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 business cycles, in turn, have been closely connected with the international monetary arrangements such as the Gold Standard, the Bimetallic Standard, the Bretton Woods system, and the Flexible Exchange Rate. I shall argue that the evolution of macroeconomic thinking is best understood as the responses of economists to, and their interaction 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, institutions, 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 arrangements 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 the Evolution of Macroeconomic Thinking since 1717 21

This paper is organized as follows. Sec- well-documented in literature（ Viner 1937; tion II focuses on the Gold Standard Era, Fetter 1965; Laidler 2000）. Two economists, which spanned more than a century, and on Henry Thornton and David Ricardo, who the bank restriction period and the Bimetallic stood out as the Bullionists who had devel- controversy. Section III examines the double oped classical monetary theory based on the emergence of the Bretton Woods system and quantity theory of money, had explained the Keynesian economics in the interwar and behavior of price level in terms of the post-WWII period. Section IV discusses the amount of money circulated（ including cred- post-Bretton Woods era with an emphasis on it, if nonconvertible）, had pointed out the re- attempts to find a better nominal anchor. The sponsibility of the Bank of England during last section concludes the paper. the suspension, and had advocated the even- tual return to the Gold Standard. They were II The Long Gold Standard Era no dogmatic proponents of the Gold Stand- Great Britain instituted the Gold Standard in ard, and they recognized the adverse effects 1717 by setting the price of gold at ₤3 17s. of sudden price changes on the real variables 10½d per ounce. The price remained the and the need for gradualism during the re- same until 1925, and the standard itself sur- turn, devaluation upon the return, and even vived until 1931, with the exception of two suspension, if necessary （Laidler 2000; notable intervals of suspension: 1797-1821 Humphrey 2004; Davis 2005）. and 1914-1925. As is well-known, the Gold Nevertheless, they did not advocate any Standard was not the global monetary order monetary rule or international monetary or- before the 1880s, which was when other Eu- der except the Gold Standard. It is true that ropean economies formally adopted it: Bi- Thornton believed in the effectiveness of pa- metallism had been more prevalent for a per credit “［I］n a commercial country, sub- long time（ Redish 2000）. jected to that moderate degree of occasional alarm and danger which we have experi- 1. The Bullionist Controversy enced, gold is by no means that kind of cir- The obvious starting point of monetary eco- culating medium which is the most desira- nomics would be John Locke, or David ble”（ Thornton 1802, 276）. It is also true that Hume, or even earlier writers on money or Thornton was in favor of the discretionary the proponents of the quantity theory of conduct of monetary policy（ 259）. He hard- money. As is evident from the price-specie- ened his position by 1810, when he contrib- flow mechanism, it presupposed the exist- uted to the draft of the Report from the Se- ence of a commodity money standard; there- lect Committee on the High Price of Bullion, fore, price level behavior was presumably the so-called Bullion report. The key prob- anchored and stabilized in some intervals. lem with the Bank of England was its incom- Investigations into the behavior of price level petence: “the Directors do not act up to the had to wait until the Gold Standard was sus- principle which they represent as one per- pended. fectly sound and safe, and must be consid- The Bullionist controversy has been ered, therefore, as possessing no distinct and 22 経済学史研究 51 巻 2 号

certain rule to guide their discretion in con- might subject to”（ 59）, with specific refer- trolling the amount of their circulation” ence to the policy of the Bank of England. （Cannan 1925, 52）. At the core of the debate His distrust of the Bank of England was so was the question of how to design a proper great that he later advocated the establish- institutional structure for monetary management of a national bank and pursued a fur- ment provided that the Bank of England, the ther reform of effective monetary policy, to only existent institution which could func- include convertibility. tion as what would later be called a central After the controversy and the resumption bank, could not be trusted: of cash payments in 1821, the Gold standard became an “article of faith”: “Political econo- The suspension of Cash payments has had mists by the 1830s had practically removed the effect of committing into the hands of the monetary standard from the area of de- the Directors of the Bank of England, to be bate”（ Fetter 1965, 140）. Frank Fetter called exercised by their sole discretion, the im- the unwillingness of political economists to portant charge of supplying the Country discuss monetary standards a “puzzle” with that quantity of circulating medium （142）, and offered three possible explana- which is exactly proportioned to the wants tions, which were recent lessons of history, and occasions of the Public. In the judg- philosophy against intervention, and eco- ment of the Committee, that is a trust, nomics: “economists’ distrust of the Bank of which it is unreasonable to expect that the England policy in the Bank Restriction, and Directors of the Bank of England should particularly of the defense of the real bills ever be able to discharge（. 52） doctrine by the Bank and the Government; second, the feeling that any monetary ar- Therefore, policy “errors are less to be im- rangement that gave discretion . . . was bad puted to the Bank Directors, than to be stated in principle; and third, the assumption that as the effect of a new system.”（ 53） changes in prices affected the distribution of David Ricardo also objected to an incon- income, but had little if any effect on the to- vertible currency, “a currency without a spe- tal of income and employment”（ 142）. The cific standard” （Ricardo 1816, 59; Davis last two reasons are not convincing since the 2005, 187）. His first reasons were theoretical best classical writers did not deny discretion and empirical: he believed that “no one has within some boundaries, and they did not de- yet been able to offer any test by which we ny-and in fact were concerned with-the could ascertain the uniformity in the value of real effects of the changes in prices on the a money so constituted”（ Ricardo 1816, 59）, economy, at least in the short-run. The first and that what we now call the price index reason could be more convincing than the was very difficult to construct（ 60）. To this, other two since classical economists were he related his second, institutional point: severely critical of the Bank of England, and without a proper index, or “test,” “it would be that particular “lesson of history” was shared exposed to all the fluctuations to which the among them.3） ignorance or the interests of the issuers Wakatabe: Understanding the Evolution of Macroeconomic Thinking since 1717 23

2. Neo-classical Economists and while neo-classical writers questioned the the Bimetallic Controversy desirability of the Gold Standard in terms of In the economies that adopted the Gold stabilizing the internal value of a currency. Standard, the price level first rose during the The neo-classical writers proposed a wide 1850s and declined from around 1873 to variety of monetary reform plans such as the 1896. This was because the demand for gold “tabular standard”（ Jevons, H. S. Foxwell）, increased relative to its supply. Although the and “symmetalism” （Marshall）. Wicksell so-called neo-classical economists were went even further by suggesting an interna- mainly concerned with solving the analytical tional paper standard in which price stability issues of monetary economics, especially would be maintained by the international co- that of reconciling value and distribution operation of central banks; this bears a strik- theories, rather than with solving real-world ing resemblance to the current inflation tar- issues（ Laidler 1991）, the link between neo- geting regime. classical economics and real-world monetary The most telling aspect of the controver- issues could have been stronger than what sy was, however, the classical defense of has been usually assumed. A notable exam- gold monometallism as the “natural” interna- ple is the “Great Depression” of the late nine- tional monetary order. On the opposite side teenth century, and the controversy surround- of the same coin, Sir Robert Giffen attacked ing Bimetallism and proposals for reforming bimetallism as both “a departure from the the Gold Standard. The Great Depression Free Trade principle” and “the management then was associated with a mild deflation, of a coinage with a view of artificially keep- and many contemporary discussions investi- ing a standard stable from period to period” gated the causes of deflation and possible （quoted in Laidler 1991, 161）. The Gold remedies.4） Standard mentality became dogmatic and The list of economists that got involved rigid, along with the dogmatic interpretation with the Bimetallic controversy was quite of the