the rise and fall of a policy rule: monetarism at the st. louis

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY/FEBRUARY 2001 1

The Rise and Fall of aPolicy Rule:Monetarism at theSt. Louis Fed,1968-1986R. W. Hafer and David C. Wheelock

“Once the quantity theory regained academicrespectability, it was obliged to resume respon-sibility for the short-run forecasting of aggre-gate movements of prices and quantities This it has begun to do, most importantlythrough the research work of the FederalReserve Bank of St. Louis, and with appreciablesuccess; but it has been lured into playing in anew ballpark, and playing according to a differ-ent set of rules than it initially established foritself [I]ts own success is likely to be transi-tory, precisely because it has relied on the samemechanisms of intellectual conquest as the[Keynesian] revolution itself and has alsoespoused a methodology that has put it in con-flict with long-run trends in the development ofthe subject.”—Harry Johnson (1971, pp. 12-13)

Macroeconomists today generally agree thatmonetary policy cannot permanentlyincrease the rate of economic growth

above its potential or decrease the rate of unem-ployment below its market clearing, or “natural,”level (e.g., De Long, 2000; Woodford, forthcoming).In the long run, monetary policy affects only therate of inflation, and many economists argue thatmonetary policy can best promote maximum sus-tainable economic growth by ensuring price level

stability (e.g., Barro, 1996). Monetary policymak-ing, however, both in the United States and else-where, is often concerned with the short-run.Policymakers meet frequently: the FederalReserve’s Open Market Committee (FOMC) meetseight times a year, for example, and a vote is takenat each meeting on whether to maintain or changethe current stance of policy. While price stability iswidely acknowledged as the appropriate long-runobjective of monetary policy, many economistsargue that policymakers should respond to fluctu-ations in real output or employment as part oftheir strategy to achieve price stability and, ulti-mately, to support maximum sustainable econom-ic growth.1

To help guide them in their deliberations,policymakers and their economic advisors rely onboth complex economic and econometric modelsand on simple rules-of-thumb based on empiricalregularities observed in macroeconomic data.Indeed, simple rules, such as the so-called Taylorrule (Taylor, 1993), which describes the response ofthe federal funds rate to past deviations of inflationand output from target values, often appearto explain well how policymakers set policy in theshort-run. Economists generally conclude thatrules-based policies are preferable to those relyingsolely on the discretion of policymakers. The trans-parency of rules reduces uncertainty about theresponsiveness of policy to economic change andcan enhance the accountability of policymakers.

Monetarists have long advocated the use ofrules to guide monetary policy, with Friedman’s(1960) proposal for a constant money stockgrowth rate being the most famous example. Atthe time it was made, Friedman’s proposal wassharply at odds with the prevailing mainstreamview that monetary policy was best conducted bymanipulating interest rates to strike a balancebetween inflation and unemployment. At the time,economists widely believed in the power ofactivist monetary and, especially, fiscal policy tolimit fluctuations in economic activity and toensure sufficient demand to provide full employ-ment economic growth over extended periods.Friedman’s “monetarist” policy rule thus attractedconsiderable attention. Moreover, a growing bodyof empirical work by Friedman and others show-ing the potential for money supply shocks to havelarge short-run impacts on output and employ-

1For a recent argument along these lines, see Mishkin (2000) and thereferences cited therein.

R. W. Hafer is a professor of economics and finance, and Director,Office of Economic Education and Business Research, SouthernIllinois University Edwardsville. David C. Wheelock is an assistantvice president and economist at the Federal Reserve Bank of St.Louis. Heidi L. Beyer provided research assistance. The authorsthank Anatol Balbach, Rachel Balbach, Michael Bordo, KeithCarlson, Brad DeLong, Bill Dewald, Jerry Dwyer, Milton Friedman,Gail Heyne Hafer, Joe Haslag, Bob Hetzel, Ali Kutan, Thomas Mayer,and Anna Schwartz for comments on an earlier draft. The authorsalso thank Gloria Valentine of the Hoover Institution for her assis-tance with the Friedman papers.

