The return of monetarism?

0:05Pushkin. Milton Friedman, who is by my reckoning the third most famous economist in the history of the world, once said the following. Inflation is always and everywhere a monetary phenomenon in the sense that it is and can only be produced by a more rapid increase in the quantity of money than in output. I do not understand what that means. Today on the show, what is monetarism and why is it coming back? This is Unhedged, the markets and finance podcast. from the Financial Times and Pushkin. I am Rob Armstrong, coming to you from an uncomfortably sticky but otherwise beautiful New York City. And I am joined by the greatest of the neo-monetarists, Brendan Greeley of Princeton University and EFT.

1:03Brendan, welcome back to the show. Thank you. But neither the first nor the second most famous economist of all time. just ranked among the neo-monitorists. I appreciate that. Brendan, we've just heard the most famous definition of monetarism by the most famous monetarist. And I think I speak for both myself and the audience when I say we did not understand it. So maybe you can do a better job for us. Tell us what monetarism is. Look, the challenge with monetarism is that it is two things. It is a pretty rigorous theory. It is also probably the way your uncle thinks about money. The easiest way to think about it is the amount of money in the economy and the speed at which it moves from hand to hand, the speed at which it gets spent together have an effect on inflation.

1:54So when you have more money in the economy moving quicker from hand to hand and the same amount of goods, the price of those goods are going to go up. So that intuitively makes a lot of sense. Of course, it always the devil is in the details in economics as in the rest of life. But why are we talking about this now? Why is monetarism as an idea making a comeback right now?

2:20Brendan Greeley: Well, Kevin Warsh, the new chairman of the Fed, has announced the makeup of a couple of different task forces that are going to change Fed policy. Usually when somebody in government announces a task force, that's a sure sign that nothing is going to happen. But I think I actually think in this case something will happen. There were a couple of rethinks under Powell. They tended to have the Fed thinking, well, you know what, we're doing a pretty good job, so we're not going to change much. Warsh has been a critic of how the Fed measures things, how the Fed talks, how the Fed uses its tools. And, you know, the people who he appointed to these task forces are serious people.

2:57Brendan Greeley: So this has opened the door to a change. And as we both know, when a door is actually open, everybody who's ever had an idea is going to sprint as quickly as possible in the direction of that door before it closes. And so one of the people who has such an idea is Stephen Moran, who has served as an advisor to President Trump. Yeah. So Stephen Moran and Nouriel Roubini published a paper for Hudson Bay Capital Management saying we should think about monetarism again. It's a good idea. It would be a way to help the Fed understand inflation and make its policies more effective. That's the idea they're sprinting towards the open door.

3:35Okay, but what I don't get, Brendan, is exactly why this had to be rehabilitated in the first place. The way you describe monetarism makes so much sense to me. All it says is if there's more money chasing the stuff, then there is stuff. The price of the stuff has to go up. And in some sense, this is surely correct and is the basis of a workable theory of inflation. Why does monetarism even need to make a comeback at this point?

4:06Brendan Greeley: Yeah, but there's a difference between an insight, a theory and a model where it's difficult to take that insight or that theory and turn it into a model is exactly at the point of measurement. And so this is historically the challenge that we've always had. So the idea of monetarism is pretty old. When we look at 16th century Spain, you get this new flood of silver coming ashore from Mexico and the Andes. And people in Spain and people in France started to notice that prices were increasing in their lifetimes. And that was something that they hadn't really experienced before. And so they had to think about why.

4:38Brendan Greeley: There were various explanations for why. They understood commerce at the time. So the theories were, you know, the silver coming in increased credit, which increased prices. We don't have to go back to 16th century Spain. But can't we? Could we please? I just spent seven years of my life, one of them, in peninsular Spain in the 16th century. But yes, we can move on. So let us abandon Spain and at least get to the 20th century in America. Milton Friedman, no matter if you have any issues with him as an economist, he was sort of an impeccable collector of monetary statistics. So he produced in the 60s with Anna Schwartz this unbelievable just doorstop of a book called A Monetary History of the United States.

5:23What that is, is a total summing up of all of the money and all its various forms on all bank balance sheets from the 1860s until the 1960s. Armed with that data, he basically said, look, we can use it to protect inflation and deflation. And it's very difficult to argue with a book like that, particularly when it's being championed by somebody who's as compelling of an arguer as Milton Friedman. And so in his championing of of monetarism, he basically said, here's where I'd like to get to. We don't know how we're going to get there, but the supply of money should increase at a regular rate every year.

6:01So it's just not an issue. But what you then have in the 1970s is a real spike in inflation. And it's a problem in there. You need tools to deal with it. And you had someone at the Fed, Paul Volcker, who was willing to think about monetarism. I keep coming back to this, Brandon. What's the problem? He looks at all the steps. steps. He shows that there's a relationship between the money supply and inflation. Are we kind of good? Why doesn't this amount to a working theory of where inflation comes from and how to fix it? Ben Bernanke actually walked through exactly what went wrong in a speech in 2006.

