeting, whereas price-level-stabilization is of course a variant of inflation targeting.

    On a separate note, much as I count myself a great admirer of Milton Friedman, I’m afraid he played no role in the renewal of interest in free banking, which started with Hayek, with smaller boosts from Benjamin Klein and Earl Thompson at UCLA and from Hugh Rockoff (who started the revisionist work on U.S. “free banking”). Friedman only came later, and grudgingly, to see the merits of the free banking position.

    Finally, concerning good writings on the good old days of great monetary economics, I highly recommend Leland Yeager’s essays “the Keynesian Diversion” and “New Keynesians and Old Monetarists,” both of which are included in The Fluttering Veil.

  41. Gravatar of Scott Sumner Scott Sumner
    23. August 2011 at 10:19

    Thanks Kevin, By now I think I’m doing nothing but repeat old posts, and old debates in comment sections. BTW, I quoted you in this post last month, in case you missed it.

    http://www.themoneyillusion.com/?p=10475

    George, I agree with everything you say. Indeed I regard both the price level stabilizers and the productivity norm people as allies, and both as being very different from the modern caricature of “classical economics.”

  42. Gravatar of W. Peden W. Peden
    23. August 2011 at 11:06

    George Selgin,

    Yours was the article that ultimately won me over to free banking, so you accomplished your goal of convincing at least one Friedmanite of the benefits of competitive money.

  43. Gravatar of Dave Dave
    23. August 2011 at 11:26

    What do you economists think of this analysis of the MV=PY equation

    http://www.cargocultist.com/?p=1586

  44. Gravatar of W. Peden W. Peden
    23. August 2011 at 11:36

    Dave,

    I didn’t quite follow it, but I am dubious about any claim that V only changes Q.

    The main problem with Fisher’s monetarism, as I see it, is the lack of focus on assets. He actually did a better job of analysing the transmission mechanism than many people (including Keynes) thought, but goods & services are only one kind of way that an individual can dispense of excess cash balances.

  45. Gravatar of George Selgin George Selgin
    23. August 2011 at 11:53

    W. Peden: I’ve always considered monetarists (“old-fashioned” ones anyway, according to Yeager’s designation) natural allies and prospects for “coming around” to free banking. Besides yourself, Yeager is a good example of one such convert, as is Anna Schwartz, who got more and more radical (as did Friedman). (For example, when I last spoke to Anna I asked her why she had long treated deposit insurance as indispensable, and she conceded that she’d been mistaken in doing so.) David Laidler has always been a sympathetic critic, though no more than that (he thinks economies of scale favor centralization of reserves; I’ve tried to convince him that he’s confusing netting economies with scale economies, where the former of course are greatest when the # of rival banks is large, and nonexistent in the case of monopoly).

    I think we’ve nearly got Sumner on-board as well, though a few more shoves wouldn’t hurt!

  46. Gravatar of Martin Martin
    23. August 2011 at 11:58

    George,

    If the rational for central banking is to stabilize income, then I don’t see why we don’t have free banking. At least under free banking, banks respond to an increase in the demand for money.

    How’s that for a rational ;)?

  47. Gravatar of W. Peden W. Peden
    23. August 2011 at 12:17

    George Selgin,

    I agree; I think that good monetarist thinking begins with applying the concepts of supply & demand to money, which is also how the most persuasive arguments for free banking begin.

  48. Gravatar of W. Peden W. Peden
    23. August 2011 at 12:19

    Also, I’ve become more interested in free banking as the Great Moderation now seems to be more and more an exception rather than a new trend. Now that the failures of inflation targeting are apparent, the bar for an alternative to modern central banking policy and modern central banking as such has been lowered considerably.

  49. Gravatar of Dave Dave
    23. August 2011 at 12:28

    W. Peden,

    OK thanks for looking at it.

