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Understanding the Evolution of Macroeconomic Thinking Since 1717: an International Monetary System Perspective＊

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Understanding the Evolution of Macroeconomic Thinking Since 1717: an International Monetary System Perspective＊ Understanding the Evolution of Macroeconomic Thinking since 1717: An International Monetary System Perspective＊ Masazumi Wakatabe Abstract: This paper proposes a way to understand the evolution of macroeconomic thinking. The macroeconomic thinking, not necessarily synonymous with macroeconomics, has been dealing with the questions of money and business cycles. Money and busi- ness cycles, in turn, have been closely connected with the international monetary ar- rangements such as the Gold Standard, the Bimetallic Standard, the Bretton Woods system, and the Flexible Exchange Rate. I shall argue that the evolution of macroeco- nomic thinking is best understood as the responses of economists to, and their inter- action with, the changing monetary and exchange rate regimes. The theoretical foundation of the paper is rather simple: the so-called trilemma, or “irreconcilable or impossible trinity.” A policymaker cannot simultaneously choose a fixed exchange rate, free mobility of capital, and domestic price stability via independent monetary policy. Facing this constraint, the policymaker can, at most, choose two from among these three goals. Therefore, further questions emerge: which goal or goals should be given priority from among these three, and what is the exact tool or mechanism that can ensure the achievement of preset policy goals. The answer to the first question determines the nature of international monetary arrangements, which, in turn, are shaped by political and economic factors. With respect to the second issue, institu- tions, or what we might call the institutional or social governance technology, play a crucial role. Throughout history, concerns over “unrestrained inflation” have been widespread, since there have always been strong incentives for a government to raise seigniorage by over-issuing money. The choice of international monetary arrange- ments depends on the availability, credibility, and effectiveness of a specific social governance technology that acts as a constraint upon policymakers, which, in turn, depend on the specific political and economic structure. JEL classification numbers: B 20, B 22, E 42. ＊ I greatly appreciate helpful comments from anonymous referees. I would also like to thank the Japan Socie- ty for the Promotion of Science（ Grant No. 18530150）, and the Waseda University Grant for Special Re- search Projects（ 2006K-010） for their indispensable financial assistance. The paper was presented at HES annual meeting at Toronto, June 2008. The History of Economic Thought, Vol. 51, No. 2, 2009. Ⓒ The Japanese Society for the History of Eco- nomic Thought. WAKATABE: UNDERSTANDING THE EVOLUTION OF MACROECONOMIC THINKING SINCE 1717 19 This paper proposes a method of under- I Introduction standing the evolution of macroeconomic The history of macroeconomics can be nar- thinking. Macroeconomic thinking, which is rated in a wide variety of ways: one could not necessarily synonymous with macroeco- describe the history as the ongoing attempts nomics, has been dealing with questions of of economists to develop ever more rigorous money and business cycles, the fluctuations analytical tools to understand macroeconom- of price level, output, and employment. Mon- ic phenomena, or one could emphasize the ey and business cycles have been closely several theoretical and methodological turns connected with international monetary ar- in the evolution of macroeconomic thinking. rangements such as the Gold Standard, the In this paper, I focus on the relationship be- Bimetallic Standard, the Bretton Woods sys- tween events and ideas in the development tem, or the Flexible Exchange Rate, which of macroeconomic thinking and pay particu- we now have. I shall argue that the evolution lar attention to the evolution of international of macroeconomic thinking is best under- monetary arrangements. stood as the responses of economists to, and There has been a long debate about the their interaction with, the changing monetary exact relationship between events and ideas and exchange rate regimes. The theoretical in the history of economic thought, but the foundation of the paper is rather simple: the significance of events in the development of so-called trilemma, or “irreconcilable or im- macroeconomic ideas has rarely been doubt- possible trinity.” A policymaker cannot si- ed. As Dennis O’Brien asserts, “［M］ajor de- multaneously choose a fixed exchange rate, velopments in macroeconomic theory have free mobility of capital, and domestic price never been independent of the background stability via independent monetary policy.1） against which they have emerged; this is par- Facing