Stan Menshikov asked me to do something for his journal which circulates
in Eastern Europe. What the Russians and Their Friends Should Know About
Monetarism. When the Soviet Union and other Eastern European countries
abandoned their command economies, they invariably turned to advice
proferred by monetarism economists from the International Monetary Fund.
Monetarism is defined by the New Palgrave as "the view that the quantity
of money has a major influence on economic activity and the price level,
and that the objectives of monetary policy are best achieved by targeting
the rate of growth in the money supply. Although the term "monetarism"
was coined by Karl Brunner in 1968 and popularized by Milton Friedman,
the practice of monetarism has deeper roots going back to the 19th
century.
Those economists who believed in and practiced the international
gold standard in the 19th century were, in effect, monetarists. Gold
flowing into a country because of an export surplus could be expected
toincrease the supply of money and therefore the price level. On the other
hand, gold flowing out of a country because of an import surplus could be
expected to reduce the money supply and the price level. In this manner,
there would be a global balance of exports and imports, as well as stable
price levels between countries in the long run.
Since there was a direct relationship between specie or gold
(sometimes silver) and the money supply, classical economists believed
in so-called "commodity" theories of money. Karl Marx, writing in this
milieu, subscribed to commodity theories of money and used his labor
theory of value to determine the value of gold and hence money. Fiat
money, or money based on "faith" in the value of money by virtue of what
it could buy, was criticized by Marx despite the fact that increasingly
countries were resorting to its use. When dogmatic Russian Marxists
claimed to be following their hero, they naturally were critical of
fiat money practices. Typically the Soviets claimed that there was a
25
25 percent gold backing behind their ruble. It was further claimed that
this version of commodity money helped explain why, in contrast to the
capitalist countries, inflation was not one of their problems.
In the early 20th century, Irving Fisher came up with the so-called
"Quantity Theory of Money" which purportedly explained why it was that
increases in the money supply were always inflationary. By assuming
stability in the velocity of money, Fisher's equation (MV=PT) was useful
in explaining why bankers were to be commended for keeping strict control
of the money supply.
John Maynard Keynes began to question the reliability of Fisher's
equation as early as1923. On the basis of England's stagnation in the
twenties and the futile attempt of the British to restore the international
gold standard after World War I, he also became convinced that the gold
standard had a deflationary bias -- because of the slow growth in the
world's supply of gold -- something that William Jennings Bryan had already
discovered in the latter part of the 19th century.
It is useful to remember that United States prices were slowly
declining throughout the twenties, and even Germany was not subject to
serious inflation after 1923. By the early thirties, it became obvious
that deflation was the real problem. The Bruning government's call for
roughly a 10 percent cut in wages in pre-Hitler Germany simply made
deflation and unemployment worse there than in the United States, thereby
providing fertile ground for the election of the Fascists.
In March, 1932, Keynes changed his earlier position on the
relationship between savings and investment. Monetarists had typically
assumed that savings was a prerequisite for investment to take place,
that savings was the dog that wagged the investment tail. In other words,
investment was passive. Instead, Keynes now realized that it was more
likely that investment was the dog that wagged the savings tail. In other
words, investment was the active variable and savings was more passive.
It now became possible for Keynes to develop his famous "paradox
of thrift." While it might be possible for individuals to better their
lives by saving more for a rainy day, this was disastrous for the economy
as a whole that was running double-digit unemployment. Thus, was born
non-monetarist or Keynesian economics.
Before Keynes, all economists were monetarist and assumed that
the economy as a whole -- what would later be dubbed as "macroeconomics"
--was simply the sum of its parts, what would later be called "microeconomics."
By 1940, Simon Kuznets would develop the rules of the game for national
income accounting as a measure of the success or failure of macroeconomic
policy.
United States policy-makers would still be monetarist and consider
inflation as the problem all through the thirties, despite the fact that
the price level was still below that of 1921. The Federal Reserve Bank
under the leadership of Marriner Eccles doubled the reserve requirements
in 1936 and helped bring on the sharp 1937/38 Roosevelt recession. As
gold flowed into the United States in the late thirties as a "safe haven"
a great deal of this metal was "sterilized" or not counted since it was
assumed to be inflationary.
Very early in the war, the United States policy makers put a
cap of 2 percent on nominal interest rates, thereby imitating the Japanese
and Germans who were actually practicing Keynesian economics long before
world War II. The success of Keynsian economics in practice during World
war II converted Keynes into a believer in greater international trade
as the economic program to accompany the creation of the United Nations.
His favorable remarks on mercantilism and protectionism in the General
Theory faded and he became the chiefarchitect -- along with Harry Dexter
White -- of the Bretton Woods Agreementin 1944.
Both White and Keynes had independently come to the conclusion
that the prewar wings of the international banking community had to be
clipped and that the fixed exchange rates administered by the IMF were
the solution to the problem. The deflationary bias of the gold standard
would supposedly be replace by a policy that put as much pressure on
creditor countries to inflate as it did on debtors to deflate.
In practice, however, the IMF has been a chief center for
postwar monetarist and deflationary forces. The "scarce currency clause"
which was designedto put pressure on creditor countries to import or
invest more abroad was never used. Instead there has been a bias towards
devaluation of currencies by debtor countries -- primarily those located
in the Third World.
The so-called "Structural Adjustment Programs" (SAP) imposed
on debtor countries in the 80s after their devaluations have followed
typically monetarist prescriptions: reduce the government sector (privatize)
balance the budget, eliminate subsidies, and raise real interest rates.
This advice should sound familiar to Russians and their friends
since they have been encouraged to follow IMF advice along the same lines
over the past four years. As in most of the Third World, their economies
are virtually "dead in the water." Monetarist advice may work for a time
in countries that are less developed than the Russian economy (Chile, for
example), but the Russians should be capable of coming up with an alternative
domestic policy, one that is more Keynesian or non-monetarist.
Clearly the Russians and their neighbors -- by drastically reducing
their real money supplies (by 70-80 percent) -- have overshot the mark
and created buyer's markets in place of their notorious seller's markets.
Some place between the two extremes there must be some more or less neutral
markets.
Monetarists typically recognize one type of inflation: demand pull
inflation that is accompanied by too much money chasing twoo fe
too few goods. In my view, much of the Russian inflation has been of the
supply-side variety coming from reductions of subsidies and prices reflecting
a true equilibrium level. Fear of hyper-inflation is a standard lever
utilized by monetarists to justify their prescriptions for balanced budgets,
more unemployment,higher real interest rates, etc. Caveat Emptor!
The Russians and their neighbors should realize that monetarism has
been suffering a declining influence in determining U.S. economic policy.
The last straw was Milton's
Friedman's prediction in early 1984 that inflation
by the end of the year would rise to double-digit proportions by the end of
the year on the basis of the large increases in money supply in 1983. In fact,
the rate of inflation at the end of the year was lower than it had been earlier.
Even Alan Greenspan, who still believes in the goal of zero inflation,
has abandoned any aggregate measure of the money supply as a meaningful
indicator of future inflation. His new Deputy, Alan Blinder, is on record
as an anti-monetarist as early as 1986 when he wrote a little book, Hard
Heads, Soft Hearts. Still earlier, he made a casefor"crowding in" of
investment as government spending raised incomes, as opposed to the monetarist's
assumed "crowding out" of private investmnt by government deficits.
Another youngish economist, Paul Krugman, goes even further in his
Peddling Prosperity (1994). His critique of monetarism, rational expectations
and real business cycle theories is must reading,along with his advocacy of
a so-called New Keynesian position. Instead of acceptingBlinder's 6 percent
unemployment as non-inflationary, Krugman is more inclined to push unemploymeent
down to 5 percent. Inview of the double-digit unemployment rates in other
advanced capitalist economies in our growing global economy, we might even
consider the long-forgotten Humphrey-Hawkins legislation of 1978 which accepted
a goal of 4 percent unemployment.
As monetarist as the economic policy emaznating from the Fed has been inthe
non-too-distant past (1979-82), it is still more benign than the thinking
coming out of the German Bundesbank and the Bank for International Settlements
in Basle. The high real interestratepolicy of the Bundesbank played a major role in
the breakdown of the European Monetary System in 1992 and the resulting
chaos in implementing the Maastricht Treaty. (Any comments would be most
appreciated!) Lynn Turgeon [EMAIL PROTECTED]
