David Laidler?s Contributions to Economics

Published by EH.NET (April 2011)

Robert Leeson, editor, David Laidler?s Contributions to Economics. New York: Palgrave Macmillan, 2010. xii + 376 pp. $110 (hardcover), ISBN: 978-0-230-01898-3.

Reviewed for EH.Net by Thomas M. Humphrey, Federal Reserve Bank of Richmond.

David Laidler, with thirty books and more than 250 published articles, notes, reviews and parliamentary papers to his credit, is among the more prolific monetary economists of his time.? His volumes on the Demand for Money, The Golden Age of the Quantity Theory, and Fabricating the Keynesian Revolution are recognized as standards in their field. As one of monetarism?s leading lights, he is famous for his buffer stock approach to money demand, for his disequilibrium, sticky price view of the monetary transmission mechanism, and for his advocacy (unusual for a monetarist) of constrained discretion rather than rigid rules in the conduct of monetary policy. What makes him unique, however, is his dual reputation as a monetary theorist and historian of monetary thought. In this respect he is in the tradition of Jacob Viner and Don Patinkin, both world-class theorists and doctrinal historians.? Today, at age seventy-three, Laidler is still going strong with a steady flow of papers in the pipeline.

In August 2006 a group of economists and policymakers assembled at the University of Western Ontario to celebrate Laidler?s contributions.? The resulting conference papers together with comments on them and an interview with Laidler form the chapters of the book under review. Of the fourteen chapters, two deal with Laidler?s work in monetary theory in general and monetarism in particular, two with his writings on doctrinal history, and three with particular economists — Thomas Tooke, Ralph Hawtrey, Lauchlin Currie, Harry Johnson, J. M. Keynes, and others — who anticipated and/or influenced him. The remaining chapters cover monetary policy and related topics of interest to Laidler.

To this reviewer, the most enlightening chapters are those on the history of monetary thought. They show Laidler?s interest in the subject to be more than aesthetic and antiquarian. To him doctrinal history is a vital analytical tool. It serves as a laboratory of earlier policy debates and experiments and provides a rich data set on those episodes. Laidler mines eighteenth, nineteenth, and early twentieth century primary sources for insights, ideas, perspectives, and approaches useful to the solution of current theoretical and practical policy problems. An example is his use of Thomas Tooke?s mid-nineteenth century recommendation that the Bank of England hold excess stocks of gold reserves sufficient to cover temporary balance of payments deficits thereby avoiding the need to resort to deflationary contractions of the money stock. Laidler cites Tooke?s prescription as the foundation of an enlightened modern policy of (1) riding out temporary real shocks to the balance of payments, (2) using currency devaluation to remedy persistent monetary shocks, and (3) avoiding deflation at all costs. Another cited example of the capacity of earlier work to inform current thinking is Keynes?s 1924 Tract on Monetary Reform, with its seminal formulation of the modern concepts of covered interest parity and of inflation as a tax on real cash balances as well as a disrupter of relative price signals and social cohesion. Still another example of the contemporary relevance of earlier work is Laidler?s use of the classical quantity theory critique of the real bills doctrine to demonstrate Thomas Sargent and Neil Wallace?s 1982 misappropriation (and misrepresentation) of that doctrine.

In contrast to the doctrinal historical chapters and those on Laidler?s contributions to monetarism, at least three chapters either say little about his writings or survey work antithetical to his. They thus seem out of place in a festschrift volume purporting to honor him. One chapter, on the inflation targeting approach to monetary policy, reports that money plays no role in such policy regimes or in the forecasting models supporting them. Inflation-targeting central banks set their policy interest rate depending on predictions from the models. And those models forecast inflation from variables uninfluenced by money. True, money could be added to the models. But it would be superfluous and redundant, an analytical fifth wheel. Another chapter on monetary institutions and theory accuses the quantity theory of being insufficiently comprehensive, confusing in its differing versions, ideologically loaded rather than scientifically neutral, politically motivated as part of a control agenda, and a tool of the wealthy and powerful, among its other faults. Still a third chapter on market clearing in monetarist models criticizes Laidler for departing from the correct Walrasian flexible price, continuous market clearing model for one in which nominal wages are sticky. Other commentators in the book, however, find this departure a virtue rather than a vice. It allows Laidler, like David Hume, Henry Thornton, Alfred Marshall, Irving Fisher, John Maynard Keynes, Lauchlin Currie, and other quantity theorists before him, to explain how monetary shocks can have temporary real effects, and to show how variables interact sequentially in the monetary transmission mechanism.

