Address and panel discussion before the Cato Institute Book Forum Celebrating the 40th Anniversary of the Publication of A Monetary History of the United States, 1867-1960 (Princeton University Press, 1963) by Milton Friedman and Anna J. Schwartz, Cato Institute, Washington, D.C., Nov. 21, 2003Monetary policy

William Poole

English

Research Papers in Economics

1
A Monetary Policymaker’s Perspective
The Cato Institute Book Forum
Celebrating the 40th Anniversary of the Publication of A Monetary History of the United States, 1867-1960
(by Milton Friedman and Anna J. Schwartz, Princeton University Press, 1963)
Washington, D.C.
November 21, 2003
policy. Bad economic analysis will almost cer-
tainly produce bad monetary policy. The real-bills
doctrine had a lot to do with the Federal Reserve’s
catastrophic mistakes in the early 1930s. Later,
beyond the period covered by the Monetary
History, the theory of a Phillips curve tradeoff
between inflation and unemployment played a
similar role in fostering the Fed’s inflationary
mistakes of the 1960s and 1970s. So also did
neglect of the key distinction between real and
nominal interest rates.
The nation is asking for trouble if central
bankers are not current on the latest developments
in monetary and macroeconomics. By “current
on” I certainly do not mean “automatically accept-
ing.” Many current developments coming out of
the academic world turn out to be wrong. I am
not criticizing academics; the essential nature of
research is a search for deeper understanding
and the effort inevitably yields approaches that
sometimes, and even frequently, turn out to be
blind alleys.
The Phillips curve tradeoff was an important
example of a wrong idea that gained wide accept-
ance and had a major impact on monetary policy.
Although ignorance of economics is a likely recipe
for failure, following the advice of mainstream
economics is hardly a guarantee of success. The
Fed did follow mainstream advice in the late
1960s and most of the 1970s, and it was precisely
that advice that created the Great Inflation.
There is no substitute for sound economics
as the underpinning for sound monetary policy,
but for me as a policymaker that fact creates a
profound problem. I am not a layman economist,
but along with laymen must find a way to sort
I
t is an honor to participate in this event,
recognizing the enormous importance of
the publication of the Friedman and
Schwartz’s Monetary History 40 years ago.
I’ve been asked to focus on the policymaker’s
perspective. However, I must emphasize that
the views I express are those of a policymaker,
and do not necessarily reflect official positions
of the Federal Reserve System.
The introduction to the Monetary History
starts with this sentence: “This book is about the
stock of money in the United States” (p. 3).
Friedman and Schwartz show convincingly that
failure to pay attention to money growth was the
source of many policy mistakes. I confess to feel-
ing very uneasy that money plays practically no
role in policy discussions in the Federal Reserve
today. I am one of the few members of the FOMC
who ever mentions money during the meetings.
Despite this observation, there is no doubt that
Friedman and Schwartz have taught everyone to
watch for warning signs from money growth; if
and when those signs appear, I will not be the
only one talking about them.
Fortunately, the book is about a lot more than
the stock of money. The Monetary History is an
important scholarly contribution about U.S. eco-
nomic history, monetary policy, and the stock of
money. There can be no distinct policymaker
view of the book’s importance because it bears
on the monetary analysis of both academics and
policymakers.
Perhaps the most important message I take
away from the Monetary History is the tremen-
dous importance of ideas in shaping monetaryout correct from incorrect ideas when the experts
differ.
Academics can help by speaking more directly
to the problems policymakers face; from my years
as both an academic and as a policymaker, I find
that academic economists are often out of touch
with the situation faced by policymakers. I am
particularly annoyed, frankly, when I hear aca-
demics’ pleas for more research when that solu-
tion is simply not relevant to a pressing need to
decide one way or the other right now. I know that
advances in economics can have important
policy implications. Those advances will register
more quickly on actual policy decisions if aca-
demics explain their relevance as they might if
they were sitting at the FOMC table and had
responsibility for policy decisions. The Monetary
History has that kind of relevance, for the analysis
can be brought to bear directly on current develop-
ments as they unfold.
There has been a substantial change in atti-
tudes within the Federal Reserve over the years.
I was a staff member at the Board of Governors
in the early 1970s and remember the visceral
negative reactions to monetarism so evident in
many senior Fed staff members and governors. I
do not see those attitudes today. Fed people are
much more open-minded than they used to be,
and that attitude is extremely helpful to the cause
of making good economics bear on monetary
policy. The Federal Reserve as an institution has