  50. Gravatar of David Glasner David Glasner
    23. August 2011 at 14:17

    George, You wrote:

    “On a separate note, much as I count myself a great admirer of Milton Friedman, I’m afraid he played no role in the renewal of interest in free banking, which started with Hayek, with smaller boosts from Benjamin Klein and Earl Thompson at UCLA and from Hugh Rockoff (who started the revisionist work on U.S. “free banking”). Friedman only came later, and grudgingly, to see the merits of the free banking position.”

    Sorry to nitpick, but both Klein in his 1974 Journal of Money, Credit and Banking paper “The Competitive Supply of Money” and Thompson in his paper “The Theory of Money and Income Consistent with Orthodox Value Theory” also published in 1974 in Trade, Stability and Macroeconomics: Essays in Honor of Lloyd Metzler preceded Hayek in developing the theory of free competitive banking. Hayek explicitly and graciously acknowledged Klein’s priority in Denationalization of Money in a footnote on p. 27:

    “But, though I had independently arrived at the realisation of the advantages possessed by independent competing currencies, I must now concede intellectual priority to Professor Benjamin Klein, who, in a paper written in 1970 and published in 1975 (sic), until recently unknown to me, had clearly explained the chief advantage of competition among currencies.”

    Hayek also cites Thompson’s paper in his bibliography to the Denationalization of Money but (I am sure inadvertently) neglected to concede priority to Thompson as well.

    I agree, of course, that Friedman played no role in developing the theory of free banking. On the contrary, he explicitly denied that competition is workable in the supply of money. For example, in his classic Program for Monetary Stability he wrote (p. 7)

    “This analysis, then, leads to the conclusion that some external limit must be placed on the volume of currency in order to maintain its value. Competition does not provide an effective limit, since the value of the promise to pay, if the currency is to remain fiduciary, must be kept higher than the cost of producing additional units. The production of a fiduciary currency is, as it were, a technical monopoly, and hence, there is no presumption in favor of the private market as there is when competition is feasible.”

  51. Gravatar of Greg Ransom Greg Ransom
    23. August 2011 at 23:00

    Steve, A version of NGDP targetting is in Hayek in the early 1930s ….

  52. Gravatar of Gabe Gabe
    24. August 2011 at 07:48

    If you really believe keynsian war spending got us out of the depression then can you please explain why a huge percentage drop in government spending after WW2 resulted in the longest bestest economic expansion of the 20th century?

  53. Gravatar of Gabe Gabe
    24. August 2011 at 07:51

    because it looks to me like when the government freeed up a lot of resources for the market economy to utilize(labor and capital)…that we had massive increases in productivity and economic expansion…the opposite of what the aggregate demand big government drones would predict.

  54. Gravatar of Gabe Gabe
    24. August 2011 at 07:52

    aggregate-demand-big government drones now dominate and have led us to our current greater depression with no end in sight.

  55. Gravatar of beowulf beowulf
    24. August 2011 at 10:17

    If you really believe keynsian war spending got us out of the depression then can you please explain why a huge percentage drop in government spending after WW2 resulted in the longest bestest economic expansion of the 20th century?

    The 8 war bond drives were a compulsory savings plan in all but name, the newly created employer withholding system deducted taxes, FICA AND war bond contributions. This– along with OPA rationing– played a huge role in driving the personal savings rate to 25%. Compulsory savings (especially if the money is going to Tsy) drain reserves and dampen aggregate demand the same as tax collections of the same amount. The difference is, every worker could see their personal wealth growing larger with every war bond purchase. Soon after the war, rationing was eliminated (effective increase in aggregate supply) and the war bond withholding ended (an effective cut in payroll taxes). If that didn’t do enough to dramatically boost aggregate demand (to replace now unnecessary defense spending), civilians could use their war bond savings, and soldiers their GI bill benefits, to pay for schooling, buy homes and start families.

    The funny thing is, the Keynesians of the era didn’t understand the mechanics of this happy accident (well, Abba Lerner probably did). So instead of bragging about the (accidental) effectiveness of their policies, they were left scratching their heads.