free trade principle. impressive, and it included almost all major The Gold Standard survived the first economists of the time from William Stanley Great Depression. This survival was due to Jevons, Alfred Marshall, Léon Walras, to several factors. First, the system was rather Knut Wicksell（ Laidler 1991, Chapter 6）. As flexible in dealing with shocks to it. When Laidler summarized, “one continuous thread an economy faced negative shocks such as runs through the discussion . . . , namely, the war or financial crisis, the country could sus- tension existing between, on the one hand, pend the Gold Standard and return to it later. the quantity theory of money and theoretical This “contingent” clause gave the system ideas associated with it, and, on the other sufficient flexibility to maintain the rule- hand, the theoretical basis of the then exist- based monetary order（ Bordo and Rockoff ing, and indeed spreading, monetary system 1996）.5） Nevertheless, it is true that the con- based upon gold”（ Laidler 1991, 187）. Clas- troversy revealed the defects and-more im- sical writers adhered to the Gold Standard portantly-the nature of international mone- using the classical theory of natural value, tary order. As the Giffen-Marshall exchang- 24 経済学史研究 51 巻 2 号 es showed, no matter how “sacred” and “nat- late into the Bimetallic controversy. His re- ural” the Gold Standard seemed, it was an vival of the quantity theory of money was institution. Another striking fact is the rela- closely related to his quest for alternative in- tionship between politics and monetary or- ternational arrangements to the Gold Stand- der. Popular sentiments against the ill effects ard, such as the compensated dollar plan on of deflation caused by the Gold Standard the one hand and his quest for alternative drove this discussion, even though the Amer- rule for monetary policy on the other hand. ican Populist movement symbolized by Wil- However, his proposals were too radical to liam Jennings Bryan did eventually fail. be considered seriously.6） Since the brief flexible exchange rate era

III Keynesian Economics was marked with high and hyper-inflation as a Bretton Woods Product episodes, the most notable example being the The outbreak of World War I led to the sus- German hyper-inflation in 1923-24, the ac- pension of the Gold Standard in major coun- tual course was decidedly oriented toward tries. The attempt at reconstruction after the the reconstruction of the Gold Standard sys- war eventually failed with the onset of the tem, with some modifications. Hawtrey, the Great Depression. It was during the interwar “enlightened advocate of the restoration of period that the immediate precursor to macro- gold,” proposed the gold exchange standard economics emerged with the publication of system, with which Keynes concurred. Both Keynes’ General Theory in 1936. This is Hawtrey and Keynes worked closely in considered to be a threshold event in the his- drafting the resolutions at the Genoa confer- tory of economic thought. The interwar in- ence in 1922. Keynes summarized the pre- stability of the gold standard regime opened vailing atmosphere quite succinctly: “It is up two possibilities: a new monetary order natural, after what we have experienced, that without gold convertibility, and new eco- prudent people should desiderate a standard nomic thinking conforming to it. The end of value which is independent of Finance products of this turbulent period were the Ministers and State Banks. The present state Bretton Woods system and Keynesian eco- of affairs has allowed to the ignorance and nomics, both of which were closely related frivolity of statesmen an ample opportunity to each other. of bringing about ruinous consequences in Economists such as Gustav Cassel, Irv- the economic field. It is felt that the general ing Fisher, Ralph G. Hawtrey, and John May- level of economic and financial education nard Keynes contributed significantly to the amongst statesmen and bankers is hardly co-evolution of institutions and ideas. The such as to render innovations feasible or common thread of their contributions was safe; that, in fact, a chief object of stabilising the primacy and desirability of stabilization ［sic］ the exchanges is to strap down Minis- of the domestic price level with a view to the ters of Finance”（ Keynes 1923, 169）. How- stabilization of employment and production. ever, Keynes countered: “the experience on The proper starting point would be Irving which they are based is by no means fair to Fisher, the American economist who came the capacities of statesmen and bankers. The Wakatabe: Understanding the Evolution of Macroeconomic Thinking since 1717 25