changed; today, it invites open discussion and is
tolerant of dissenting views.
Friedman and Schwartz are clear about the
importance of good leadership. In discussing why
Fed policy was so inept during the early 1930s,
they say, “[t]he detailed story of every banking
crisis in our history shows how much depends
on the presence of one or more outstanding indi-
viduals willing to assume responsibility and
leadership” (p. 418). They emphasize the impor-
tant role played by Benjamin Strong in the 1920s
and the void left by his death in 1928. The leader-
ship of Paul Volcker and Alan Greenspan made
an enormous difference to outcomes over the
last quarter century and their example will have
lasting importance for the practice of central
banking.
If competent leadership is essential to good
monetary policy, then a natural focus is on insti-
tutional arrangements that maximize the potential
for putting competent leaders in office and ensur-
ing that they have the political freedom to manage
policy wisely. The Monetary History does treat
some issues of institutional design, especially
the unsatisfactory features of the original Federal
Reserve Act that created an ambiguous governance
structure between the Federal Reserve Banks
and the Board in Washington. Legislation in the
1930s largely cleared up this problem. However, I
do not recall much discussion in the Monetary
History about how Fed governors and Bank pres-
idents were selected.
The issues of institutional design are impor-
tant, and are on my mind a lot. I recall the
Friedman and Schwartz discussion of how the
Fed, in the early 1930s, engaged in expansive
open market operations under congressional
pressure, but ceased such efforts when Congress
went out of session. Unfortunately, it would not
be difficult to find a hundred examples of bad
congressional advice for every example of good
congressional advice.
Since the Monetary History, the profession
has developed a consensus that central bank
independence is a better institutional design
than tight control by the legislative or executive
branch of government. It is interesting to note
that the Federal Reserve, with Reserve Bank pres-
idents appointed by the boards of the Reserve
banks, has a greater private sector input than any
other major policy institution in the United States.
Some view this structure as antidemocratic, but
in my view the current arrangement provides
clear political control through the Board of
Governors while the private sector role through
the Reserve Banks makes the institution more
directly accountable to the broad public interest
than would be the case if all control came from
Washington. In any event, issues of institutional
design were part of the analysis in the Monetary
History and what Friedman and Schwartz say
about these issues is highly relevant to debates
today.
MONETARY POLICY AND INFLATION
2One of my special interests is the role of
expectations in shaping economic developments.
Friedman and Schwartz discuss expectations in
a number of contexts. One of these concerns the
effects of anticipations of a depression following
World War II. Today, our knowledge of expecta-
tions is vastly superior to the data available for
the period covered by the Monetary History. We
have extensive survey data on expectations about
a wide variety of economic variables. More impor-
tantly, we have excellent market data on inflation
expectations, from trading in indexed bonds, data
on oil price expectations from trading in long-term
oil price futures, and data on monetary policy
expectations from the federal funds futures mar-
kets. Data from derivatives markets permit cal-
culations of risk assessments in many markets.
Data on expectations certainly make the life of a
policymaker a lot easier.
I wonder, though, to what extent the behavior
of the economy itself has changed as a conse-
quence of the proliferation of financial instru-
ments. Certainly, behavior in many individual
markets has changed, but as far as I know we do
not have reliable estimates of effects on the macro-
economy. This is an important issue, as a chang-
ing economic structure degrades the value for
current policy of experience in earlier eras.
I’ll finish by returning to my main point,
which is the importance of good economics for
good monetary policy. A theme running through
the Monetary History is role of inflation in the
business cycle. The Federal Reserve has finally
been successful, at least for the moment, in stabi-
lizing the price level. Depending on your view as
to the bias in price indexes, the rate of inflation
today is zero or only slightly above zero. The
Friedman and Schwartz work demonstrates that
price stability was achieved momentarily a num-
ber of times in U.S. history, but that blissful state
was never lasting. I am acutely aware of that his-
tory today and hope that the Federal Reserve’s
recent success in creating price stability can
become a permanent feature of the economy.
Our history makes clear that price stability is not
automatic.
A Monetary Policymaker’s Perspective
3

A monetary policymaker's perspective

http://fraser.stlouisfed.org/historicaldocs/1099/download/41124/20031121.pdf

A monetary policymaker's perspective

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics