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The writer is the author of The Almighty Dollar: 500 Years of the World’s Most Powerful Money
Stephen Miran left his temporary appointment at the Federal Reserve in May, returning to his old job at Hudson Bay Capital Management. This month, in a paper for Hudson with economist Nouriel Roubini, he announced his new project: reanimating the corpse of monetarism.
Kevin Warsh, new chair at the Federal Reserve, has announced the composition of five task forces, each with a brief to reimagine some part of monetary policy. The Fed attempted to examine itself and its tools under Jay Powell, too, but Warsh’s plan promises to be more ambitious. In a time when things might actually change, any doctrine has a chance.
Monetarism enjoys the questionable honour of being both a rigorous framework with a long history and the way your least favourite uncle probably thinks about money. At its most basic, monetarism argues that the supply of money in an economy and the speed at which it changes hands have a combined effect on inflation. More money, moving faster, creates more inflation.
It’s possible to see bits of monetarism as early as 16th-century Salamanca, where scholars noticed a rise in prices in Seville and wondered whether it had something to do with the silver arriving from Mexico and the Andes, or the expansion in credit that followed. In the early 20th century, the economist Irving Fisher argued that bank closures during the early Depression had collapsed the supply of money, leading to a rapid deflation that made existing debts worse, in turn weighing even more on banks.
After the Depression, the Federal Reserve began to keep statistics on the supply of money coming from new bank loans, and in 1963 Milton Friedman and Anna Schwartz published A Monetary History of the United States, a doorstop-sized record of the money supply by year since the American Civil War. Friedman and Schwartz were convinced that the Fed had failed to replace the money missing on bank balance sheets during the Depression, an idea that left a strong impression on Ben Bernanke, a PhD student at MIT in the 1970s.
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Friedman argued in favour of automating a stable growth rate in the supply of money, and briefly in the early 1980s the Fed even targeted the money supply as a variable it could control. In a speech in 2006 Bernanke, who had by then become Fed chair, laid out why the bank had ultimately decided to target inflation instead. It had been too hard to measure all the shifting sums of money, he said, and too hard to predict how quickly they might grow.
And the empirical relationship between money and inflation was unclear, meaning the Fed had no theory on which to rest its practice. Bernanke concluded that “a heavy reliance on monetary aggregates as a guide to policy would seem to be unwise in the US context”. These seem like soft words, but in central banker speak, he might as well have stuck the knife in himself. In 2006, monetarism was dead.
In his paper for Hudson, Miran points out that Congress has already instructed the Fed to pay attention to the supply of money. He’s right. America directs its central bank explicitly to “maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production.”
That line comes after the “shall” in the law, which means the Federal Reserve has to do it. But it doesn’t, choosing instead to focus on the bit that comes next, about maintaining stable prices and full employment. In abandoning monetarism completely, the Fed has assigned itself its own homework, then graded itself as well.
Miran isn’t arguing that the Fed should again target the total supply of money in America’s economy. Rather, he’s looking at aggregates of different kinds of money — physical currency, checking deposits, Treasuries. These are all “divisia”, named after the French economist François Divisia. Each divisia has a different “moneyness” — a different liquidity. Physical currency is perfectly liquid, Treasuries less so.
Unlike Milton Friedman’s total sum of money, divisia provide what Miran calls “useful information” about which kinds of money might cause inflation. And looking at different kinds of money does provide a reasonable explanation for why the Fed might have failed to encourage inflation over a decade of increasing reserves, while the Treasury might have worsened inflation in 2021 by pushing deposits out to consumers.
Warsh has suggested in speeches that the Fed needs to pay more attention to the supply of money, and that it was a mistake to abandon monetarism entirely. Inconveniently, Thomas Sargent, one of the heads of Warsh’s new task forces, is the co-author of an influential paper titled “Some Unpleasant Monetarist Arithmetic,” an argument for the limits of monetarism.
If the Fed does not adopt Miran’s divisia approach, though, it should at the very least start paying close attention to the growth of all the different kinds of money and credit — as the law already demands.
