Author Essays, Interviews, and Excerpts, Economics

Read an Excerpt from “The Monetarists” by George S. Tavlas

The University of Chicago has a long, storied history within the field of economics. While Milton Friedman looms large within Chicago’s legacy, The Monetarists explores fellow scholars whose work and lives forever influenced and shaped modern economic thought. Read an excerpt below, introducing the incredible intellectual history that marks the unique legacy of the Chicago monetary tradition.

Black and white book cover with headshots of older white men

This book tells the story of a small group of University of Chicago economists who preserved the importance of the quantity theory of money and defended the free-market system. They did so at a time when the American economics community discredited the role of monetary forces in the economy, viewed fiscal policy as the only game in town, and embraced a greatly expanded role for government in economic affairs. The members of “The Group”—as the Chicagoans referred to themselves in the 1930s—included Henry Simons, Lloyd Mints, Paul Douglas, Frank Knight, Aaron Director, and Garfield Cox. The Group used the quantity theory of money to formulate an unconventional and original policy agenda that included (1) money-financed fiscal deficits to combat depressions with the provision that the budget should be balanced over the business cycle; (2) monetary rules to reduce uncertainty; (3) 100 percent reserve requirements on demand deposits to ensure the safety of deposits, control the quantity of money better, reduce the frequency and the intensity of the business cycle, and make seigniorage from money creation the exclusive privilege of the government; and (4) flexible exchange rates to provide space for domestic economic policies.

Jacob Viner, who, along with Knight, was the most renowned of the Chicagoans in the 1930s, mostly dissented from The Group’s policy platform although Viner’s interpretation of Federal Reserve policies during the Great Depression found its way, via Mints, into Milton Friedman’s work. Douglas, who agreed with and helped create the policy platform, mainly dissented from The Group’s free-market principles, but his dissension softened after the early 1930s.

Using the quantity theory of money, the Chicagoans advocated increasing the money supply to combat the Great Depression. They believed that fiscal deficits were the most effective way to generate increases in the money supply, thereby linking fiscal deficits with the quantity theory. Thus, the Chicagoans were well placed to reject the central policy message of John Maynard Keynes’s 1936 book The General Theory of Employment, Interest and Money, a main purpose of which was to provide a theory to rationalize fiscal deficits. In the late 1940s, the ideas of these economists found a cohort in Friedman, who, after joining the Chicago economics faculty in 1946, adopted and pushed forward their policy agenda.

The period chronicled in this book begins in 1927, a year that saw the arrival of Knight, Simons, and Director at Chicago, and the initial sprouts of ideas that would become hallmarks of Chicago monetary economics over the ensuing several decades. The period ends in 1960, the year in which Friedman published the book A Program for Monetary Stability, which summarized the policy conclusions, including his monetary-growth rule, that sprang from his research in monetary economics during the previous decade. Several years after the publication of that book, Friedman’s research findings, emphasizing the important role played by money in the economy and the policy conclusions of those findings, came to be characterized as “monetarism.” This book tells the story of the emergence and development of what came to be known as the Chicago monetary tradition.

The notion of a Chicago monetary tradition became the focus of professional interest with Friedman’s essay “The Quantity Theory of Money: A Restatement,” in 1956. In that essay, Friedman, who had been a graduate student at Chicago in the early 1930s, claimed that his monetary economics derived from a 1930s and 1940s oral Chicago quantity-theory tradition developed by his mentors—singling out Simons, Mints, Knight, and Viner. The next fifty years saw an outpouring of publications that examined the validity of Friedman’s claim. The doctrinal literature called an assortment of monetary economists who wrote in the 1930s and 1940s—Chicagoans and non-Chicagoans alike—to the stage to shed light on the following question: Did Friedman’s monetarist framework more closely resemble what had been produced earlier at Chicago, or did it more closely resemble what had originated outside of Chicago? The predominance of the doctrinal historical evidence concluded that Friedman’s monetary framework, in terms of its (1) emphasis on the efficacy of monetary policy conducted through open-market operations, (2) empirical orientation, (3) monetary interpretation of the origins of the Great Depression, and (4) espousal of a money-supply-growth rule, had numerous forerunners at American institutions outside of Chicago in the 1930s and 1940s but few forerunners at Chicago. Thus, the evidence concluded that, contrary to Friedman’s claim, the Chicago Economics Department of the 1930s and 1940s had not been an isolated center that used the quantity theory to stress the importance of money. Indeed, a conclusion that emerged from the debate over the existence of a Chicago monetary tradition was that Friedman’s 1956 “Restatement” of the quantity theory resembled more closely the Keynesian theory of liquidity preference than any version of the quantity theory used, either at Chicago or at any other American institutions, in the 1930s and 1940s.

In light of the evidence produced up to that time, notably by Don Patinkin, in his 1970 Richard T. Ely Lecture before the American Economic Association, Harry Johnson, Friedman’s Chicago colleague, accused Friedman of having “invented” a Chicago monetary tradition. Friedman, Johnson charged, attempted to manufacture a counter-revolution in macroeconomics to show that his monetary framework had pre–General Theory roots and, thus, could be considered a valid counter-revolutionary challenge to the prevailing Keynesian orthodoxy. Other researchers joined Johnson in the accusation that Friedman had invented a Chicago monetary tradition. The doctrinal evidence produced over the years was sufficiently compelling against Friedman’s position that, in the early 2000s, Friedman, who did not have expertise in doctrinal history, backtracked on his earlier claim of a Chicago monetary tradition that was related to his monetary framework.

This book provides a very different view of the matter. I provide evidence that challenges—and, I believe abrogates—the prevailing consensus that Friedman invented an earlier Chicago monetary tradition. I also challenge the related contention that, even if such a tradition existed, it was not unique in a way that directly influenced Friedman’s monetarist views. In particular, I show that (1) there was a 1930s and 1940s Chicago quantity-theory tradition; (2) the quantity-theory framework developed and used at Chicago was very different from that used at other institutions; (3) at the time (in the late 1940s) that Friedman made monetary economics the main focus of his research, his views fully reflected that tradition; and (4) the Chicago version of the quantity theory provided a platform for Friedman to launch the monetarist counter-revolution. Without that particular platform, any other challenge to the Keynesian orthodoxy of the 1950s and 1960s would likely have taken a very different form. I provide contemporaneous evidence from the 1940s and early 1950s that the Chicago Economics Department was considered by other economists at the time to have been an iconoclastic fortress that defended the importance of money in the economy and the advantages of the free-market system.

Why do the results contained in this study differ so fundamentally from the prevailing consensus about the absence of a Chicago monetary tradition that cultivated Friedman’s monetarism? There are several reasons. The first relates to the rules of engagement followed in previous research on the relationship between Friedman’s monetarist economics and the monetary economics of his quantity-theory predecessors. The objective of that research strategy has been to search for forerunners of Friedman’s views in the 1930s and 1940s—an approach that is comparative static in essence. In contrast, my approach is to analyze the evolution of Chicago monetary economics. In other words, although the comparative-static approach can yield anticipations of Friedman’s monetarist framework in the 1930s and 1940s literature, it does not necessarily provide evidence of an influence on Friedman’s monetarism. The approach I take is to trace the development of monetary economics at Chicago. This development explains the way Friedman’s views on monetary economics were shaped shortly after he began teaching at Chicago in 1946. Second, in addition to Chicagoans Simons and Viner, whose work in the 1930s and 1940s had been the primary focus in previous doctrinal studies, my cross section of Chicagoans includes the works of Mints, Director, Douglas, Knight, and Cox. Each of them has previously been thought to have had marginal or peripheral influences on the development of Friedman’s monetary thought. By broadening the cross section of Chicago economists considered in the data sample, I show that—far from having been marginal figures—those economists appreciably and fundamentally helped shape Friedman’s monetarist framework. Thus, I trace direct lines of influence on Friedman’s initial thinking on monetary economics from the Chicago monetary framework as it existed in the early 1930s to its embellishment from the mid-1930s to the late 1940s by Simons, Mints, Knight, and Director. I also show that the work of a non-Chicagoan, Clark Warburton, intrudes into this Chicago story; Warburton’s work in the 1940s and early 1950s played a pivotal role in helping shape Friedman’s emerging monetarism.

Third, unlike previous research on the doctrinal foundations of Friedman’s monetarist economics—which typically focused on the differences in the theoretical frameworks between the 1930s and 1940s Chicagoans and Friedman’s version of the quantity theory (and, as I document, any differences in monetary theory were relatively minor at the time that Friedman began working in the field of monetary economics)—I focus on the policies advocated by the earlier Chicagoans and Friedman. I show that, with minor modifications, Friedman espoused the earlier Chicago policy agenda at the time that he made monetary economics his primary field of interest in the late 1940s, and incorporated much of that policy agenda into his monetarist framework of the late 1950s. Fourth, my data set includes both published and unpublished works by the economists in question. The unpublished material, some of it presented for the first time in the literature, provides additional evidence on the influence of other economists, especially Director and Warburton, on Friedman’s thinking. Finally, at the time (in the late 1940s) that he moved into monetary economics as his primary field of interest, Friedman brought to the table a skill set that his Chicago predecessors did not have—a cutting-edge knowledge of applied and theoretical statistics. I show the way Friedman applied that skill set to the monetary framework that he had inherited from his Chicago mentors to develop, from the late 1940s to the late 1950s, what became known as monetarism. In this way, he launched a successful counter-revolutionary challenge to the Keynesian orthodoxy. I also show that, in the 1950s, Friedman and Director moved the Chicago framework in the direction of reduced government involvement in economic affairs compared with the involvement advocated, notably by Simons, at Chicago in the 1930s and the 1940s.

George S. Tavlasis alternate to the governor of the Bank of Greece for the European Central Bank Governing Council and distinguished visiting fellow at the Hoover Institution of Stanford University. He is a former division chief at the International Monetary Fund, senior economist at the US Department of State, and advisor to both the World Bank and the Organization of Economic Cooperation and Development.

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