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George Tavlas on the History of Monetarism | Hoover Institution · The Capitalism and Freedom in the Twenty-First Century Podcast

0:09
- This is The Capitalism of Freedom,
0:10
the 21st Century podcast
0:12
and official podcast with the Hoover Institution Economic
0:14
Policy Working Group, where we talk about economics,
0:16
markets, and public policy.
0:17
I'm Jon Harley, your host Today my guest is George Tavlas,
0:20
an alternate governor to of the Bank of Greece
0:23
for the European Central Bank since 2008.
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He's also a distinguishing fellow at the WHO Institution at
0:28
Safer University, and he was previously the Director General
0:31
of the Bank of Greece from 2010 to 2013,
0:34
and a member of the General Counsel
0:36
and the Monetary Policy Council of the Bank
0:37
of Greece from 2013 to 2020, who's also an advisor
0:41
to the governors when the country entered the Eurozone
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and was involved in the management
0:45
and resolution of the Greek debt crisis. Welcome, George.
0:49
- Thank you so much, Jon.
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It's a pleasure to be here,
0:51
and I thank you for the invitation.
0:53
- Well, I, I wanna start by gaining into your early life.
0:56
Where did you grow up
0:57
and how did you first get interested in economics?
1:00
- I was born in Worcester, Massachusetts
1:02
to Greek immigrant parents.
1:06
My father left Greece and his village in Greece
1:10
and his formal education when he was 12 years old,
1:13
and he came to the United States at the end
1:15
of the First World War.
1:18
He worked his way up
1:19
and became a successful business person.
1:21
He owned several retail stores and rental properties.
1:25
He learned to read and write in English
1:27
and read the Wall Street Journal every day.
1:31
Like many immigrants. He had a simple dream.
1:35
He wanted to see his children have the education
1:38
that he never was able to have.
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And so when I was 13, he enrolled me into the one of, one
1:44
of the top prep schools in New England.
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It was located in, it is located in my hometown,
1:51
it's called Worcester Academy.
1:53
But then tragedy struck several weeks
1:56
before I started my first classes.
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My dad died unexpectedly of a heart attack after that.
2:04
I didn't take classes. I didn't take school seriously.
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And so my grades at Worcester Academy were terrible.
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I had to repeat my fir my junior year.
2:18
And then I did something
2:19
that perhaps was the first in the history of the school,
2:23
which is pretty hard to do
2:24
because the school was founded in the 1830s.
2:28
I field my junior year a second time around.
2:31
In fact, my grades the second time
2:33
around were worse than the first time.
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Well, that summer,
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after the second junior year, a letter arrived at my home,
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addressed to my mother.
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It was from the headmaster of the school,
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and he advised her that the school board had determined
2:49
that I wasn't college material.
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She should look elsewhere for me to enroll.
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My mother never saw the letter.
2:58
I intercepted it
3:00
and he immediately went to see the headmaster,
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and I asked him for another chance.
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He gave it to me. He allowed me to enter my senior year
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with the provision that my grades had to show immediate,
3:15
immediate improvement.
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Well, that changed things around.
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For the first time, a fire was lit under me.
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I realized that I had to study. My grades went up.
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I applied to five colleges, was admitted into all of them.
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My family steered me to Babson College,
3:38
be it's a business college
3:40
because it had expected, it assumed
3:42
that I was gonna go into the family business.
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And so the letter addressed to my mother some years later
3:51
when I, on the day that I received my PhD degree,
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I showed my mother that letter for the first time
3:58
at the same time that I showed her my PhD diploma.
4:04
After I graduated from Worcester Academy,
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I attended Babson College, which is
4:13
a, as I mentioned, a business school in,
4:16
in Massachusetts at Babson.
4:19
In my first year, I took
4:23
an economic principles course with Bill Casey.
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Bill had just graduated from Boston College.
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We become lifelong friends. The course lit a fire.
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I knew from the, almost from the first that I wanted
4:37
to pursue economics for a career.
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I liked the quantification and the logic of economics.
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The faculty at Babson encouraged me
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to do my graduate work at New York University.
4:52
At NYU three courses were especially important
4:55
for my future research.
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Monetary economics taught by Bill s, silver Bill
5:01
and I have become lifelong friends.
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History of economic thought and econometrics.
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My dissertation combined the first two areas,
5:10
monetary economics and a history of thought.
5:13
Upon completing my PhD dissertation in 1977,
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I was offered a position as a macro econometric modeler
5:22
and a newly formed economic analysis team at the
5:25
State Department.
5:27
The team was created by Richard Cooper Cooper,
5:31
who had been teaching at Yale,
5:33
and subsequently was the teacher at Harvard,
5:35
had become under Secretary
5:37
of State in the patter administration. He wanted to build
5:40
- Me very famous, very famous international comics
5:42
who just passed away a few years ago.
5:45
- Excuse me. Yes, he did. Yes, he did.
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And he, yes, and he was an excellent economist
5:51
and an excellent writer.
5:53
Cooper wanted me, well, under
5:58
the main motivation for the economic analysis team under,
6:03
under Cooper was to create
6:06
a group at the State Department
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that could support econ these state departments positions at
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interagency meetings.
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So while at at State, I learned how to build
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and simulate macro econometric models.
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While at state, I received an offer from the OECD in Paris
6:28
to help them build their multi-country macro model.
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I accepted the offer
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and I took a leave
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of absence from the State Department in 1980.
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That turned out to be a good decision professionally
6:43
and a great decision personally,
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because while living in Paris, I was able to visit
6:50
Greece frequently because my mother had resettled there.