this constraint, the policymaker can ticularly true of monetary theory”（ O’Brien choose at most two from among these three 2004, 164）. As is emphasized in the litera- goals. Therefore, further questions emerge: ture, institutions are usually defined as the which goal or goals should be given priority “rule of games”（ North 1990） and they en- from among the three, and what is the exact tail beliefs; monetary institutions are also an- tool or mechanism to ensure the achievement chored by beliefs and expectations. David of preset policy goals. The answer to the first Laidler has raised another interesting point: question determines the nature of interna- the behavior of economic agents depends on tional monetary arrangements, which are the specific models, beliefs, or ideas that they shaped by political and economic factors. hold, and hence, a systematic investigation of With respect to the second issue, institutions, them-the history of economic thought- or what we might call the institutional or so- should be an integral part of practicing eco- cial governance technology, play a crucial nomics（ Laidler 2004; 2007）. In this con- role. Throughout history, concerns over “un- nection, policy issues should necessarily be restrained inflation” have been widespread, emphasized as channels through which since there have always been strong incen- events and ideas interact with each other. tives for a government to raise seigniorage 20 経済学史研究 51 巻 2 号 by over-issuing money. The choice of inter- sponded with the Bretton Woods system. national monetary arrangement depends on This paper is drawn from previous litera- the availability, credibility, and effectiveness ture on the history of macroeconomics and of a specific social governance technology macroeconomic history. Scott Sumner focus- that acts as a constraint upon policymakers, es on the relationship between the evolution which, in turn, depends on the specific politi- of macroeconomics and that of international cal and economic structure.2） monetary arrangements. He has argued that Let us begin with several observations. Keynesian economics was essentially a Gold First, for a long time, economists have been Standard model in which monetary policy concerned with what we call growth and de- was constrained, that there were no sustained velopment, and certainly, the history of mac- inflationary expectations due to the nature of roeconomic thinking must explore this as- the Gold Standard regime（ Sumner 1999）, pect. After all, Adam Smith wrote An Inquiry and that the evolution of macroeconomics into the Nature and Causes of the Wealth of and the fluctuating popularity of the IS-LM Nations. Economists have engaged in a se- model were explained by its relationship to ries of discussions about money and fluctua- international monetary regimes （Sumner tions of price level, output, and employment; 2004）. According to Sumner, the IS-LM the macroeconomics we know today has model presupposes the monetary policy con- emerged from these discussions. Second, the ducted through nominal interest rate and history of economics is full of controversies, does not distinguish between nominal and but the role of controversies in the history of real interest rates. The model worked quite monetary economics seems to be more sig- well and was hence popular in the low-infla- nificant in that it has furthered development tion situation during the Bretton Woods sys- in other fields of economics. Third, these tem up to 1968. The onset of the Great Infla- controversies have in one way or the other tion in the 1970s and the breakdown of the revolved around the nature and desirability system led to a decline in the popularity of of international monetary arrangements. The the model. Since then, the Bretton Woods era works of Henry Thornton and David Ricardo economics has become a flourishing research were direct products of the Bullionist contro- field（ Leeson 2003; Endres 2005; Cesarano versy; neo-classical monetary economics 2006）. Furthermore, macroeconomic histori- was closely involved with the “Great Depres- ans such as Barry Eichengreen, Peter Temin, sion” of the 1880s and with the controversy and Christina Romer are keenly aware of the over the Bimetallic Standard. The interwar importance of ideas in understanding history period leading to the Great Depression was （Eichengreen 1992; Eichengreen and Temin both the hotbed of macroeconomic thinking 2003; Romer and Romer 2002）. Though this （that culminated in the publication of John paper shares a perspective similar to that of Maynard Keynes’ General Theory of Em- Sumner and others, it will argue beyond the ployment, Interest and Money） and the emer- periods that Sumner has analyzed. This paper gence of “macroeconomics.” The rise and is an attempt to place this literature in a wid- fall of Keynesian macroeconomics corre- er context of macroeconomic history. WAKATABE: UNDERSTANDING
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