non-metallic standards, of which we have In economics, the stabilizationist per- experience, have been anything rather than spective prevailed, but with an unintended scientific experiments coolly carried out . . . . result. The role of economists and the “pre- I do not see that the regulation of the stand- vailing atmosphere” was vital. By the end of ard of value is essentially more difficult than the 1930s, they came to believe that the all many other objects of less social necessity too brief experiences of the flexible ex- which we attain successfully”（ 169-70）. Al- change rate episodes were a demonstration though he thought that “the gold standard of the failure of market adjustment. This was ［was］ already a barbarous relic”（ 172）, his later to be summarized in Ragnar Nurkse’s practical proposal was the international co- classic account （Nurkse 1944; Bordo and operation of the two monetary authorities of James 2002）. Moreover, they were not cer- the United States and Great Britain to “aim tain of the competence of monetary authori- at the stability of the commodity value” of ties to conduct proper monetary and fiscal the currencies “rather than at stability of the policies. With respect to these factors, Key- gold-value” of the currencies（ 203）. nes belonged to the “prevailing atmos- The second Great Depression of the phere” : he led the argument during the 1930s led to the collapse of the Gold Stand- 1920s for a managed currency, but after the ard system. Deflationary forces were so se- suspension of the Gold Standard in Great vere that policymakers could not maintain Britain in 1931, he no longer did so.8） Price the Gold Standard. Further, there was an im- stability remained the most desirable goal, portant political change: policymakers could combined with the desirability of the stable earlier have ignored the people’s demand for exchange rate and the undesirability of free action, but the democratization after WWI mobility of capital; the road to the Bretton and the increased rigidities in wage and price Woods system was well-paved （Cesarano settings in the economy made it increasingly 2006）. difficult for them to ignore the voice of the Post-WWII macroeconomics was epito- people. As recent literature in economic his- mized in the IS-LM framework, the essence tory emphasizes, the Gold Standard was a of which is the static equilibrium theory of propagating, if not the initiating, factor of the the aggregate variables. Important insights of Great Depression（ Eichengreen 1992）, and pre-WWII macroeconomic thinking, such as contemporary economists were keenly aware dynamics, inter-temporal choice and expec- of the “Golden Fetters,” that is, the constraint tations, and inter-temporal coordination fail- of the Gold Standard on the conduct of mac- ures “were lost with IS-LM” （Backhouse roeconomic policy. Policymakers and some and Laidler 2004）. Also lost was the concept economists resisted and argued against the of policy regimes. Post-WWII macroeco- abandonment of the Gold Standard. Some nomics reflected a consensus among policy- even argued against the need for counter-cy- makers and economists regarding the inter- clical measures: the Gold Standard mentality national monetary order. This Nurkse-Bret- was strong. However, in the end, there was ton Woods consensus placed priority on fis- no choice.7） cal policy, although the exact mechanism of 26 経済学史研究 51 巻 2 号

the relative effectiveness of fiscal and mone-

tary policies under different exchange rate IV In Search of a Better Nominal Anchor regimes was clarified later in the early 1960s by the development of the Mundell-Fleming The breakdown of the Bretton Woods sys- Model and the IS-LM-BP version.9） The or- tem between 1971 and 1973 marked the be- der of developing from a closed-economy ginning of a renewed search for the consen- model to an open-economy model contrasts sus model. It also marked the beginning of starkly with pre-WWII macroeconomic the turbulent period called the Great Infla- thinking, which had always assumed the in- tion. Recent studies on the Great Inflation ternational adjustment mechanism. episode reveal the several conditions under The significance of Milton Friedman’s which this inflation became rampant. One of challenges（ Friedman 1953） should be un- the most plausible explanations turns on the derstood against the background of post-De- mistaken view of the economy that was held pression Bretton Woods economics. Beneath by policymakers and economists alike: they the Bretton Woods system lay the fear of in- neglected the monetary explanation of infla- flation. Jacob Viner’s remark is quite telling: tion, and therefore, the importance of mone- “cult, myth, rigidity, illogicality