A highlight of the book is the late Milton Friedman?s last published paper. He addresses the Taylor curve tradeoff between the variabilities (standard deviations) of inflation and output. Friedman argues that while the Taylor curve is a valid theoretical construct in a model of optimal monetary policy, empirically it is belied by the data, which show no tradeoff between the two variabilities. Indeed, Friedman demonstrates that erratic monetary policy has caused the two to be positively, not negatively, correlated: The greater the variability of inflation, the greater, not less, the variability of output. Friedman also disputes the interpretation of the Taylor rule (for the setting of the federal funds rate) as a tradeoff between the goals of price stability and full employment. He denies that full employment is a separate goal of monetary policy. Instead it is a side-effect of the achievement of price stability. For him, the sole justification for including output gaps in the Taylor rule is to estimate the price-stabilizing federal funds rate when money growth and output are at disequilibrium levels.

The book contains some surprises reported both by Laidler in his interview and by other contributors to the volume. It was not Paul Samuelson and Robert Solow, but rather Grant Reuber, Richard Lipsey, and Harry Johnson who took the lead in interpreting the Phillips Curve as a policy tradeoff between inflation and unemployment. Laidler?s auto license plate sports the Cambridge cash-balance equation M = KPY.? George Stigler, despite his outstanding work in doctrinal history, nevertheless supported abolition of the history of economic thought as a requirement for the economics Ph. D at Chicago. Some LSE Keynesians in the late 1950s suspected that the real purpose of Milton Friedman?s A Theory of the Consumption Function was to discredit redistribution policies. Friedman?s finding that the long run function C = f(Y) was a straight line passing through the origin of the C-Y diagram implied that redistribution from the rich to the poor was powerless to raise the overall marginal propensity to consume and so boost aggregate demand.

A disappointment of the book is that its papers were presented in 2006, too early to address the recent financial crisis and its recessionary aftermath. Nevertheless, the doctrinal-historical chapters and those on monetarism hint at what Laidler might have said about these events and their policy responses. As a careful reader of the writings of Henry Thornton and Walter Bagehot, the nineteenth century fathers of lender-of-last-resort theory, Laidler almost surely would approve of their prescription to quell runs on financial institutions by accommodating all panic-induced demands for money via preannounced provision of emergency liquidity created either through open market operations or through the central bank?s loan facilities. He might even agree with Thornton?s and Bagehot?s condemnation of bailouts of insolvent firms, including too-big-to-fail ones. Following Bagehot, he might disapprove of emergency lending at subsidized, below market, interest rates.

As for the great recession, the book suggests that Laidler?s brand of monetarism, if not Laidler himself, supports quantitative easing as the way out. Laidler is skeptical of liquidity traps just as he is skeptical of assertions of the predominance of interest rate channels (rather than those of excess money supplies and demands) in the transmission mechanism. Accordingly, he rejects the claim that the zero lower bound to the federal funds rate renders monetary policy powerless. His money supply and demand framework, together with his asserted belief that, even at the zero interest rate bound, unconventional tools — including Fed purchases of long-term government bonds, private equities, foreign exchange, and other assets — imply that such purchases on a massive scale will so increase the money stock compared to the demand for it that the resulting attempts of cash holders to rid themselves of the excess stock of money by spending it will stimulate real activity. Presumably he would support payment of zero or negative interest on excess reserves during steep slumps to ensure that increases in the monetary base are translated into increases in the broad money stock.

Thomas M. Humphrey, retired senior economist at the Federal Reserve Bank of Richmond, is author of Money, Exchange and Production (Elgar 1998), Money, Banking and Inflation (Elgar 1993), and Essays on Inflation, fifth edition (Federal Reserve Bank of Richmond). E-mail: mvequalspt@verizon.net

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