A typology of monetary theories - I

As a much delayed follow up from my post proposing a top-level framework for thinking about business cycle macro, here's a framework for thinking about monetary theories.

Note that this is primarily about a theory of monetary mechanisms and propagation and thus corresponds better as a theory of monetary policy, rather than pure monetary theory, which would be more concerned with questions like 'why does money have non-zero value in equilibrium'. Yet, because of the centrality of the financial system in macroeconomic ups and downs and because of the growth of central banking with the urge to exert control over the financial system, arguably developments in the history of macroeconomic thought basically parallel developments in the history of central banking.

So here it is - a typology of monetary theorists and theories.

 Here, I've attempted to categorize monetary theories along two axes. The first axis deals with who is the primary monetary actor - central bank vs pvt banks & financiers. The second axis deals with what is the primary monetary mechanism - interest rates (real or nominal) vs the quantity of some monetary aggregates. Short notes on some of the cells follow :

1. Ricardo : As Schumpeter notes in his monumental History of Economic Analysis (Book III, Chapter 7, pp 657-719) the contemporary history of monetary theory goes back to the Bullionist Controversy in the early 19th century, and David Ricardo was the leading flag bearer for the currency school. Broadly speaking, a Ricardian monetary intuition involves a commitment to the quantity theory of money in some form or the other, a belief that 'outside' or central bank money is special, and that what is truly special about CB money is currency. As of today, Scott Sumner best represents Ricardianism in monetary thought. 

2. Old Monetarists : Old monetarists would broadly be people who focus on monetary aggregates, albeit both on base money (currency + reserves) and broad money (bank deposits etc.) aggregates. A classic tendency would be to focus purely on the liabilities of the banking system - as exemplified by Milton Friedman's contention that banks "also" have assets and that that's not quite important - and to infuse the central bank with a lot of control over the banking system. Nick Rowe would probably be a good example of a current theorist who is an old-style monetarist.

3. Real Bills Doctrine : This was the opposite side to Ricardo/Thornton in the Bullionist controversy, and this position has been revived a few times since. The basic contention is that 'money' - liquid media of exchange - is basically to be issued by pvt banks against high quality, short-term collateral. In old-school jargon, this went by the name of discounting against self-liquidating 'real' bills. Though this seems more like practical advice than monetary theory, the implied theory is easy to spot. Central banks are only supposed to respond to accommodate endogenous demand against specific, limited collateral, so that the primary monetary actors are private banks and financiers. Also, the restrictions on the quality and maturity of collateral to be admitted restricts interest rates to a rather narrow band - it is clear that quantities of collateral and exchange media issued are the main mechanisms here. As Perry Mehrling notes in his book on Fischer Black, Milton Friedman blamed this view for demanding that the central bank act in a pro-cyclical fashion and thus exacerbating business cycles.

4. Fisher : Irving Fisher created the first neoclassical macro model, and brought monetarist thought to the United States. He revived the quantity theory, but also brought to notice the monetarist paradox in interest rates - the observation that inflationary policies were associated with higher interest rates rather than lower. He conducted deep research into the construction of price indices and proposed that a monetary regime attempt to maintain price stability. It is clear that Fisher thought it was firmly within the remit and capability of central banks to maintain macroeconomic stability, through quantity mechanisms or rates mechanisms.

Descriptions of the other cells and some 'quadrant'-level aggregations will follow in the next post.