Macroeconomic Issues are Old

1. History of Modern MacroeconomicsLecture 1. The Background to Modern Macroeconomics (before the 1930s) Kevin D. HooverDepartment of EconomicsDepartment of PhilosophyCenter for the History of Political EconomyDuke University Econ 314S History of Modern Macroeconomics Fall 2017

2. Macroeconomic Issues are Old Sir William Petty (1623-1687) Henry Thornton (1760-1815) Econ 314S History of Modern Macroeconomics Fall 2017

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 Econ 314S History of Modern Macroeconomics Fall 2017

4. The Slow Diffusion of the Micro/Macro Distinction Econ 314S History of Modern Macroeconomics Fall 2017

5. Macroeconomics Before 1930: Main Concerns • Monetary Theory • Theory of the Trade Cycle (later Business Cycle) Econ 314S History of Modern Macroeconomics Fall 2017

6. Macroeconomics Before 1930: Main Concerns • Monetary Theory • Theory of the Trade Cycle (later Business Cycle) Econ 314S History of Modern Macroeconomics Fall 2017

7. Mercantilism Favorable Trade Balance  More Precious Metals Gold and Silver = Power Colonies  Favorable Trade Balance Econ 314S History of Modern Macroeconomics Fall 2017

8. Europe on the Silver Standard Medieval Silver Penny Econ 314S History of Modern Macroeconomics Fall 2017

9. Econ 314S History of Modern Macroeconomics Fall 2017

10. Spanish Gold and Silver Econ 314S History of Modern Macroeconomics Fall 2017

11. Econ 314S History of Modern Macroeconomics Fall 2017

12. The Foundation of Political Economy as Anti-mercantilism Adam Smith (1723-1790) Author of “The Wealth of Nations” David Ricardo (1772-1823) Discoverer of the Principle of Comparative Advantage Econ 314S History of Modern Macroeconomics Fall 2017

13. 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) Econ 314S History of Modern Macroeconomics Fall 2017

14. 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” Econ 314S History of Modern Macroeconomics Fall 2017

15. 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” Econ 314S History of Modern Macroeconomics Fall 2017

16. 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” Econ 314S History of Modern Macroeconomics Fall 2017

17. 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 stopsThe gold of Spain becomes the gold of England; the real wealth of Spain or England little changed Econ 314S History of Modern Macroeconomics Fall 2017

18. Independence of Money and Finance Econ 314S History of Modern Macroeconomics Fall 2017

19. Hume Ignored Financial Innovation Scottish paper guinea (Paisley Banking Company, 1785) English gold guinea (George III, 1776) Econ 314S History of Modern Macroeconomics Fall 2017

20. 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 Econ 314S History of Modern Macroeconomics Fall 2017

21. The Quantity Theory of Money: The Equation of Exchange • MV = PQ • M = money • V = velocity of circulation(number of transactions per dollar of money) • P = general price level • Q = transactions (real dollars per unit time) Simon Newcomb (1835-1909) Irving Fisher (1867-1947) Econ 314S History of Modern Macroeconomics Fall 2017

22. 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) Econ 314S History of Modern Macroeconomics Fall 2017

23. 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) Econ 314S History of Modern Macroeconomics Fall 2017

24. 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 policy Knut Wicksell (1851-1926) Econ 314S History of Modern Macroeconomics Fall 2017

25. Macroeconomics Before 1930: Main Concerns • Monetary Theory • Theory of the Trade Cycle (later Business Cycle) Econ 314S History of Modern Macroeconomics Fall 2017

26. Business Cycles: Main Issues • Good and bad times alternate • Develop data • indices (price and others) • business cycle barometers • Theory • identify patterns • are patterns regular? Econ 314S History of Modern Macroeconomics Fall 2017

27. Data and Patterns: Warren Persons Harvard Business-Cycle Barometer Econ 314S History of Modern Macroeconomics Fall 2017

28. Wesley Clair Mitchell (1874-1948): Cycles are Qualitatively Not Quantitatively Similar Econ 314S History of Modern Macroeconomics Fall 2017

29. Natural Cycles Tides – Morro Bay, California Musical Instruments Econ 314S History of Modern Macroeconomics Fall 2017

30. 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) Econ 314S History of Modern Macroeconomics Fall 2017

31. 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) Econ 314S History of Modern Macroeconomics Fall 2017

32. 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) Econ 314S History of Modern Macroeconomics Fall 2017

33. Eugen Slutsky: Cumulative Random Shocks Can Appear Cyclical Econ 314S History of Modern Macroeconomics Fall 2017

34. 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) Econ 314S History of Modern Macroeconomics Fall 2017

35. Attempts to Wed Monetary Theory and Business-Cycle Theory Friedrich Hayek(1899-1992): Monetary Theory and the Trade Cycle (1929)Prices and Production (1931) John Maynard Keynes (1883-1946): Treatise on Money (1930) Econ 314S History of Modern Macroeconomics Fall 2017

36. Thanks  The End Econ 314S History of Modern Macroeconomics Fall 2017