    On another note, that great Keynesian (and good man) William Vickrey was most complimentary to the 1920s economy. His cap and trade gross markups market was designed to return to the 1920s level of unemployment by controlling inflation along the way.
    “The last time we had in peace time, what I would consider an acceptable level of employment, was in 1926 when it is estimated that unemployment in terms of the currently used definition was about 1.8 percent for the year as a whole. We have not had anything like that since, except in war time [1.2% in 1944]“
    http://findarticles.com/p/articles/mi_hb6413/is_n1_v22/ai_n28645797/?tag=mantle_skin;content

  56. Gravatar of Gabe Gabe
    24. August 2011 at 10:46

    With all those post-war stupid masses directing their savings without the proper direction of economic experts, the central planners should be shocked that it went to anything productive. The central planning advocates would have us believe that only experts can invest wisely…beowulf’s explanation doesn’t match up.

  57. Gravatar of Russ Anderson Russ Anderson
    24. August 2011 at 14:51

    Scott wrote “I was talking about economic theory, not policy. Sigh.”

    Wasn’t economic policy driven by economic theory? Herbert Hoover did not make up the Gold Standard policy that he so stubbornly followed, he followed an economic theory. The Federal Reserve (George L. Harrison, Roy A. Young) did not make up the gold sterilization policy, they were following an economic theory that insisted the inflow of gold would cause inflation. There were economists pushing those theories, and none of them was Keynes. Why do they get a pass?

  58. Gravatar of OGT OGT
    24. August 2011 at 17:39

    Right, Russ, Sumner’s blanket pardon of economic thinkers in the twenties for the impending disaster of the Depression is not internally consistent with his stated mission on this blog to influence the Fed by influencing the economic consensus. Either economic theorists had no influence on policy makers, and therefore influencing their thinking is of little importance, or they had influence and bore disastrous results.

    Perhaps, Sumner believes that economic thinkers have more influence now, but I see no evidence of that. Quite the opposite, politicized economists like John Taylor seems to be shaping their views to the political consensus in their own party.

    BTW, Speaking of economic myths and legends, most economists seem to completely misquote, misapply and misunderstand Adam Smith’s ‘Invisible Hand’ metaphor.

    http://economistsview.typepad.com/economistsview/2011/08/warren-samuels-on-the-invisible-hand-1-1.html

  59. Gravatar of W. Peden W. Peden
    24. August 2011 at 17:47

    I think that the easy get-out-of-jail-free card for Scott here is just to say that the Classicals were generally all right and it was the Real Bills guys who were the problem.

    On Adam Smith, if there’s one thing I’ve learned about Adam Smith, it’s that any thinker can be interpreted by anyone as being in support of them. So Adam Smith was a proto-Marxist, Keynes was a conservative, David Hume was a great theist thinker and Jesus was a Buddhist.

  60. Gravatar of OGT OGT
    24. August 2011 at 18:03

    W. Peden- That all seems more than a bit too easy and too convenient. Perhaps the Real Bills people were not the holders of the consensus in the twenties, but when the chips were down they appear to be the ones who came to prominence. In that case, which seems to be analogous to current political/economic interactions in both the Democratic and Republican parties, the stated mission of Sumner’s blog is fatally flawed.

    Either the economic consensus in the twenties was flawed (De Long’s assertion) or it was impotent (Sumner’s implied assertion).

  61. Gravatar of W. Peden W. Peden
    24. August 2011 at 19:01

    “Perhaps the Real Bills people were not the holders of the consensus in the twenties, but when the chips were down they appear to be the ones who came to prominence.”

    All that is required for the triumph of evil is for good men to do nothing (or nothing effective). The triumph of the real bills doctrine is an interesting issue, but it’s not clear that it’s any more informative of the consensus than the triumph of the Vulgar Austrians today.

    The important thing, as I see it, is for the right economists to out-influence the wrong. Sometimes they will succeed, sometimes they will fail.