2 JANUARY/FEBRUARY 2001

R E V I E W

ment led to the development of an alternativeframework for conducting stabilization policybased on targeting growth of the money stock.

The Federal Reserve Bank of St. Louis playedan important and highly visible role in the devel-opment and advocacy of stabilization policy basedon the targeting of monetary aggregates. This arti-cle examines the development of the monetarist-based stabilization policy framework advocated bythe St. Louis Bank between the late 1960s and the1980s, with an eye toward identifying lessonsfrom that experience for the conduct of stabiliza-tion policy in general.2

This article also illustrates how the FederalReserve System’s decentralized structure fosters aclimate of internal debate. Beginning in the 1960s,the monetary policy actions advocated by the St.Louis Bank in its research publications, in publicforums, and in the participation of the Bank’spresidents in policy meetings often were sharplyat odds with the policies adopted by the FederalReserve System. The Fed’s decentralized structurepermitted the development of alternative policyviews and the exploration of new ideas within theSystem (Wheelock, 2000). Policy debates oftentook place within System publications. Wedescribe the public debate as we trace the evolu-tion of the St. Louis Fed’s monetarist policy, andthe criticism of that policy by other Fed officials,in the Federal Reserve Bank of St. Louis Review,other System publications, and in the publicspeeches of Darryl Francis, President of the Fed-eral Reserve Bank of St. Louis from 1966 to 1976.

To provide a backdrop to our discussion, thenext section summarizes the dominant policypositions taken by economists during the 1960sand early 1970s about the causes of inflation andthe role of monetary policy. We point out keyissues where monetarists disagreed with the con-ventional wisdom. In the subsequent two sectionswe review the research and policy positions takenby St. Louis Fed economists and officials from the1960s through the early 1980s. We limit our dis-cussion mainly to the period 1968-86. In 1968,the Federal Reserve Bank of St. Louis published aneconometric analysis of the relative impacts ofmonetary and fiscal policy on economic activity.That article, by Andersen and Jordan (1968),became one of the most cited papers in econom-ics in the past 40 years. In 1970, the Bank pub-lished the first version of its monetarist model forgauging the impact of monetary policy actions oneconomic activity (Andersen and Carlson, 1970).

The year 1986 marked the appearance of the finalversion of that model (Carlson, 1986). We showhow research conducted at the Federal ReserveBank of St. Louis extended earlier monetaristanalysis that had focused on the role of money inexplaining economic activity in the long run.Their success in finding apparently robust, stablerelationships in both long- and short-run data ledmonetarists to apply long-run propositions toshort-run policy questions, effectively competingwith alternative views of the time. When theshort-run correlation between money and eco-nomic activity went astray in the early 1980s,however, the efficacy of the monetarist rule andappeals for targeting monetary aggregates toachieve economic stabilization quickly lost credi-bility.

THE SETTING: FINE-TUNING THEECONOMY

The 1960s were the glory days of activist,short-run stabilization policy. Policymakers hadconfidence in their ability to achieve full employ-ment using fiscal and monetary policy to “finetune” or manage aggregate demand. For a time,their confidence seemed justified: Before the pres-ent expansion, the 1960s witnessed the longestuninterrupted expansion in U.S. history, with theeconomy operating at full employment (definedthen as a civilian unemployment rate of 4 percentor less) from 1966 to 1969.

Beginning in 1965, however, rising inflationand an increasing balance of payments deficitreflected the cost of expansionary macroeconom-ic policies. Policymakers felt increasing pressureto control inflation but were hesitant to takeactions that might reduce employment and realoutput growth. Because policymaking was viewedas striking a balance between inflation and unem-ployment, disagreements about policy, accordingto one Fed governor, boiled down to one’s prefer-ences between the two outcomes.3 Because un-employment frequently was viewed as a more

2The defining characteristics, technical aspects, and legacy of mone-tarism in general have been explored elsewhere, e.g., DeLong(2000), Melzter (1998), Rasche (1993), and Woodford (forthcoming).

