Abstract
The terms most often used (or misused) in politico-economic controversy are seldom defined. “Monetarism” is one of those words. Precision remains impossible as long as monetarists are unable to agree on what money is or how to count it. Nevertheless, the essential idea of monetarism may be captured in the following propositions: (1) money is an exogenous constant of monetary policy rather than an endogenous variable of monetary theory, and (2) therefore, the central bank can, if it will, control the money supply by making a “monetary aggregate” the target of monetary policy.
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Endnotes
For Keynes, neglect of money in the early chapters of The General Theory was a tactic to isolate his analysis of real income (employment) preparatory to introducing the complications of monetary income. The original Keynesian converts, caught in the time warp of the Great Depression and the expected postwar unemployment, generally failed to proceed beyond the master’s employment theory to the fifth book of The General Theory on “Money-Wages and Prices” and completion of his general theory.
Examples are Chinese knife money and Indian fishhook money, each of which, for convenience, ultimately became a token of the original.
What became generally acceptable as a medium of exchange varied with the stages of economic development. Many of our pecuniary terms, such as chattel and capital, have come to their present usage from the pastoral era when cattle, counted by the head, constituted the principal source of food, clothing, and shelter. In a nomadic society, their convenience as a means of storing value (with built-in portability) made up for their inconvenience as a means of making payments. Some farm product became the “cash crop” when people settled down to an agricultural way of life. Metals that provided raw materials for the necessary contemporary tools were fashioned into coins used to mediate exchange as well as count and store wealth in the handicraft and manufacturing stages of development. Gold triumphed over the other metals until its advantages of portability, malleability, etc., were eclipsed by the greater convenience of credit entries and electronic transfers.
The alleged central bank money monopoly that monetarists speak about refers to central bank notes (i.e., currency), which once amounted almost to a synonym for money but has in modern history lost both its relative and absolute significance as a component of the money supply except for the underground economy and illegal drug traffic.
When, as a consequence of recurrent external gold drains in the late fifties and early sixties, the Fed’s power to create domestic bank reserves approached its legislative limits, the limits were removed by Congress. Where were the monetarists when they were needed? Actually, the Fed’s legal reserve requirements had never served as a limitation on the money stock of the U.S. since the inception of the Federal Reserve System in 1914. Enormous excess reserves were the consequence of the “golden avalanche” from Europe that began with the First World War (Graham and Whittlesey 1939) and continued through the Second. The International Monetary Fund’s (IMF’s) pegged exchange rate system was subsequently abandoned by national and international actions taken from 1971 to 1973 when West Germany refused to continue supporting the dollar to offset the lack of reserve constraint on the U.S. money stock.
Consequently, it was (and, unfortunately, still is) thought that the gold standard lasted as long as the vpolicy of gold convertibility of the currency, however circumscribed that convertibility became (ultimately by only one country, the U.S., for only foreign central banks).
Fisher’s “equation of exchange” (MV + MV = PT), which categorically distinguished “bank deposits” from “money,” was not collapsed into MV = PT until World War II (e.g., Chandler 1940, p. 23).
The English Bank Act of 1844 was a virtual dead letter by the time it was passed because the principle it was supposed to implement (that a mixed currency system should operate like a pure gold currency) was negated by the fact that bank deposits (though not limited by gold reserves as bank notes were) had become a more important means of payment than either bank notes or specie (Hayek 1939, pp. 8–9, 82–83). See also Mason (1963, p. 65).
Don Patinkin (1969) found Milton Friedman’s alleged “restatement of the quantity theory” to be unrelated to either the Chicago tradition or the quantity theory. See also supra, Chaps. 3 and 5.
This fact is reinforced by the additional misconception that “monetary” policy” (i.e., central bank policy) is the only means of achieving economic (including nonmonetary) goals, such as full employment (cf. Mason 1963, pp. 113–115).
The so-called “monetary aggregates” are really financial aggregates. The monetary aggregate cannot be identified until money is. Central banks hide their inability to control the money stock behind the equivocality of these misnamed aggregates (Mason 1976a, pp. 525–526, 528–530; 1980, pp. 216–218). Without a consensus on either the concept of money and its empirical quantification or the criterion of monetary policy, the “monetarist rule” is arbitrary. Markets make more sense than theoreticians operating according to peremptory rules of indistinguishable thumbs and fingers. That was the germ of truth in “supply-side economics”. Wholly exogenous money is limited to cases of exponential printing press issue of fiat money to meet the accelerating costs of war by a “government,” often revolutionary, lacking the power of commensurate taxation.
Hayek (1978, p. 77): “Monetary management cannot aim at a particular predetermined volume of circulation [of money].… Only the market can discover the ‘optimal quantity’ of money.” The reason, he added, is that “money is not a tool of policy that can achieve particular foreseeable results by control of its quantity” independently of the production process responding to free markets (p. 98).