though it be, tary policy（ Mayer 1999; Nelson 2005）. But . . . is in many countries the sole surviving this misconception was a by-product of a barrier to almost unrestrained inflation” particular international monetary order, the （quoted in Leeson 2003, 45）. Instead, Fried- Bretton Woods system, under which, mone- man was free of the so-called Gold Standard tary policy was not taken seriously, and was mentality that Viner referred to, and ap- accorded at best a secondary role. The mone- proached the question of price stability in tary policy neglect during and leading up to terms of a logical calculation of costs and the period of the Great Inflation was benefits. Friedman was not alone in his criti- strengthened under the Bretton Woods sys- cism of the Bretton Woods system, or in his tem. There was a bit of irony about the Bret- case for a flexible exchange rate regime.10） ton Woods consensus, however. The stabili- Roy Harrod and Gottfried Haberler also ar- zation policy worked well in an environment gued along similar lines, to name a few in which expectations about price change economists（ Leeson 2003, Chapter 6）. From were stable. This success encouraged the the 1940s to the 1960s, economists became continuous use of the stabilization policy and increasingly aware of the defects of the sys- eventually led to the destruction of the system such as the lack of adjustment of persist- tem. “It was easier before 1971 than after for ent imbalances, and they proposed reform policymakers to use monetary and fiscal pol- plans to introduce greater flexibility in ex- icies to manipulate output and employment change rate determination; this was in the because policies with inflationary conse- spirit of Friedman 1953. By around the late quences were not expected to persist and 1960s, a new academic consensus had been hence their short-run stimulating effects forged（ Leeson 2003, Chapter 7）. were not neutralized by higher wages and costs. Stabilization policy was more effec- Wakatabe: Understanding the Evolution of Macroeconomic Thinking since 1717 27 tive”（ Eichengreen 1993, 639）. ty by monetary authorities. The impor- The so-called Keynesian-Monetarist de- tance of expectations was underscored. bate, which had reached a stalemate during The advent of rational expectations the 1960s, was resolved in a varied manner: along with developments of game theo- the IS-LM framework survived, with differ- ry contributed to a renewed understand- ent interpretations and micro-foundations at- ing of the institutional structure of the tached to it; much of monetarist critiques conduct of monetary policy. Now it is were absorbed into mainstream economics. argued that policymakers needed a com- By 1990, New Keynesian economists could mitment device to discipline themselves claim that they could as well be called New from deviating from the ideal of price Monetarists. The newly formed consensus is stability. Discussions on the institutional summarized as follows （Mishkin 2007; governance structure of policymaking Goodfriend 2007）: bodies lead to recognition of the role of central bank independence and rule- ・ The Great Inflation brought the question based conduct of policy. The insights of of money to the fore: economics has re- Simons’ 1936 paper, which advocated discovered the importance of money the importance of rule-based conduct of （“money matters”）. Milton Friedman’s economic policy, were revived. famous dictum, “inflation is always and everywhere a monetary phenomena,” is ・ Commitment to a nominal variable, the taken now as a truth rather than a claim. “nominal anchor,” has been greatly em- In this sense, he prevailed. However, phasized. Money supply growth rate, monetary targeting-monetarists’ fa- exchange rate, and inflation rate have vorite mechanism to ensure price stabil- been tried as targets for monetary poli- ity-was eventually abandoned or mod- cy. The way to ensure commitment var- ified so much that it could not be identi- ies, but from the 1990s, inflation target- fied as such.11） ing has become popular and widespread （Bernanke and Mishkin 1997; Bernanke ・ The significance of price stability is rec- et al. 1999）. ognized. Price stability benefits in the long-run; in the short-run, there is a ・ Interest in the relationship between the Phillips curve relationship between the financial market and business cycles has unemployment rate and changes in the revived. Irving Fisher’s debt-deflation price level. However, policymakers can- theory of depressions came back with not engineer an ever-decreasing unem- new analytical tools of financial accel- ployment rate by raising the rate of in- erator model with imperfect informa- flation. tion.