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And on one of those visits, I met my future wife, Sophia.
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After I returned to the State Department,
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George Schultz had become Secretary of State.
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Alan Wallace had become his undersecretary.
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Wallace had been his former colleague at Chicago,
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Martin Bailey,
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who had taught macro at Chicago in the
7:13
1970s, 1960s.
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In 1970s, he was a secret assistant secretary at the US
7:20
Treasury had become the chief economist.
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Martin was a, the attrition, he was a brilliant,
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the attrition, he needed someone to do the estimation,
7:30
to test his ideas, and I was the person to do it.
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We worked very closely together.
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We wrote several, published several papers that continued
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to re receive citations.
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I learned a lot from that from Martin.
7:44
In 1985,
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I received an offer
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to join the IMF,
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and I accepted it at the IMFI was assigned to do research
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among other things on the international monetary system.
8:00
One of the things I, I was especially involved
8:03
with on was looking at the advantages
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and disadvantages
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of a country having an international currency such
8:09
as the US dollar, a very topical,
8:12
dis topical issue today in light of the tariffs.
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However, as I rose through the ranks at the IMF
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and was promoted to managerial positions, I had less
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and less time to do research, which I especially enjoyed.
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And so, having spent several years visiting the Bank
8:32
of Greece in the late 1990s,
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I accepted an offer from the bank to become a director
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at the bank where I was able to continue
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to do research while at the same time continued to do
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policy relevant work in such areas
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as the Euro sovereign debt crisis,
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and of course, monetary policy.
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Among the, that I've had at the bank in 2002,
8:58
the then governor appointed me as his
9:02
then accompanying person,
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but it's essentially the same
9:05
as his alternate on the governing council of the ECB.
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Now, the way this works, each governor at the ECB is allowed
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to bring one person with them into the meetings to be able
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to consult with the alternate takes the place
9:20
of the governor should the governor not be able
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to attend the meetings.
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Since that appointment, success
9:28
of governors at the Bank of Greece have reappointed me
9:32
as their alternate on the governing council.
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So having served on the governing council
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as an alternate since 2002, continuously,
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I'm the longest serving member of the governing council.
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During the past 10
9:48
or 12 years, I've had the privilege
9:50
to be visiting such institutions
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of Chicago on several occasions,
9:56
Drexel Duke,
9:57
and of course, the Hoover Institution at the invitation
10:02
of John Taylor.
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These academic associations have been instrumental in,
10:08
in helping me revisit the fierce debates over Milton
10:12
Friedman's Monetarism in the 1970s when I was a
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graduate student.
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They become the, they became like a thread
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of my research over the years,
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and it's the reason that I was able to write the book,
10:27
the Monetarists.
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- That, that's terrific. I wanna talk about the
10:30
mantras in a moment.
10:33
I also just wanna talk about a little bit about your career.
10:35
I mean, you're there at the dawn of, of,
10:40
of the Euro.
10:41
You, you've seen the, you know, the,
10:45
the European debt crisis in the early 2010s play out.
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What do you think we've learned in the past 25 years
10:54
since the advent of the Euro about the nature of
10:59
monetary unions without a fiscal union?
11:03
And and what do you think
11:07
the Euro will look like in the future?
11:09
I mean, do, do you see there being more fiscal
11:11
integration in, in the future?
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Obviously there's a lot that's changing right now in Europe,
11:15
in, in 2025 with Greece military spending and, and,
11:20
and, and more debt being issued, for example, by Germany
11:24
to, to partly fund this.
11:25
But I'm just curious, having been there at the beginning,
11:30
having seen some of its, and,
11:32
and been part of managing some of its greatest challenges.
11:36
Notably, you know, Greece,
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the SAR debt crisis in the early 2010s, and,
11:40
and it's, you know, been put, put in a better trajectory.
11:43
I mean, at the time there were a lot of questions
11:45
around whether Greece would, would leave the Euro
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or other countries would leave the Euro.
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That that hasn't happened yet.
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But there are many critics, I guess you say that, that a
11:55
a monetary union without a fiscal union is,
11:59
isn't sustainable in the long run,
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and that encourages free riding
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on, on the part of some countries.
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I'm just curious what, what you've learned and,
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and what you think economists have learned about that,
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the nature of, of this monetary union.
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- Well, I don't think that economists have learned a great
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deal about the need of a fiscal union.
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They ne they knew that
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before the Euro system started, they thought
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that the monetary con union could survive in the absence
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of a fiscal union,
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because they thought that the markets would,
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would impose discipline on countries
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that were spending extravagantly.
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But it didn't happen that way.
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Between 2005
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and 2009,
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Greek government debt doubled from about a hundred external
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debt from about 150 billion to 300 billion.
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And yet, from much of that time,
13:00
Greek interest rates were very low.
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The markets thought that if Greece got into trouble,
13:08
the Euro area would
13:12
bail increase.
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It wouldn't let a crisis happen.
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And so, while the Greek debt was building doubling,
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as I mentioned, in the five years, 2005 to 2009,
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especially during the early years, 2005
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and six Greek interest rates were not ma very much different
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from German interest rates.
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So one lesson that, that we've learned from the Euro is
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that countries have to maintain their, their fiscal,
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fiscal host is in order.
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We've also learned that we need
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to have a stronger fiscal mechanism
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inherently in Europe, in case countries do get in trouble,
14:02
where that mechanism can
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support the countries may perhaps impose policies on
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the countries to take should a crisis erupt.
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Now, when the crisis erupted in Greece in late 2009,
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the the Euro system had
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to rely on the IMF and the European Union.
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And it was a little bit unorthodox
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because having been at the IMF when the country got into
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trouble and the IMF visited the country to see
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what policies would be needed, the IMF would sit on one side
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of the table and the finance ministry
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and the central banks from the other country would sit
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on the other side When a Greek crisis erupted.
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We had the Bank of Greece
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and the finance ministry on one side.
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On the other side, we had the IMF,
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we had the European Commission,
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and we had the Central bank of the Euro area, the ECB.
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So in a way, there was an advi adv.
15:19
There was a clash between
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our central bank, which was really the ECB
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and the policies that were being formulated to deal
15:30
with the Greek crisis.
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In retrospect, the crisis that were taken in Greece
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were very, very contractionary.
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And it was very difficult for Greece
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to emerge from the crisis.
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We needed support from the
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rest of the union, but we didn't get the support.
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And so what happened, the markets of course,
15:58
perceived this
15:59
and they, they perceived
16:00
that there's some other countries on the line that could
16:04
possibly erupt into crisis such as Portugal,
16:10
Ireland, and even Spain, which required a program
16:15
for its baking system.
16:17
So one lesson that we learned is that we need
16:21
to have an internal mechanism within the Euro area.
16:25
So we don't need to rely on the IMF. Sure. The crisis aup.
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Another thing that we learned was,
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and now as I mentioned at the beginning of the Euro area,
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people understood that
16:40
we weren't a complete fiscal union.
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And that was going to create a problem.
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But one thing we didn't anticipate,
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nobody essentially anticipated maybe one
16:51
or two people in peripheral journals.
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'cause they came across one, one person who
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argued this in the early 1990s.
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But nobody paid attention to him.
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We learned that we needed a banking union.
17:06
We need, we learned that if Greek banks got in trouble,
17:11
the markets weren't going to believe
17:13
that the Greek government, a small country, is going to able
17:18
to take care of the banks.
17:20
Now, we had a situation in the us I think it was in
17:25
2002, as Silicon Valley Bank got in trouble.
17:29
You remember that. And one
17:32
or two other banks followed Sue
17:34
and those banks were going under,
17:36
and it started looking like it could become a full
17:39
scale crisis.
17:41
And so the ma the stock market,
17:43
the financial markets began to tank.
17:46
And then one day within a, within of the crisis,
17:50
having erupted Secretary of State, secretary of Treasury,
17:54
Janet Yellen said all deposits will be covered in full the
17:59
next day or around the same time.
18:02
Jerome Powell said the same thing.
18:05
Was it Jerome Powell who was, yeah,
18:07
Jerome Powell said the same thing,
18:09
we will bail out everybody.
18:12
End of crisis. We did, we don't have that in the Euro zone.
18:16
If the Greek government said in 2012 13,
18:21
we'll take care of the Greek banks crisis over,
18:25
where were they gonna get the resources?
18:27
They didn't have it. So we also need a banking union.
18:31
We also need a capital markets union to further integrate
18:36
countries, you know, across countries.
18:39
So there, there are certain, certain priorities
18:43
or prerequisites for a well-functioning monetary union
18:48
that we started to build.
18:51
We're in the process of building,
18:52
but we're not all the way there yet.
18:54
We've learned lessons, we're applying it,
18:57
but it's a slow lesson to come to a complete monetary union.
19:02
And that's one reason why, despite the fact
19:06
that the dollar has been under siege
19:09
as an international currency over the last year,
19:13
there's really no rival to come up in
19:17
and take the dollar's place.
19:18
It sh you know, it's Chinese wand.
19:20
The financial markets are very opaque.
19:23
Investors don't want to go with the Chinese, want
19:27
the Euro area.
19:29
We have tried to make the, the euro
19:31
and international currency,
19:33
but we still lack, the mechanisms are just underlined
19:37
to make the Euro such a
19:41
valid international currency.
19:44
We're way away, some way away from doing that.
19:49
We're working on it, it's moving in that direction.
19:52
But things are slow.
19:55
My governor, by the way, had had a,
19:59
a guest column in the Economist about two months ago,
20:03
John Y. Stone, which was
20:06
pointed out all those issues in a very nice way.
20:11
- Perfect. So I, I wanna get into your book,
20:15
the Monarch First, which you published in 2023
20:18
with the University of Chicago Press.
20:20
And this, this book essentially argues that
20:25
on the topic of Monoism, which I think is, you know,
20:27
broadly speaking, the, the doctrine that
20:31
inflation is always in everywhere, a monetary phenomenon,
20:35
and that mv equals pq.
20:38
It's, you know, the quantity, the theory of exchange
20:42
or the quantity theory of money that, that sort of front
20:47
and center for, for monetary policy,
20:48
that monetary policy aggregates matter.
20:52
You know, some people, some monitors might argue
20:55
or might we're certainly arguing in the 1980s
20:58
that monetary aggregates were a tool,
21:01
a monetary policy tool that should be used.
21:02
I think c of should a bit away from that,
21:05
obviously embracing interest rates.
21:07
But this was an idea that was largely promoted
21:09
by Milton Friedman
21:11
and Anna Schwartz in, I think the public Mind.
21:14
You know, there was a, a big book that,
21:17
that they released a monetary,
21:19
a monetary history in the United States.
21:21
Very famous book that that tries to make the case
21:23
that the contraction
21:24
of the money supply caused the Great Depression.
21:28
And then this, this was published in, in the 1960s
21:30
and a a, a very popular book and,
21:32
and arguably one of Friedman's most influential books.
21:35
Now, your book, the Monetarists sort
21:39
of gets into this, you know, the intellectual history
21:43
of Monetarism and argues that there was a tradition
21:46
of monetarism before Milton Friedman in Anna Schwartz,
21:51
largely at the University of Chicago.
21:54
And I'm just curious, how, how did you get into, you know,
21:57
the debates about Chicago Monetarism,
21:59
and could you explain to us, you know, who some
22:02
of these earlier Chicago interests were and,
22:06
and how they might have influenced Friedman later?
22:10
- Well, how did I get into the debate?
22:12
- Yeah, I'm just curious, how, how did this,
22:15
how did getting into this intellectual history begin for you
22:19
and, and how did you sort of discover that, that the,
22:24
the story of Chicago Monetarism begins well
22:27
before Milton Friedman?
22:29
- Well, when I was doing my dissertation in the middle
22:33
of 1970s, there was a heated controversy underway
22:37
between Milton Friedman on one side
22:40
and just about everybody else on the other side.
22:45
Freeman had claimed that his
22:50
moist views were the,
22:53
well Friedman, let me backtrack.
22:55
He had been a, a graduate student
22:58
and a research assistant at the University
23:00
of Chicago when the first had of, of the 1930s.
23:04
And when Monetarism became, began
23:08
traction in the, in the late 1950s
23:11
and early 1960s, he had argued that his
23:15
moist views derived from an, an important,
23:18
what he called oral quantity theory tradition at Chicago.
23:23
That tradition, he argued different from other versions,
23:27
what he called rigid versions
23:28
of the quantity theory utilized at other institutions
23:32
because unlike those other versions, he argued
23:35
that the Chicago version was policy relevant.
23:39
And this policy relevancy argued was able to
23:46
lead the Chicago quantity theorist less vulnerable
23:49
to the Kenan Revolution
23:51
and quantity theorists at other institutions.
23:54
He singled out some of his mentors
23:57
as having developed the Chicago quantity theory.
23:59
I'll mention four of them.
24:00
Henry Simons, Lloyd Minz, Frank Knight and Jacob Weiner.
24:05
Now with the rise of Monetarism
24:07
as a counter-revolutionary force
24:10
in the late 1960s,
24:14
Friedman's claim
24:16
of a Chicago monetary tradition came under fire.
24:19
The first to take game at Friedman was Dawn Patinkin,
24:24
who had undertaken his graduate studies
24:27
and undergraduate studies at Chicago in the 1930s
24:31
and 1940s in 1969,
24:34
writing in the inaugural issue of the Journal
24:37
of Money Credit and Banking.
24:39
Patinkin presented evidence,
24:42
doctrinal evidence from the writings
24:44
and teachings of his teachers at Chicago showing
24:48
that Friedman's theoretical framework had nothing to do with
24:51
what had been written about a taught at Chicago in the late
24:55
19, in the 1920s and 1930s.
24:58
Because partic showed
25:00
that the earlier Chicagoans used Irving fishers,
25:03
as you mentioned, velocity based equation
25:05
of exchange money times velocity equals prices
25:08
times transactions.
25:10
Whereas Friedman used a money demand approach
25:15
to his monetary analysis.
25:19
And so the issue arrived, arise
25:23
that since the two theories were so different,
25:27
how could they be related?
25:29
Well enter into the picture Harry Johnson,
25:33
who was Friedman Chicago colleague, not necessarily
25:37
- Famous international economist.
25:38
- No, huh. - A a very famous international economist. They
25:42
- Also, his Chicago colleague,
25:43
not necessarily his Chicago friend, who used the
25:48
occasion of the 1970 richer t Lee lecture in
25:53
front of the American Economic Association to argue that,
26:00
well, he made the argument that if in order
26:03
to create a successful counter revolution
26:07
to the Keynesian Revolution, Friedman had
26:10
to establish some plausible linkage with Pres in Orthodox
26:15
with what came before the Kings in revolution,
26:19
Friedman solution and Johnson's words was to,
26:24
and this is pretty brutal,
26:25
to invent a Chicago monetary tradition
26:29
and Johnson's words, Friedman had engaged in scholarly
26:32
cannery and the debate
26:36
with partaken on this issue in the journal political economy
26:40
in 1972, Friedman admitted
26:43
that his monetary theory had been influenced
26:47
by Keynesian theory,
26:49
but he also continued to insist
26:51
that his overall monetary economics was, what he continued
26:56
to argue was a direct outgrowth
26:59
of a unique Chicago quantity theory tradition.
27:03
He was incensed with both Patinkin and Johnson.
27:07
He thought that Patinkin had mischaracterized the Chicago
27:10
monetary tradition
27:12
and by doing so, had damaged his treatments,
27:15
professional reputation and private correspondence.
27:18
He accused Johnson of having committed libel.
27:22
And so while I was a graduate student,
27:25
I had followed the debate closely
27:28
and I decided to write my dissertation
27:32
on the origins,
27:33
the doctrinal historical origins of Monetarism.
27:37
I wrote five essays, four had been accepted in journals.
27:41
The fifth one dealt directly
27:44
with the Freedman Patinkin Exchange in the Journal
27:47
of Political Economy.
27:49
I wrote a paper in which I showed that there were
27:53
Chicago economists in the late twenties, early thirties,
27:57
who were in favor of policy rules like Freeman.
28:01
And not only that, they advocated a Freeman rule
28:05
before Freedman did.
28:06
They advocated that the money supply should grow by three
28:09
to 5% annually.
28:11
- Hmm. - I, I submitted that paper to the Journal
28:15
of Political Economy.
28:17
The editor wrote back that he,
28:20
he sent the paper in his words
28:22
to a learn scholar in the area.
28:26
The Learn Scholar wrote a lengthy rejection letter.
28:30
Now, at that time in the 1970s, one
28:34
of the most popular graduate textbooks was Patinkin
28:38
1965.
28:39
Money, interest in prices.
28:41
I had studied it, read it many times,
28:45
and studied it very hard.
28:48
And I knew Patinkin writing style.
28:50
I had no doubt that Patinkin was the guy
28:53
who rejected my le my paper.
28:56
So I then submitted the paper to the Journal
28:58
of Money Credit and Banking.
29:00
The editor wrote back that he sent the paper
29:03
to an associate editor.
29:04
The associate editor liked the paper,
29:06
but he thought that the only two people
29:08
that were really qualified to judge it with Don Patinkin
29:12
and Milton Fried, the editor wrote, wrote to me that he
29:17
asked Patinkin and Friedman to referee the paper.
29:21
Patinkin wrote back that he already refereed
29:25
and rejected the paper confirming my suspicion.
29:29
Patin Friedman had not responded.
29:32
The editor said, I leave it up to you
29:35
to see if you can get Freeman to respond to your paper.
29:38
I wrote to Freeman and told him what the circumstances were.
29:43
He wrote a lengthy letter to the editor
29:46
of the James CB telling him
29:47
that the paper should be accepted.
29:49
It was, it was published in 1977
29:53
and there began a lengthy correspondence between me
29:57
and Friedman that lasted until a couple of months
30:00
before Freedman passed away.
30:02
That how is, that's how I got involved in
30:06
the debate about the Chicago monetary tradition.
30:10
- That's fascinating.
30:12
You know, all these characters were involved in,
30:15
and you famously, a lot of these, you know,
30:18
icon class economists would, would clash with each other.
30:20
And I, I guess it's, you know, one thing that I guess some,
30:24
some don't realize is that, you know,
30:25
I guess the Chicago school isn't necessarily like a
30:28
monolithic school of economists.
30:33
And, and also, you know, it, it's, it is very fascinating
30:36
that your pointing out this, this fact that, you know, the,
30:41
the idea for like a K percent money growth rule sort
30:44
of proceeded Freeman.
30:46
I, I think, you know, the equation
30:47
of exchange you mv equals pq goes back
30:50
to I think David Hume maybe even earlier.
30:54
So, you know, I, I think at some level there, there's sort
30:57
of different, even different schools
30:59
of monetarism in the sense that like, you know, today there,
31:02
there's maybe some people who argue
31:04
that I think increasingly following the early 2020s
31:07
inflation, that which also saw the money supply
31:10
or measures of money supply like M two grow pretty rapidly
31:15
during that same time that we should look back to,
31:19
to monetary aggregates,
31:21
which previously had fallen out of favor.
31:23
I guess my, my question,
31:25
- Can I just, lemme say one thing.
31:27
Jon Monetarism is just not money.
31:31
Money was the vehicle.
31:34
The treatment thought was important
31:37
for judging monetary policy,
31:40
but the lasting contribution of Monetarism was
31:44
to bring back
31:47
or highlight the importance
31:50
of monetary policy itself.
31:54
In the 1940s, fifties, sixties, even the first half
31:58
of the seventies, monetary policy was considered a
32:02
secondary tool.
32:03
It took a backseat to fiscal policy.
32:07
What Freedman and Monetarism did, didn't bring back money.
32:11
That was their way of saying that money was,
32:14
that monetary policy was important,
32:18
but what really mattered was monetary policy,
32:22
whether with money or with interest rates.
32:26
That monetary policy was one
32:28
of the most important tools in the macro economy in the
32:33
1940s, fifties and sixties.
32:35
It was downgraded, it had secondary status.
32:39
So the Monetarist revolution, when some people say,
32:42
well, where's money?
32:44
It doesn't matter. What matters is, look
32:48
where monetary policy is.
32:49
It's right there on top.
32:52
It's the, it's the primary tool
32:55
for managing the macro economy.
32:58
When mon, when the Federal Reserve
33:01
or the European Central Bank make a decision on interest
33:04
rates, everybody's following, everybody reacts.
33:09
And depending upon the decisions,
33:11
the reactions could be benign
33:13
or they can be, they can be very volatile.
33:17
But monetary policy is right there at the top
33:21
of the policy list of the policy options
33:25
that we have in the economy.
33:27
And that absolutely is due to Monetarism.
33:30
- Absolutely. And it, it's worth noting that, you know,
33:35
thinking back to the 1970s, I think, I think there,
33:38
there was a, an idea that, you know, inflation,
33:41
some people argued that, you know,
33:42
price controls were the right answer to fighting inflation.
33:45
You know, this was, I think,
33:46
apparent in the Nixon administration,
33:50
- And that was Arthur Burns.
33:51
That was Arthur Burns, who, when he was appointed chair
33:54
of the, of the Federal Reserve, Friedman was ecstatic
33:58
because he thought that Burns was somebody
34:00
who understood monetary policy,
34:03
but no burns relied, as you said, on price
34:06
and wage controls.
34:08
He let monetary policy run loose.
34:11
And we had two episodes, one in the mid 1970s
34:15
and one in the mid 1970s
34:18
where inflation reached double digit levels.
34:21
And it was Paul Volcker who came to on the scene,
34:26
and he understood more as well as anybody else,
34:30
the importance of endogenous expectations.
34:34
He understood that markets had to re had to
34:39
have fi have belief in
34:42
that the Federal Reserve is doing the right thing.
34:47
Volcker's approach was to apply cold Turkey,
34:51
raise interest rates to close to 20%,
34:54
let the economy go into recession.
34:57
It had to prove something.
34:59
It had to prove that the Federal Reserve was
35:02
what we now call hard nosed.
35:06
It had to credibility.
35:08
The Fed gained credibility under Volcker
35:11
and it maintained credibility under the success
35:14
of Fed Shares like Alan Greenspan
35:17
and Bernanke and Yellen.
35:19
They all understood
35:21
that credibility is very, very important.
35:24
And when we had the rise
35:25
of inflation in the early two twenties,
35:30
both the ECB and the,
35:33
and the Fed may have been a little slow react,
35:37
especially the Fed,
35:39
but the Fed had credibility,
35:41
price expectations never took off
35:44
because the markets had believed, believed
35:47
that the Fed would take the necessary action
35:50
to bring inflation back down.
35:52
And it did. And that's all the legacy of the
35:56
what happened in the late 1970s,
35:59
early eighties from Volcker.
36:02
- You know, I also tend to think that there's two schools of
36:05
of Monetarism
36:08
and you know, I think there, there's various sub schools
36:10
of monetarism in the sense that there's, I'd say a group
36:14
of maybe passive monitors,
36:15
think Milton Friedman K percent rule that argues, you know,
36:19
that the Fed should just be run like a computer,
36:22
just grow the money supplied by 2% every year.
36:25
We don't need FOMC meetings
36:26
or we don't need monetary policy council committee meetings,
36:31
and that the central banks sole jobs should be just to
36:35
ha you know, maintain price stability
36:40
and do so with a constant money percent growth rule.
36:44
And, and that's it.
36:45
And I, I would say there's maybe another school of people
36:49
who argue that, you know, yes, MV equals PQ matters,
36:54
but you know, per Freeman's observation, you know,
36:57
monetary policy is, is not neutral in the short run in
37:02
that it can impact real economic variables
37:06
and that the Fed
37:09
or central banks should intervene during periods
37:12
of recession, should provide monetary accommodation
37:17
to improve real economic variables
37:21
during recessionary times and,
37:24
and should also contract the money supply when,
37:26
when the economy's, you know, so-called overheating
37:29
and you, you get big spurts of, of inflation.
37:33
I'm curious how you've seen that play out,
37:37
I guess in in your, in your research of, of the mantras
37:42
of how people think,
37:45
how different mantras have thought
37:48
that money should be used in monetary policy.
37:52
- Well, I think Friedman wouldn't always say that
37:58
a monetary role should be used all the time
38:03
when we were in the Great Depression.
38:05
He would, he would not have advocated a monetary rule.
38:09
He thought that this was a time
38:11
to employ activist monetary policy,
38:13
expansionary monetary policy.
38:15
What he does argue,
38:17
however, is that by following a rule, we're less likely
38:21
to have episodes as we did during a great Depression,
38:26
that the, that the central banks
38:32
sometimes do make mistakes.
38:36
Sometimes they are under political pressures.
38:40
We see that today, don't we?
38:42
That they follow, that they make policy mistakes because it,
38:46
because of the political pressures and for other reasons.
38:49
And in order to keep the economy on a more even keel,
38:54
you follow a policy rule.
38:57
I think the same thing applies to a Taylor rule.
39:00
The Taylor rule is, is an activist rule
39:03
because it involves the economy responding
39:07
to developments in the economy,
39:09
whereas Friedman's rule does not,
39:11
Friedman's rule is always three to 5% monetary growth.
39:15
But the, a advantage
39:18
of a monetary rule is
39:20
that it prevents policy mistakes from occurring
39:24
and it appre, it prevents political interference
39:28
with monetary policy.
39:30
The debate continues.
39:33
It's hard to take a position on one side
39:35
or the other, especially since I'm a central banker.
39:39
And I don't want to, you know, I, I don't want
39:43
to prejudge this issue as a central banker.
39:47
- I I wanna ask you about the current state of,
39:50
of Monetarism
39:52
and how, how it kind of fell out of favor
39:56
in the sense that how monetarism in, in part has fallen out
40:01
of favor at central banks
40:02
and in monetary economics in, in, in academia.
40:05
So, you know how I think of, I guess the sort
40:08
of rough history of, of, of these things is you,
40:11
you had the sort of old keynesians
40:15
and then around the same time in the 1970s you sort
40:18
of had both in, in the sixties
40:21
and seventies, you, you had both monetarists emerging
40:25
like Milton Friedman
40:26
and those that were highlighting MV equals pq,
40:29
which is I think very popular in the, the public,
40:34
in in the public in general.
40:36
MV equals PQ is I think a pretty easy thing to communicate.
40:39
And then, you know, the, for a brief period of time,
40:41
the Federal Reserve was targeting monetary policy aggregates
40:46
in the 1980s.
40:48
Then it sort of realized
40:49
that money demand wasn't quite predictable
40:52
and it kind of abandoned that.
40:53
And then it moved toward targeting interest rates.
40:56
So sort of in parallel
40:57
what was going on at the same time in the seventies, you had
41:01
the rise of the rational expectations revolution
41:04
that influenced macro economists, you know, thinking,
41:07
you know, Prescott sergeant and,
41:11
and many others who were very influential.
41:14
And, and the challenge there though was that, you know,
41:16
policy monetary policy didn't really matter.
41:19
So you also had folks, you know, the,
41:21
the New King unions kind of emerged around
41:22
that time as well.
41:24
Folks like John Taylor, er, Alvo and, and
41:28
and later Mike Woodford and,
41:30
and Rich Claire and many others.
41:33
George Galley who argued that, well if you have some sort
41:36
of frictions, whether it's, you know, seeking prices
41:39
or seeking wages or
41:40
or seeking information that,
41:44
that you could,
41:46
monetary policy could produce real economic effects,
41:49
you would get monetary, non neutrality.
41:52
And, and, and not only that,
41:54
but you also have interest rates as being sort of the key
41:58
monetary policy instrument in, in that type of modeling.
42:02
And so in the early nineties there was, I think this,
42:06
you know, pretty quick shift along with
42:10
when inflation targeting was introduced to sort
42:14
of put interest rates as, as sort
42:18
of the key policy instrument of, of interest,
42:21
no longer money, no longer, you know,
42:24
thinking about the money supply.
42:26
And then we, you know, then central bankers got very focused
42:29
on, on targeting inflation,
42:32
2% in particular largely to 2% inflation targets
42:37
and use interest rates to, to achieve that
42:43
and, and not necessarily target some sort of
42:46
monetary aggregate growth.
42:48
And, and I think we've kind of been in that regime
42:51
for the past, say 35 years
42:54
or so, where, you know, economists
42:56
who are writing macroeconomic models write down these three
43:00
equation DSGE models, you know, you came DSGE models
43:05
and you know, there's, there's a Taylor rule in there,
43:09
a monetary policy rule.
43:11
There's a, a Phillips curve, there's an IS equation,
43:15
or you think it was like an aggregate demand, kind
43:17
of like a, a, a equation investment savings curve.
43:19
And, and, and, and that's it. Money is nowhere to be found.
43:24
So I'm, I'm just curious, there's some people who point
43:27
to monetary aggregates as being sort of a useful indicator,
43:31
maybe a predictor of inflation and,
43:33
and many people on Wall Street, I think still use money and,
43:37
and talk about monitors all the time.
43:38
But largely when, when I hear about Tism today,
43:42
it's not in academic seminars
43:44
or from central banks, it's largely from Wall Street
43:47
or the a few monetary congress
43:51
and few mantras who are still out there.
43:54
I'm curious, you know, what happened in your mind
43:57
and is, is money making in any way?
44:00
- I I think you're gonna it pretty well,
44:02
pretty right when you made the analysis about
44:06
monetary aggregates were unstable in the 1980s
44:10
and 1990s,
44:11
and so central banks stopped putting an emphasis on,
44:16
on growth of monetary aggregates.
44:18
When the ECB started in 1999, it,
44:23
its main pillar for monetary policy was M three growth
44:28
with that lasted for about four or five or six years.
44:31
And it, it became evident that
44:35
focusing on monetary growth
44:38
or monetary policy was not the right way to go,
44:41
that the aggregates were unstable
44:44
and could not be relied on.
44:46
And so just like the other central banks,
44:49
the ECB started focusing on interest rates.
44:53
I think this is just taking into account
44:57
reality now in the year two 20,
45:03
when just
45:04
before inflation started taking off,
45:06
M three in the US jumped by,
45:09
I think it was 35% in one year.
45:12
We had a very, very large, perhaps not
45:17
as large rise in M two in, in the Euro zone.
45:22
And sure enough, a year
45:23
or two later we had big surges of inflation.
45:27
Now you can argue whether those surges were due to the,
45:30
to the monetary growth itself,
45:32
to the financing the fiscal deficits, especially in the US
45:37
or to the supply side sharks
45:39
that came from COVID in the Russian invasion of the Ukraine.
45:43
But in any case, it, it
45:44
provided some a, a bit of a rebound for the view
45:49
that money is under monism matters.
45:53
But it was just a,
45:56
it was not a long lasting
45:59
to make a long lasting impression on monetary
46:03
policy makers.
46:05
But what is important is what I came, what I referred
46:09
to earlier is that, alright, we got inflation up
46:14
as we did in 2223.
46:16
How do we bring it down?
46:19
We, we bring it down by wage price controls.
46:23
Nobody ever talks about wage price controls anymore.
46:26
We know they're a failure from the 1970s.
46:29
We brought them down by high interest rates,
46:32
monetary policy.
46:34
If you didn't know the debates in the
46:38
1950s
46:39
and 1960s, you would've never had suspected
46:43
that monetary policy would become the chief instrument
46:47
for dealing with shocks on the inflation front.
46:51
So again,
46:52
a lasting contribution from Milton Friedman was the
46:57
emphasis that he put
46:59
and other monetarists that they put on, on
47:04
monetary policy per se, whether pursued through,
47:09
by having the main instrument, the money supply
47:12
or the main instrument, the interest rate.
47:15
And don't forget when we had quantitative easing
47:20
in, in the Eurozone in 2014,
47:24
2015, that was essentially increasing the money supply,
47:29
try and get the interest rate up
47:31
because we reached the lower bound of interest rates.
47:34
We even had negative interest rates in the Eurozone,
47:38
but they weren't being effective in bringing inflation up.
47:41
So we relied on quantitative easing, which meant
47:47
buying large purchases of, of bonds
47:51
and increasing the money supply.