“… Whatever our views about the desirable behavior of the total quantity of money, they can never legitimately be applied to the situation of a single country which is part of an international economic system, and … any attempt to do so is likely in the long run and for the world as a whole to be an additional source of instability” (Hayek 1939, p. 93). This insight was a major reason for Hayek’s 1975 Nobel Prize.
Hayek (1978, p. 77) credited Walter Bagehot with recognition that panic is the consequence of public awareness of an approaching upper limit to the amount of cash in circulation when the “need for increased liquidity could not be met.” U.S. experience in 1980–1982 showed that such panic is still followed by recession if not depression.
Apparently, it is easy to forget that the “ultimate goals of economic policy” cannot be attained by monetary policy alone and that monetary policy includes fiscal, debt management, and exchange rate policies as well as central bank policy (Mason 1963, p. 113). Paradoxically, Karl Brunner, who provided the original rationalization for targeting monetary policy (see n. 17 of this chap.), cautioned that “demanding tasks are increasingly assigned to monetary authorities without much thought as to whether or not these tasks can be effectively accomplished under the existing arrangements” (1971a, p. 129). Benjamin Friedman (1975, p. 470) later concluded: “Use of a specific noninstrument variable (such as the money stock) as an intermediate target variable does not constitute optimal central bank procedure.… Therefore, the central bank … should avoid relying on a particular intermediate target variable.” He indicated that the simplistic linearity of the construct is irrelevant to the complexity of analyzing the policy implications of the long-run target during the short-run, dynamic fluctuations of the business cycle when central bank decisions must, perforce, be made (pp. 464–468).
Central banks and parliaments like to keep their objectives ambiguous so that each can use the other as the scapegoat for its own malfeasance. The consequent lack of accountability in monetary matters will continue as long as it is tolerated.
Subsequent discussions of “indicators” and “targets” have remained consistently faithful to their confusion in Brenner’s treatment of the “indicator problem” as the “Interpretation Problem” (1971a, pp. 112–119) and the “target problem” as the “Determination Problem” (pp. 121–122 ff). The difficulty seems to have been an overclassification problem.
For disclosure of the fundamental flaws in the concept of an intermediate target of monetary policy and description of its empirical insufficiency, see Benjamin Friedman (1977), who concludes, “While money should not be the intermediate target variable of monetary policy, therefore, it should be a useful and probably an important information variable — but not the only one” (p. 335).
See supra, Chap. 7, pp. 5 and 10.
“Free market” is a loosely used term referring to primary, though not necessarily exclusive, dependence on private sector supply and demand forces to determine the supply and price of a product or service. This implies freedom of entry and exit under the democratic framework of equal justice under the law. “Market perfection,” also used loosely, refers to the degree of competition characterizing the market, which can range from perfect competition among buyers and sellers (meaning enough of both that no one can significantly affect the price) through the imperfections of monopolistic and/or monopsonistic competition.
In contrast to the prior neoclassical dichotomization of the analysis of the economy (Mason 1974 and supra, Chap. 3).
Reliance on this monetarist claim resulted in the modern practice of financing government by inflation (Havrilesky 1979, pp. 64–66,74, 82).
Recurrent disclosures of insider trading on Wall Street have revealed that our freest markets are not perfect. They require laws and enforcement thereof to retain their freedom.
See also Mason (1980–81, pp. 242–245).
The aberrant reverberations do not stop at the nation’s border. The foreign debts of other countries may motivate them to seek alleviation through global inflation. The high interest rates emanating from the U.S. in the early eighties compelled the less developed countries (LDCs) of Latin America to resort to more foreign borrowing in order to service their already excessive foreign debts. Willingness of the banks of developed countries to extend such loans was dependent upon availability of supplementary IMF loans. The necessary enlargement of the Fund was assured by Congressional approval of an $8.4 billion increase in the U.S. quota. It is ironic, to say the least, that its monetarist policies confronted the U.S. with the dilemma of choosing between adding fuel to the global inflationary fire or risking initiation of an international financial collapse (Mason 1987, pp. 142–150).
A really free market would eliminate incompetence and predatory or parasitic behavior in the marketplace. In contrast, the contemporary malignant ineptitude and/or conspiratorial corruption and fraud continued to be subsidized through the offering of bankrupt savings and loan associations as transferable tax shelters, rather than expose the malfeasance of the executive and legislative branches of government responsible for the financial fiasco. Meanwhile, loans on inflated real estate equities supplemented the hawking of plastic charge cards in bankers’ contemporary inflationary hype. The public will ultimately pay the bill in higher taxes and/or prices.
The interest rate decline and business revival were both faster in the Panic of 1907 (before establishment of the Federal Reserve System) than in the “Repression” of 1980–82 (supra, Chap. 7, Figs. 6 and 7). Nevertheless, in the absence of a central bank, preservation of banking system liquidity sufficient to prevent recurrent collapse of the economic system would be a problem.