・ The Great Inflation was brought down The precise impact of current mainstream by a firm “commitment” to price stabili- macroeconomics on economic policy is de- 28 経済学史研究 51 巻 2 号

batable.12） Yet the current mainstream has re- creasingly come to understand the desirabili- discovered “lost” elements of pre-WWII ty of price stability and the “managed” aspect macroeconomic thinking, and this rediscov- of money. This desirability in turn depends ery has a close relationship with the current on features of the economy such as price and international monetary regime. The current wage rigidities and stickiness, and the regime, often dubbed a “non-system,” has strength of the voice of those who are affect- been transforming into what might be called ed by price changes. However, the policy an Inflation Targeting regime（ Rose 2007）. goal of price stability conflicts with the sta- It grew out of spontaneous responses to the bility of the exchange rate, and creates possi- need for a nominal anchor by governments ble tensions between price stability and a and central banks, the notable examples be- particular form of international monetary or- ing New Zealand and Great Britain. In this der. This tension first manifested itself in the sense, the current regime is decentralized, Gold Standard era, and culminated in the and hence durable. The current regime also Great Depression of the 1930s. The tension shares several characteristics with current resurfaced under the Bretton Woods system, mainstream macroeconomics. The basic and led to its demise. The current Inflation premise is “constrained discretion,” or Targeting regime still survives, precisely be- “framework”（ Bernanke and Mishkin 1997）. cause it places price stability at the top of It is supposed to be rigid enough to constrain policy priority. central banks and stabilize expectations, but The perceptions of events of various also flexible enough for central banks to deal groups of people, not necessarily only econo- with shocks to the economy. With central mists, could play a vital role in the co-evolu- banks conducting monetary policy that aims tion of institutions and ideas. One driving at a certain range of inflation rates, the ex- force that determined the durability of inter- change rate will be determined, on principle, national monetary arrangements was “lessons by differentials in targeted inflation rates from history,” which they drew from recent （Mehrling 2002）. As a result, the exchange experience. The “prevailing atmosphere” sur- rate movement will be stabilized as well.13） rounding the discussion exerted a great influence on the choice of international monetary V Concluding Remarks arrangements, as was the case in the transi- Historically, specific institutions such as in- tion from the Gold Standard system to the ternational monetary arrangements have ex- Bretton Woods system. Also, these “lessons erted an enormous influence over the evolu- from history” should include the economists’ tion of macroeconomic thinking. Major assessment of institutional or social govern- changes in macroeconomic thinking have ance technology. For a long time, economists coincided with major changes in internation- did not have a high regard for the compe- al monetary orders. The common concern tence of governments and central banks, and running through history was that of econo- more often did not trust them. This judg- mists over price stability. There was an ebb ment on the institutional mechanism ensur- and flow in their concern, but they have in- ing price stability has constrained the way in Wakatabe: Understanding the Evolution of Macroeconomic Thinking since 1717 29 which economists have developed macro- while they did not explain the behavior of economic thinking. output. As they point out at the end of the paper, the possible transmission was consid- Masazumi Wakatabe: Faculty of Political ered from the changes in the price level to Science and Economics, Waseda University growth through “expectations and incom- plete contracts, as in, for example, Irving Notes Fisher’s debt-deflation story.” 1） Empirically speaking, it is possible that 5） There was also another causational link- the impossible trinity does not hold up in the age, however. The possibility of, or even a strict sense, since there is a varying degree of hint of a withdrawal from the Gold Standard laxness of each component. Obstfeld et al. would be a cause for financial panic, as hap- 2005, however, show that the trilemma has pened in the United States in 1893. held up empirically throughout the classical 6） Irving Fisher further proposed the price Gold Standard period to the present. level targeting mandated by the Congress 2） In this respect, it is no coincidence that during the 1920s. For the evolution of the Jean Bodin, who presented one of the earliest stabilizationist perspective before and after versions of the quantity theory of money, the Great Depression of the 1930s, see also advocated constitutionalism in the polit- Wakatabe 2008. ical sphere. In this connection, see Holmes 7） After this period, what may be called liq- 1995. uidationism went out of fashion. The connec- 3） As for the Banking School-Currency tion between liquidationism and the Gold School controversy, suffice it to