PowerPoint slides - Center for the History of Political Economy

History of Modern Macroeconomics Lecture 3.1. The Background to Modern Macroeconomics (before the 1930s) Kevin D. Hoover Department of Economics Department of Philosophy Center for the History of Political Economy Duke University

Center for the History of Political Economy Summer School (Module 2), July 2011

1

Macroeconomic Issues are Old

Sir William Petty (1623-1687) Center for the History of Political Economy Summer School (Module 2), July 2011

2

The Distinction Between Macroeconomics and Microeconomics is Recent 







Ragnar Frisch (1895-1973), Norwegian economist, winner of the first Nobel Prize in Economics



Ragnar Frisch in Cassel Festschrift (1933): microdynamics vs. macrodynamics Frisch in mimeographed lectures (1933/34): mikroøkonomiske vs. macroøkonomiske

Jan Tinbergen in Revue de l'Institut International de Statistique/Review of the International Statistical Institute (1936): macroéconomique J.M. Fleming in Economica (1938): macro-economic Ultimate source: Frisch; diffused through early meetings of the Econometric Society

Center for the History of Political Economy Summer School (Module 2), July 2011

3

The Slow Diffusion of the Micro/Macro Distinction Figure 1 The Diffusion of "Microeconomics" and "Macroeconomics" 25

Percentage of All Articles

20

15 "Macroeconomics"

10

"Microeconomics" 5

0

38

19

2

4 19

46 19

19

50

19

54

19

58

62 19

66 19

70

19

74

19

78

19

82

19

Center for the History of Political Economy Summer School (Module 2), July 2011

86

19

9 19

0

94 19

98 19

02 20

4

Macroeconomics Before 1930: Main Concerns 1.

Monetary Theory

2.

Theory of the Trade Cycle (later Business Cycle)

Center for the History of Political Economy Summer School (Module 2), July 2011

5

David Hume and Classical Monetary Theory International Quantity Theory of Money: Principal Doctrines  The Classical Dichotomy  Domestic Quantity Theory of Money (short run and long run)  The International SpecieFlow Mechanism  The Independence of Money and Finance David Hume (1711-1776) Center for the History of Political Economy Summer School (Module 2), July 2011

6

The Classical Dichotomy: Hume on the Nature of Money “[Money] is none of the wheels of trade: it is the oil which renders the motion of the wheels more smooth and easy.” David Hume “Of Money”

Center for the History of Political Economy Summer School (Module 2), July 2011

7

Domestic Quantity Theory of Money: Hume on the Neutrality of Money Suppose that four-fifths of all the money in GREAT BRITAIN to be annihilated in one night, and the nation reduced to the same condition, with regard to specie, as in the reigns of the HARRYS AND EDWARDS, what would be the consequence? Must not the price of all labour and commodities sink in proportion, and every thing be sold as cheap as they were in those ages? David Hume “On the Balance of Trade” Center for the History of Political Economy Summer School (Module 2), July 2011

8

Domestic Quantity Theory of Money: Hume on the Short and Long Run Effects of Money . . . though the high price of commodities be a necessary consequence of the encrease in gold and silver, yet it follows not immediately upon the encrease; but some time is required before money circulates through the whole state, and makes its effect be felt on all ranks of people. At first, no alteration is perceived; by degrees the price rises, first one commodity, then of another; till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom. . . it is only in this interval or intermediate situation, between the acquisition of money and rise of prices, that the encreasing quantity of gold and silver is favorable to industry. . . It is easy to trace the money in its progress through the whole commonwealth; where we shall find, that it must first quicken the diligence of every individual, before it encrease the price of labor. David Hume “Of Money” Center for the History of Political Economy Summer School (Module 2), July 2011

9

The International Specie-Flow Mechanism Spain imports gold  (pSpain / pEngland) ↑  demand for English goods & gold flows into England  pSpain↓ & pEngland ↑ until trade balanced and gold flow stops The gold of Spain becomes the gold of England; the real wealth of Spain or England little changed Center for the History of Political Economy Summer School (Module 2), July 2011

10

Independence of Money and Finance

Center for the History of Political Economy Summer School (Module 2), July 2011

11

Hume Ignored Financial Innovation

English gold guinea (George III, 1776)

Scottish paper guinea (Paisley Banking Company, 1785)

Center for the History of Political Economy Summer School (Module 2), July 2011

12

The Gold Standard Was Not Automatic 

Suspensions   



The Problem of management of paper currency  



Panic of 1797: Suspension of convertibility of Bank of England notes into gold, 1797-1821 U.S. Civil War Britain in World War I Banking School (Real Bills Doctrine) Currency School (U.K. Bank Charter Act of 1844; U.S. National Banking Acts of 1863 & 1864)

Management of interest rates: The rules of the game Center for the History of Political Economy Summer School (Module 2), July 2011

13

The Quantity Theory of Money: The Equation of Exchange Simon Newcomb (1835-1909)



MV = PQ  

Irving Fisher



(1867-1947)



M = money V = velocity of circulation (average turnover time per dollar) P = general price level Q = transactions (dollars per unit time)

Center for the History of Political Economy Summer School (Module 2), July 2011

14

The Quantity Theory of Money: The Cambridge Equation 

M/P = kY   



M = money P = general price level k = fraction of income held as money Y = income (pounds sterling per unit time)

Alfred Marshall (1842-1924) Center for the History of Political Economy Summer School (Module 2), July 2011

15

Comparison of Two Approaches to the Quantity Theory 

Equation of Exchange  





Cambridge Equation   



MV = PQ V = speed of turnover of money “ . . . money on the wing” Dennis Robertson M/P = kY k = size of money holding “. . . money sitting” Dennis Robertson

Equivalence: V = 1/k if QY

Dennis Robertson (1890-1963) Center for the History of Political Economy Summer School (Module 2), July 2011

16

Wicksell: Cumulative Process and the Natural Rate of Interest 









real rate of interest (rr) = nominal rate (r) – inflation rate (P) (Fisher) Stable Economy: M  Y & I and P constant at the natural rate of interest (rN) M > needed  ↓r below rN  ↓ rr  ↑I & ↑ P  further ↓ rr  further ↑I & ↑ P . . . Self-limited under gold standard as ↑ P  gold outflow  ↓M offsetting first cumulative process Not self-limiting in pure credit economy  need for active monetary policy

Knut Wicksell (1851-1926) Center for the History of Political Economy Summer School (Module 2), July 2011

17

Business Cycles: Main Issues 

Good and bad times alternate



Develop data  



indices (price and others) business cycle barometers

Theory  

identify patterns are patterns regular? Center for the History of Political Economy Summer School (Module 2), July 2011

18

Data and Patterns: Warren Persons Harvard Business-Cycle Barometer

Center for the History of Political Economy Summer School (Module 2), July 2011

19

Natural Cycles Tides – Morro Bay, California

Musical Instruments

Center for the History of Political Economy Summer School (Module 2), July 2011

20

Wesley Clair Mitchell (1874-1948): Cycles are Qualitatively Not Quantitatively Similar

Center for the History of Political Economy Summer School (Module 2), July 2011

21

Cycles Have Deep Hidden Causes 



Business cycles are like the tides, only vastly more complex Hierarchy of cycles:  



Kitchen (40 month) Juglar (9-10 years = 3  Kitchen’s) Kondratieff (60 years = 6  Juglar’s)

Joseph Schumpeter (1883-1950) Center for the History of Political Economy Summer School (Module 2), July 2011

22

Clément Juglar: Credit Cycles 



Every cycle has a proximate trigger – the straw that breaks the camel’s back But cycles have a deeper root cause – the ebb and flow of financial credit

Clément Juglar (1819-1905) Center for the History of Political Economy Summer School (Module 2), July 2011

23

Cycles Have Real Causes 

Jevons: business cycles follow agricultural cycles, which follow the cycle of sunspots

William Stanley Jevons (1835-1882)



Henry Ludwell Moore (1869-1958)

Moore: business cycles are closely correlated to cycles in the orbit of Venus

Center for the History of Political Economy Summer School (Module 2), July 2011

24

Problem of the 1920s and 1930s 





Monetary theory is theoretically more developed Business cycle analysis is the premier empirical analysis of the whole economy How can they be brought into contact:     

Frisch Tinbergen Keynes and many others Foundation of the Econometric Society (1933) Center for the History of Political Economy Summer School (Module 2), July 2011

25

Thanks  The End Center for the History of Political Economy Summer School (Module 2), July 2011

26