6:39So he looked back at this history of monetarism at the Fed. And so you have this attempt under Paul Volcker to explicitly restrain growth in the money supply. They're doing exactly or almost exactly what Milton Friedman said. Following the Friedman playbook, yeah. Following the Friedman playbook, they're looking at the money supply as a variable that they can control. Here's the challenge. First of all, just the money supply is very difficult to measure. So despite what your uncle may believe about gold, all of our money sits on bank balance sheets. So if we're going to add up the total sum of money in the economy, what we're doing is looking at different bank balance sheets and trying to figure out how to add them all up.

7:19So the Fed is one of those banks. Banks hold reserves at the Fed. We call that M zero, the most basic kind of money. So deposits at the Fed, we call them reserves. That's a form of money. Bank deposits, which you and I use to pay our bills, which happen when banks make new loans. That is another form of money. You got to stack that on top of what the Fed has. Then we start to get into harder to measure things. We're looking at money market accounts and savings accounts and certificates of deposit. Plain old loans from banks probably go on that too. Loans from banks, different kinds of loans from banks.

7:51Yeah. So the way we sum up all the money is by looking at a sum of different things that we call money on bank balance sheets. The challenge, of course, is, as you and I have already run into, it's really difficult to agree, even among the two of us. And we like to agree on what exactly on bank balance sheets we need to call money and measure. So monetarism, tell me if I'm summing this up incorrectly, is an elegant theory that is smashed on the rocks of actually measuring empirical reality. Is that fair? No, that's absolutely right. And it's even more difficult when you start to measure the velocity of money.

8:32So it's the formula is involves both the sum of money and its velocity. Velocity is a nightmare to measure. It's really difficult. You cannot get into people's bank accounts on that granular level and figure out how often they're spending things. You end up with big, vague formulas like you take GDP or GNP and divide it by the supply of money. So it's very difficult. As you point out, this intuition makes sense. Very difficult to come up with the measurements that actually say, yeah, we can use it to predict things. So what are Moran and Rubini and perhaps by extension Warsh up to then? We've tried to turn this theory into practice before.

9:09It didn't work very well. Why are we having another go?

9:13Brendan Greeley: Well, the Fed tried to turn it into a theory of everything, meaning you can add up all the sum of money in the economy. You can agree on that number and then you can predict things from it. Moran and Rubini are proposing something a little different, which is that even if you cannot come up with a theory of everything that rests on the total sum of money in the economy. Looking at different kinds of money and how they have different properties is still really useful information. And I think that's kind of a fascinating point. And what they point out is different money is liquid in different ways.

9:47Brendan Greeley: So reserves, that's definitely real money, but it's not really liquid. You can push reserves out into the system and they won't necessarily generate new bank loans if banks don't feel like making new loans. So a lot of reserves just kind of sit there. They get lost in the couch cushions at big banks. Deposits, however, direct transfers from the government into your bank account that looks like a brand new deposit for you. That's incredibly liquid. It does things like drive up the price of GameStop. You know, we can look back at recent history and understand that different kinds of money have different liquidity and move in different ways and have different effects.

10:22Brendan Greeley: And so what they're suggesting is don't go back to a theory of everything. But also in getting rid of monetarism altogether, we lost some really valuable information about how different kinds of money affect the economy in different ways. And as you just intimated, surely that's the deep lesson of the post-COVID stimulus plan slash inflation, that we had one kind of monetary stimulus, quantitative easing, that pushed reserves into banks, not a big inflationary impact. But when we pushed money into checking accounts of actual consumers, there was an inflationary impact. So in a sense, the theory was powerfully predictive in this case.

11:07Yeah, absolutely.

11:09Brendan Greeley: And we're familiar with all the memes of money printer go burr throughout the entire 2010s and nothing happened. And it turns out that what the money printer is printing really matters. The problem is right now, man, you have got to understand just how out of favor monetarism is at the Fed. They really treat it like it's astrology. They really feel like the difficulty of measuring it was so horrific in the 1980s that there's just no point in going back to it. And they find it a little distasteful and embarrassing. Like when you go to the American Economist Association annual meeting in January, there's no like meeting of the monetarists.

11:45They got to hide themselves. We will do some things that are unpopular and distasteful after a short break when we come back with Long and Short.

12:04Listeners, welcome back. This is Long and Short, which is the portion of the show where we go long things we like and short things we don't like. Brendan, are you long or short something today?

12:16Brendan Greeley: Yeah, I'm actually long these Fed task forces. Nobody ever gets excited about a task force that's not in the nature of a task force to excite. Yes, this is a very contrarian call by you. It is. And I've watched the Fed try and reinvent itself before, and it's failed. And Warsh seems to be serious about it. And he has put some very serious people on these task forces. Raghuram Rajan, Tom Sargent. These are people who in the past have been critical of the way the Fed operates and seem to want to do it in a different way. I'm actually really excited about what's going to come out. I am long the good old correction in the stock market.

12:50Headline in the FT this morning, U.S. tech stocks tumbled into correction territory on Tuesday. Corrections are part of the game. I think they're kind of invigorating. They make you rethink things. I think a good correction is good for the soul, Brendan. They give the chance to the older traders on trading floors to be like, well, kids, we've seen it before. Exactly. We will be back with you listeners with more age-old wisdom on Thursday. Until then, stay cool out there.