The Quantity Theory of Money: From Locke to Keyes and Friedman.

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.