The ironic logic in this appears to be that since commercial banks produce more money than the central bank wants to allow, all financial institutions (in the interest of equity?) should be permitted to participate in money creation. The irony as well as the logic is open ended: all private enterprises that an active imagination could call “financial” were encouraged to get on the monetary bandwagon by extending their operations to banking. Government appeared to be preparing to allow merchants to create money for the purchase of their own merchandise! Legislators may have interpreted the term “merchant banker” too literally. Was not the prevention of exactly that kind of insider operation the reason for the American Glass-Steagall Act separating commercial and investment banking? The present delay in replacing or amending the Act is explained by the unresolved dilemma of who should bear the risk of securities sales by an integrated commercial investment banking firm with guaranteed deposits.
The regulatory implications of the geographic, metropolitan-suburban-rural, and branch versus unit banking issues are complicated by a Texas sized banking debacle. Merger of the overly merged Dallas based First Republic Bank and the Houston based First City Bankcorp. of Texas shut off (instead of supplied) capital to small town enterprises in the vain hope of forestalling its own failure (Wallstreet Journal, May 25,1988, pp. 1,18).
The ultimate question remains: should creation of money be restricted or open to anyone without any limits (Girton and Roper 1979), leaving determination of the money supply to the ultimate freedom of (all?) markets? In the present state of law enforcement (or lack thereof), can illegal markets be realistically excluded? In the world of “junk bonds” and the “monetary aggregate” M3, how is counterfeit money to be distinguished from legitimate money? Should (must?) the monetary role of the underworld as well as the underground economy be acknowledged?
The leveraged takeovers reported daily in the media (until the current slump) are typically financed by expanded bank credit (i.e., new money). It is estimated that the $200 billion of junk bonds in the U.S. amounted to over a quarter of the nation’s corporate bonded indebtedness in the late 1980s. Leveraged takeovers do not ordinarily require additional so-called “base money” until an institutional takeover financier must be “bailed out.”
The proximate cause was the refusal of Congress and the central bank bureaucracy to face the consequences of being forced, by the recurrent external drains of gold associated with our foreign deficits in the fifties and sixties, to reduce the domestic money supply. The ultimate result was to replace the benign temporary effects of issuing currency to stop bank runs in financial crises, by the long-run inflationary consequences of saving financial enterprises through central bank or government credit. The former practice had operated automatically to transfer deposits into currency and back to deposits (when depositors saw that their deposits were safe) without any net effect on the total quantity of money. Saving the financial firms instead of depositors increases reserves and deposits, thus augmenting the money supply without any provision for reducing the created precautionary cash balances (and inflationary potential) after the crisis has passed. The problem and its political response illustrates the incompatibility of the long-run posture of monetarism with the short-run orientation of modern political institutions. So-called “base money” has little contemporary significance in the long-or short-run. It is neither controlled nor controlling, but issued at will (without limit) for the convenience of the public in pursuing its illegal as well as legal endeavors.
For the confusion and its recognition see Brunner and Meltzer (1969, pp. 4–6, 9,13,25) and Dewald (1969, pp. 315, 321–322), respectively. A recent Federal Reserve publication explained that the immediate implication for the Fed of the growing “fuzziness” of the meaning of money “is that there is no longer a single, well-understood, leading indicator that will serve as a reliable guide in the formulation of monetary policy. The Federal Reserve continues to set targets for the broad monetary aggregates, M2 and M3, but recognizes that at times neither one may be a particularly reliable indicator in the short-run” (Federal Reserve Bank of San Fransisco 1989, p. 2).
Such application is actually precluded by the present general absence of a minimum reserve ratio for central banks.
Notice, for instance, the recurrent unchallenged reference to the necessity for restricting the growth of GDP in order to reduce inflation, implying the absurdity that production is inflationary. The folly of such nonsense was the real message of “supply-side economics.”
The growing importance of international capital movements has made a travesty of nationalistic monetarism and domestic “monetary aggregate” targets of monetary policy (Mason 1987, pp. 142–145), which are demonstrably inconsistent with the international financial integration of the modern world. On the monetarist closed economy assumption, the current central bank research program (with its crude macroeconomic aggregation and meaningless historical averages) does not furnish the data necessary for the daily policy decisions central banks are required to make. The sources of the monetarist contradiction are at last revealed: “Because financial sector innovation is an ongoing, open-ended process, the knowledge policymakers would need does not exist. Thus, in a dynamic financial environment the knowledge problem effectively drives a wedge between the intentions of policymakers and the undesigned process of the market” (Butos 1986, p. 863). See also supra, pp. 121–123 of this chap.
This was the goal of Volcker’s “practical monetarism” that did not prove to be practicable because it cannot be achieved by disconnecting the creation of money from the production of goods. The central bank is actually more exogenous than money.
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Mason, W.E. (1996). Monetarist Misconceptions of Money and its Management. In: Butos, W.N. (eds) Classical versus Neoclassical Monetary Theories. Springer, Boston, MA. https://doi.org/10.1007/978-1-4615-6261-0_8
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