Center for the History of Political Economy Summer School, June 2014 1

History of Modern MacroeconomicsLecture 1. The Background to Modern Macroeconomics (before the 1930s)

Kevin D. HooverDepartment of EconomicsDepartment of Philosophy

Center for the History of Political EconomyDuke University

Center for the History of Political Economy Summer School, June

2014 2

Macroeconomic Issues are Old

Sir William Petty (1623-1687)

Center for the History of Political Economy Summer School, June

2014 3

The Distinction Between Macroeconomics and

Microeconomics is Recent Ragnar Frisch in Cassel Festschrift (1933): microdynamics vs. macrodynamics

Frisch in mimeographed lectures (1933/34): mikroøkonomiske vs. macroøkonomiske

Jan Tinbergen in Revue de l'Institut International de Statistique/Review of the International Statistical Institute (1936): macroéconomique

J.M. Fleming in Economica (1938): macro-economic

Ultimate source: Frisch; diffused through early meetings of the Econometric Society

Ragnar Frisch (1895-1973), Norwegian economist, winner of

the first Nobel Prize in Economics

Center for the History of Political Economy Summer School, June

2014 4

The Slow Diffusion of the Micro/Macro Distinction

Figure 1The Diffusion of "Microeconomics" and "Macroeconomics"

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"Macroeconomics"

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Center for the History of Political Economy Summer School, June

2014 5

Macroeconomics Before 1930: Main Concerns

1. Monetary Theory

2. Theory of the Trade Cycle (later Business Cycle)

Center for the History of Political Economy Summer School, June

2014 6

David Hume and Classical Monetary Theory

International Quantity Theory of Money:

Principal Doctrines The Classical Dichotomy Domestic Quantity

Theory of Money (short run and long run)

The International Specie-Flow Mechanism

The Independence of Money and Finance

David Hume (1711-1776)

Center for the History of Political Economy Summer School, June

2014 7

The Classical Dichotomy: Hume on the Nature of Money

“[Money] is none of the wheels of trade: it is the oil which renders the motion of the wheels more smooth and easy.”

David Hume “Of Money”

Center for the History of Political Economy Summer School, June

2014 8

Domestic Quantity Theory of Money: Hume on the Neutrality of Money

Suppose that four-fifths of all the money in GREAT BRITAIN to be annihilated in one night, and the nation reduced to the same condition, with regard to specie, as in the reigns of the HARRYS AND EDWARDS, what would be the consequence? Must not the price of all labour and commodities sink in proportion, and every thing be sold as cheap as they were in those ages?

David Hume “On the Balance of Trade”

Center for the History of Political Economy Summer School, June

2014 9

Domestic Quantity Theory of Money:

Hume on the Short and Long Run Effects of Money. . . though the high price of commodities be a necessary

consequence of the encrease in gold and silver, yet it follows not immediately upon the encrease; but some time is required before money circulates through the whole state, and makes its effect be felt on all ranks of people. At first, no alteration is perceived; by degrees the price rises, first one commodity, then of another; till the whole at last reaches a just proportion with the new quantity of specie which is in the kingdom. . . it is only in this interval or intermediate situation, between the acquisition of money and rise of prices, that the encreasing quantity of gold and silver is favorable to industry. . . It is easy to trace the money in its progress through the whole commonwealth; where we shall find, that it must first quicken the diligence of every individual, before it encrease the price of labor.

David Hume “Of Money”

Center for the History of Political Economy Summer School, June

2014 10

The International Specie-Flow Mechanism

Spain imports gold (pSpain / pEngland) ↑ demand

for English goods & gold flows into England

pSpain↓ & pEngland ↑ until trade balanced and gold

flow stops

The gold of Spain becomes the gold of England;

the real wealth of Spain or England little changed

Center for the History of Political Economy Summer School, June

2014 11

Independence of Money and Finance

Center for the History of Political Economy Summer School, June

2014 12

Hume Ignored Financial Innovation

English gold guinea (George III, 1776) Scottish paper guinea (Paisley Banking Company, 1785)

Center for the History of Political Economy Summer School, June

2014 13

The Gold Standard Was Not Automatic

Suspensions Panic of 1797: Suspension of convertibility of Bank of

England notes into gold, 1797-1821 U.S. Civil War Britain in World War I

The Problem of management of paper currency Banking School (Real Bills Doctrine) Currency School (U.K. Bank Charter Act of 1844; U.S.