47:53
So I would not go
47:58
so far to say that monetarism
48:01
as a emphasis on money is something that is no longer
48:07
being discussed.
48:08
It has been used, it has shown to be
48:13
valid in the year 2020 years, 2020
48:16
and 21 in terms of bringing inflation up.
48:21
And monetary policy itself has been the main tool
48:25
for bringing inflation under control.
48:30
- Well, it's, - And one other thing, let me let, if I,
48:34
if I may, one of the tenets of monism
48:39
or one of, yeah, I would call it a tenant
48:42
of freedman's monism, was the importance
48:46
of flexible exchange rates.
48:49
When Friedman first wrote his article on the
48:53
desirability of flexible exchange rates in 1953,
48:58
he predicted the demise
49:00
of the Bretton Woods adjustable PEG system.
49:03
He said it couldn't last.
49:04
He said we would move to a system
49:07
of flexible exchange rates sooner
49:09
or later we would get there.
49:11
It was only system that would, that would be viable
49:15
and sustainable.
49:16
He was right in 1973, the world will move to a system
49:20
of flexible exchange rates that became part of Monetarism.
49:25
And so, you know, when we say monetarism,
49:30
it's just not money, it's other things as well.
49:33
It's rules versus discretion.
49:35
It doesn't have to be a three to 5% monetary rule.
49:39
You know, we now think that a Taylor rule works better,
49:43
but it's rules versus discretion.
49:46
So there are a number of aspects to Monetarism
49:50
that have survived to this day,
49:53
even though the emphasis on the quantity
49:56
of money is not the, the main element that has survived.
50:03
- Absolutely. It's, it's interesting too.
50:08
You know, you think about,
50:09
I know we're talking about luxury advanced economies
50:12
and times where I think inflation's been fairly stable.
50:15
I think, you know, even if setting aside the early 2020s,
50:20
you know, inflation jumping to nearly 10%,
50:24
- Over 10% in Europe,
50:26
- Over 10 in Europe, but in the US just under 10%.
50:29
But you know, I think about, you know, all these episodes
50:32
of hyperinflation
50:34
and you the thinking to, you know,
50:38
Zimbabwe thinking to Venezuela
50:42
and thinking to all these episodes where,
50:47
you know, there's been massive amounts of inflation.
50:51
You can see, you know, there's obviously in all these cases
50:55
there's a massive surge in the money supply
50:58
and you know, there's Thomas Sergeant's very famous paper,
51:03
the ends of of four big hyperinflations, I think is the,
51:06
the title of it, the, the ends of four big Inflations.
51:08
And it, this, that particular looks at all the interwar
51:14
European countries, Germany, you know, why Germany, Austria,
51:18
Hungary, that, that have these massive inflations,
51:23
you know, they were trying to essentially inflate away
51:26
their, their, their war related debts.
51:31
And it's, it's interesting how just in all these cases,
51:35
money is there
51:37
and it's, it, it's, it's expanding enormously.
51:40
And so, you know, all these regressions that I like
51:45
to show of, you know,
51:47
monetary policy growth versus inflation.
51:52
When you plot all these, all this cross country data, you,
51:56
you, you see a pretty clear relationship that you know,
52:00
when, when you have massive inflations,
52:02
there's always a a money story there.
52:04
Now when we get into, you know, low inflation environments,
52:08
like in advanced economies, you know, it, it's less clear
52:12
that there's, you know, a a such a direct relationship
52:15
between money and prices at, at,
52:17
at lower levels of inflation.
52:18
But a big, you know,
52:20
with big hyperinflations money is al always
52:23
growing enormously.
52:24
So I think, you know, freedman's maxim that, you know,
52:27
inflation is always in everywhere.
52:28
Monetary phenomenon bears a lot of truth.
52:32
I I think, you know, especially with larger inflations,
52:34
especially with looking at the cross country
52:38
and historical evidence.
52:39
So I think, I think there's a, a very good, i I think monism
52:43
itself for this idea that money is behind inflation,
52:46
certainly I, I think holds up well,
52:49
especially when we look at larger
52:51
inflations. George, I, I really, I
52:54
- Wanna, and also it also holds up at five
52:57
to 10% inflation rates too.
53:01
There have been studies done that show that
53:05
the money's a predominant cause of inflations in the levels
53:10
between, as I mentioned, five and 10%.
53:13
It's only at low low frequencies of inflation, one,
53:18
two, 3%.
53:20
That money is not, not an important variable these days,
53:25
but at the medium frequencies
53:27
and the very high frequencies that you mentioned,
53:30
it's always a predominant cause of inflation.
53:33
- Absolutely. - So one reason why perhaps
53:36
less emphasis is in placed on money over the past
53:40
25, 30 years is because we've had low inflation rates,
53:44
but as we know, we had a high inflation rate in 22, 23.
53:48
And we also know that that was preceded by very high rates
53:51
of money growth both in the US in the Euro zone.
53:56
- Absolutely. Well,
53:58
well it's been a fascinating conversation George,
54:00
really want to thank you for coming on
54:02
and for all your excellent scholarly work on, on monetarism
54:06
and monetary economics, so us all, your public service.
54:08
It's a real honor to have you on.
54:10
- It's been a pleasure and an honor,
54:12
and I thank you so much for having invited me.
54:16
- This is the Capitalism and Freedom
54:17
of the 21st Century podcast, an official podcast
54:20
of the Hoover Institution Economic Policy Working Group,
54:22
where you talk about economics, markets, and public policy.
54:24
I'm Jon Hartley, your host. Thanks so much for joining us.