say the fol- Standard was clear: advocates of liquidation- lowing. First, the adherents of both schools ism such as Friedrich Hayek, Joseph Schum- worked on the same assumption of the con- peter, and Lionel Robbins also argued for the vertibility, the Gold Standard being firmly maintenance and restoration of the Gold established. A notable exception of the Bir- Standard. For liquidationism, see De Long mingham economists, such as the Attwood 1990. For the counterargument, see White brothers, did question the compatibility of 2008. the Gold Standard with other macroeconom- 8） This apparent change of stance or discon- ic goals, but they were effectively marginal- tinuity seems to be a mystery: one possible ized in economics. Second, the economists explanation would be that Keynes did not were slow to recognize deposits as money, change his mind at all. He might have been possessing what may be called the “desire to thinking in terms of the Gold Standard exclude deposits”（ O’Brien 2004, 169）. This framework all through his career（ Sumner attitude was closely related to the primacy of 1999）. Nevertheless, the contrast between gold-backed currency. Keynes of the 1920s and Keynes of the 4） Modern research sheds a different light 1930s was stark. on the period: Bordo and Redish found that 9） For the development of the IS-LM-BP the connection between inflation/deflation model, see Young and Darity 2004. and boom/slow growth in the United States 10） One referee pointed out the possibility of and Canada was “more coincidence than Friedman being an “inflationist.” The word causation”（ Bordo and Redish 2004, 213）. has so many negative connotations that the The money supply shocks could explain the precise definition becomes unclear, but it is large part of the variations in the price lveel, wrong to call Friedman an inflationist. Fried- 30 経済学史研究 51 巻 2 号

man was convinced that all we needed was a Bernanke, B. S. and F. S. Mishkin. 1997. Infla- stable rule to ensure price stability such as tion Targeting: A New Framework for monetary targeting and that we could estab- Monetary Policy? Journal of Economic lish such a rule without any religious faith in Perspectives 11（ 1）: 97-116. a particular commodity. In this sense, he was Bordo, M. D. and H. James. 2002. Haberler ver- free of the Gold Standard mentality. sus Nurkse: The Case for Floating Ex- 11） Bernanke et al. argue that the Bundes- change Rates as an Alternative to Bretton bank’s famous “monetary targeting” was in Woods? In The Open Economy Macro- fact inflation targeting by another name, or model: Past, Present, and Future, edited “hybrid” inflation targeting（ Bernanke et al. by A. Arnon and W. Young. Boston: Klu- 1999, 41）. For a standard introduction to in- wer Academic Publishers: 161-82. flation targeting, see Bernanke and Mishkin Bordo, M. D. and A. Redish. 2004. Is Deflation 1997. Depressing?: Evidence from the Classical 12） For contrasting views on the relationship Gold Standard. In Deflation: Current and between modern macroeconomic theory and Historical Perspectives, edited by R. C. K. policy, compare Mankiw 2006’s skeptical Burdekin and P. L. Siklos. Cambridge: view and Chari and Kehoe 2006’s positive Cambridge Univ. Press: 191-217. view. Bordo, M. D. and H. Rockoff. 1996. The Gold 13） Mehrling 2002 argues that the inflation Standard as a ‘Good Housekeeping Seal of targeting regime resembles the Gold Stand- Approval.’ Journal of Economic History ard system, in particular, Hawtrey’s version 56:389-428. （Hawtrey 1913, 265）. The resemblance of Cannan, E. 1925. The Paper Pound of the end result is similar, but the fundamental 1797-1821, 2nd ed. London: P. S. King & ideas of the two regimes are sharply differ- Son. ent: the current regime is based on the pri- Cesarano, F. 2006. Monetary Theory and Bret- macy of price stabilization. Mehrling was ton Woods: The Construction of an Inter- correct to point out that even under the Gold national Monetary Order. Cambridge: Standard system, authorities began to con- Cambridge Univ. Press. duct an embryonic price stabilization policy, Chari, V. V. and P. J. Kehoe. 2006. Modern and that it was precisely that kind of mone- Macroeconomics in Practice: How Theory tary policy that exacerbated the tension in is Shaping Policy. Journal of Economic the system. Perspectives 20（ 4）: 3-28. Davis, T. 2005. Ricardo’s Macroeconomics: References Money, Trade Cycles, and Growth. Cam- Backhouse, R. E. and D. Laidler. 2004. What bridge: Cambridge Univ. Press. Was Lost with IS-LM. In The IS-LM Mod- De Long, J. B. 1990. ‘Liquidation Cycles’: Old el: Its Rise, Fall, and Strange Persistence, Fashioned Real Business Cycle Theory and edited by M. De Vroey and K. D. Hoover. the Great Depression. NBER Working Pa- Durham and London: Duke Univ. Press: per Series No. 3546. 25-56. Eichengreen, B. 1992. Golden Fetters: The Gold Bernanke, B. S., T. Laubach, F. S. Mishkin, and Standard and the Great Depression, A. S. Posen. 1999. Inflation Targeting: Les- 1919-1939. New York: Oxford Univ. sons from the International Experience. Press. Princeton, NJ: Princeton Univ. Press. -. 1993. Epilogue: Three Perspectives on the Wakatabe: Understanding the Evolution of Macroeconomic Thinking since 1717 31

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