National Banking Acts of 1863 & 1864)

Management of interest rates: The rules of the game

Center for the History of Political Economy Summer School, June

2014 14

The Quantity Theory of Money: The Equation of Exchange

MV = PQ

M = money V = velocity of

circulation (average turnover time per dollar)

P = general price level Q = transactions

(dollars per unit time)

Simon Newcomb

(1835-1909)

Irving Fisher

(1867-1947)

Center for the History of Political Economy Summer School, June

2014 15

The Quantity Theory of Money: The Cambridge Equation

M/P = kY

M = money P = general price level k = fraction of income

held as money Y = income (pounds

sterling per unit time)

Alfred Marshall (1842-1924)

Center for the History of Political Economy Summer School, June

2014 16

Comparison of Two Approaches to the Quantity Theory

Equation of Exchange MV = PQ V = speed of turnover of

money “ . . . money on the wing”

Dennis Robertson Cambridge Equation

M/P = kY k = size of money

holding “. . . money sitting”

Dennis Robertson Equivalence: V = 1/k if

Q Y Dennis Robertson (1890-1963)

Center for the History of Political Economy Summer School, June

2014 17

Wicksell: Cumulative Process and the Natural Rate of Interest

real rate of interest (rr) = nominal rate (r) – inflation rate (P) (Fisher)

Stable Economy: M Y & I and P constant at the natural rate of interest (rN)

M > needed ↓r below rN ↓ rr ↑I & ↑ P further ↓ rr further ↑I & ↑ P . . .

Self-limited under gold standard as ↑ P gold outflow ↓M offsetting first cumulative process

Not self-limiting in pure credit economy need for active monetary policyKnut Wicksell (1851-1926)

Center for the History of Political Economy Summer School, June

2014 18

Business Cycles: Main Issues

Good and bad times alternate

Develop data indices (price and others) business cycle barometers

Theory identify patterns are patterns regular?

Center for the History of Political Economy Summer School, June

2014 19

Data and Patterns: Warren Persons Harvard Business-Cycle

Barometer

Center for the History of Political Economy Summer School, June

2014 20

Natural CyclesTides – Morro Bay, California

Musical Instruments

Center for the History of Political Economy Summer School, June

2014 21

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

Quantitatively Similar

Center for the History of Political Economy Summer School, June

2014 22

Cycles Have Deep Hidden Causes

Business cycles are like the tides, only vastly more complex

Hierarchy of cycles: Kitchen (40 month) Juglar (9-10 years = 3

Kitchen’s) Kondratieff (60 years

= 6 Juglar’s)

Joseph Schumpeter (1883-1950)

Center for the History of Political Economy Summer School, June

2014 23

Clément Juglar: Credit Cycles

Every cycle has a proximate trigger – the straw that breaks the camel’s back

But cycles have a deeper root cause – the ebb and flow of financial credit

Clément Juglar (1819-1905)

Center for the History of Political Economy Summer School, June

2014 24

Cycles Have Real Causes

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

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

William Stanley Jevons (1835-1882)

Henry Ludwell Moore (1869-1958)

Center for the History of Political Economy Summer School, June

2014 25

Problem of the 1920s and 1930s

Monetary theory is theoretically more developed

Business cycle analysis is the premier empirical analysis of the whole economy

How can they be brought into contact: Frisch Tinbergen Keynes and many others Foundation of the Econometric Society (1933)

Center for the History of Political Economy Summer School, June

2014 26

Thanks

The End