3 Governor Sherman Maisel argued at an FOMC meeting on October20, 1970, “that at least some of the Committee’s differences on pol-icy reflected difference in basic value judgments regarding the rela-tive importance of various conflicting goals—for example, regard-ing the appropriate trade-off between employment and price stabil-ity” (FOMC Minutes, October 20, 1970, p. 41).



serious concern than inflation, for many years theFed opted for maintaining an inflationary bias inmonetary policy to avoid higher rates of unem-ployment. Fed officials, like other governmentofficials, argued that the inflation-unemploymenttradeoff could be improved only through the coop-eration of business and labor in the setting ofprices and wages or, if necessary, by the use ofanti-trust and other polices to make price settingmore competitive. Alternatively, inflation could becontrolled through explicit regulation of wages andprices

Juxtaposed against this mainstream view wasan alternative associated with the work of MiltonFriedman, Anna Schwartz, Karl Brunner, AllanMeltzer, and other so-called monetarists. Monetar-ism was rooted in the Quantity Theory of Money.The core of the Quantity Theory is that, in the longrun, inflation reflects excessive growth of themoney stock relative to real output growth, the lat-ter determined fundamentally by non-monetaryforces such as population growth and productivity.An important component of this position is the sta-bility of the public’s demand for money.Monetarists amassed empirical evidence showingthe demand for money to be more stable thanmoney supply or, equivalently, that velocity is sta-ble.4 Stability of velocity supported monetarists’view that short-run fluctuations in economic activ-ity often are caused by fluctuations in money sup-ply growth—fluctuations brought about by centralbank policy actions.5 Monetarists concluded thatcentral bank attempts to manipulate interest rateshad led to destabilizing fluctuations in money sup-ply growth and, therefore, in economic activity.Hence, monetarists argued that monetary policy-makers should minimize the variation of thegrowth rate of the money stock both in the short-run and over time. Lags in assessing economicconditions and in the effects of policy actions oneconomic activity, they argued, made attempts at“fine tuning” a balance between inflation andunemployment futile. Instead, monetarists arguedfor a policy that maintained growth of the moneystock at a low, fixed rate, irrespective of the busi-ness cycle.

The Federal Reserve Bank of St. Louis was thecenter of monetarism within the Federal ReserveSystem from the 1960s into the 1980s.6 DarrylFrancis, who became president of the St. LouisBank in 1966, was an especially strong advocateof monetarist policy prescriptions. At FOMCmeetings, he argued frequently for a policy of

minimizing variability in money stock growtharound a moderate trend. In public forums,Francis made the case that growth of the moneystock was the most accurate reflection of monetarypolicy and that excessive monetary growth wasthe fundamental cause of inflation. Francis wassupported in his policy views by St. Louis Fedeconomists, whose research findings were largelyin accord with those of other monetarists butsharply at odds with the conventional wisdom ofthe times, including the views about monetarypolicy held in most quarters of the FederalReserve System.

Mainstream Views About MonetaryPolicy in the 1960s

A review of monetarism and all of its differ-ences with mainstream Keynesian macroeconom-ics of the 1960s is beyond the scope of this article.Sharp theoretical differences about the cause orcauses of inflation and economic fluctuations, aswell as methodological differences about theempirical analysis of the effects of policy actionson economic activity, however, are fundamental tounderstanding why St. Louis Fed research and poli-cy positions were controversial. These differencesinclude whether a tradeoff exists between inflationand unemployment, either in the short or the longrun, and whether such a tradeoff is exploitable bypolicymakers. A related question is whether mone-tary policy can, or should, be used to fight inflationwhen the economy is at less-than-full employ-ment. Monetarists and non-monetarists dividedalso over the measures that best reflect the impactof monetary policy actions—monetary aggregatesor interest rates and credit aggregates. Finally,monetarists and non-monetarists debated the toolsand methods for identifying the impact of mone-tary policy on the economy.