  62. Gravatar of W. Peden W. Peden
    24. August 2011 at 19:02

    Oh, and-

    “That all seems more than a bit too easy and too convenient.”

    So do a lot of things. It doesn’t mean that they aren’t right! ;)

  63. Gravatar of Deus-DJ Deus-DJ
    25. August 2011 at 15:18

    http://bilbo.economicoutlook.net/blog/?p=15765

    Why Scott Sumner is a fool.

  64. Gravatar of Ron T Ron T
    26. August 2011 at 06:21

    Scott,

    Ron, You said;

    “…. Sigh.”

    I was talking about economic theory, not policy. Sigh.

    How can we have a sensible policy if the theory is in shambles? That is some sophism. If you understood that interest rates are the only tool the Fed has, if you understood how the banking system works, you (and many others) could concentrate on what works: fiscal policy adding to spending dollar for dollar. But no, you prefer to talk nonsense about people borrowing cash from banks and the Fed impacting the money supply by fiddling with the monetary base. There is no basis for this, and the economics profession, Bernanke included, is wasting our time with QEs of any sort.

    And you say that economic policy is ding great. Too much Italian wine?

  65. Gravatar of Ron T Ron T
    26. August 2011 at 06:22

    I meant “economic theory is doing great” – no, it is not.

  66. Gravatar of Morgan Warstler Morgan Warstler
    30. August 2011 at 12:36

    Deus-DJ,

    You are an idiot.

    http://bilbo.economicoutlook.net/blog/?p=15765

    Does a FINE job of explaining why I AM RIGHT:

    http://biggovernment.com/mwarstler/2011/01/04/guaranteed-income-the-christian-solution-to-our-economy/

    Your guy says, “I agree with critics that unemployment benefits are a poor response to a crisis and a much more preferable fiscal response would be direct public sector job creation.”

    My better response to his argument is:

    1. Gvt. provides Guaranteed Income. Not a job.
    2. Gvt. auctions those in the GI program to the private sector starting at $1 per hour.

    My method maintains the supremacy of the private sector, and makes sure the gvt. does the least harm possible, while making sure those that want to work have a liveable wage.

  67. Gravatar of Diatom Diatom
    3. September 2011 at 06:10

    Winterspeak takes on Sumner’s NGDP targeting idea http://www.winterspeak.com/2011/08/unconventional-monetary-policy.html

  68. Gravatar of W. Peden W. Peden
    3. September 2011 at 08:31

    Ron T,

    “Fiddling with the monetary base”

    You never cease to amuse me.

  69. Gravatar of Doc Merlin Doc Merlin
    6. September 2011 at 09:24

    “which (short of WWII) are almost never effective.”

    Barro has definitively shown that WWII was not effective monetary stimulus.

  70. Gravatar of Scott Sumner Scott Sumner
    10. September 2011 at 07:09

    Dave, I stopped after the first sentence. MV=PY has NOTHING to do with the quantity theory of money.

    George, If we have a monetary system where NGDP futures are the medium of account then I’m all for free banking.

    Gabe. I’m not saying fiscal stimulus in 1940 was a good thing, I’m saying it boosted GDP. Didn’t RGDP fall in the US between 1944 and 1946?

    I certainly don’t think fiscal stimulus is a necessary condition for prosperity, so it is no surprise the post war years were good.

    Russ, It takes a while for cutting edge theory to be implemented into action. Most of the best theorists in the 1920s favored price level or NGDP targeting.

    OGT, I disagree with Samuels, the invisible hand is a great metaphor for the market.

    In the 1920s Strong was running Taylor Rule type policies. The problems occurred after he died.

    Ron, You need to listen to what Bernanke says. He’s not saying the Fed is out of ammo–he’s saying we don’t need more spending. Theory is not the problem.

    Diatom, He makes up views I don’t in fact hold–like the Fed buying bridge builders.

    Doc, Didn’t Barro address fiscal stimulus? And didn’t he show the multiplier was greater than zero?

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