4Velocity was stable not as an arithmetic constant, but in the sensethat its behavior was related predictably to changes in the opportu-nity cost of holding money and to changes in income or wealth ofindividuals.

5 Perhaps the most famous statement and evidence of this proposi-tion is Friedman and Schwartz (1963).

6 Consider Friedman’s (1992) appraisal: “The interesting thing to mehas always been that the most important contributions to under-standing of monetary theory and monetary institutions have notcome from Washington during the decades in which I’ve beenactive. The Federal Reserve Bank of St. Louis in the 1950s, ’60s and’70s was by far and away the pre-eminent producer of significantmonetary research within the System.”


R E V I E W

Inflation and the Phillips Curve

The Phillips curve—the inverse relationshipbetween unemployment and wage growth inBritish historical data observed by Phillips(1958)—was a key empirical regularity at the heartof macroeconomic policy discussions in the1960s. The Phillips curve was viewed as a con-straint on stabilization policy; policymakers withboth unemployment and inflation goals had tochoose a feasible combination of the two becausepolicies that, say, reduced inflation would invari-ably slow economic activity and increase unem-ployment. Perry (1966, p. 3) noted that

a fairly general consensus exists among econ-omists [that s]uccessively higher levels ofactivity are associated, roughly at least, withcorrespondingly larger rates of price increase.In this situation, the more traditional problemof adjusting aggregate demand so as to reachfull employment without overshooting intothe area of inflation must be replaced with thedual problems of deciding what combinationof unemployment and inflation to aim at andthen adjusting aggregate demand to reach thispoint.

Fed governor Sherman Maisel (1973, p. 14)observed succinctly: “There is a trade-off betweenidle men and a more stable value for the dollar.A conscious decision must be made as to howmuch unemployment and loss of output is accept-able in order to get smaller price rises.”

Although many influential economistsbelieved that the hyperbolic shape and negativeslope of the Phillips curve were fixed, it was clearthat the position of the Phillips curve could moveover time. The U.S. experience of 1955-58 waswidely discussed: In 1955-57, the unemploymentrate hardly changed when the inflation rateincreased sharply; in 1958, when inflation abated,the increase in the unemployment rate seemeddisproportionately high. Concern arose that theU.S. economy had an “inflation bias,” meaningthat inflation, perhaps accelerating inflation, wasnecessary to achieve and maintain full employ-ment (Wheelock, 1998).

The experience of 1955-58 gave prominenceto the notions of “cost-push” inflation and “wage-price spirals.” The term cost-push inflation wasused to define an ongoing increase in the generallevel of prices caused by firms passing along

increases in production costs, in contrast to“demand-pull” inflation caused by increases inaggregate demand. Cost-push forces were thoughtto explain how inflation could occur at less thanfull employment. The “essence of the problem,”according to Samuelson and Solow (1960, p. 181),stems from the absence of perfect competition infactor and product markets and was, Bronfen-brenner and Holzman (1963) noted, associatedwith the power of “economic pressure groups,”such as labor unions and monopolistic firms.If a powerful union extracts a real wage increase,the quantity of labor demanded falls. If affectedfirms have pricing power, they pass along a por-tion of the increase in wages to consumers in theform of higher prices. If perfect competition existsin other industries and labor markets, prices andwages fall to offset the increases in the first indus-try. If wages are downwardly rigid throughout theeconomy, however, the aggregate price level mightrise alongside an increase in unemployment.

Throughout the 1960s, the Economic Report ofthe President blamed inflation on “excessive” wageand price increases. The clear implication was thatmonetary and fiscal policies were not responsiblefor inflation when the economy was at less thanfull employment. The Economic Report for 1965explained that “in a world where large firms andlarge unions play an essential role, the cost-pricerecord will depend heavily upon the responsibilitywith which they exercise the market power thatsociety entrusts to them” (1966, p. 179). Hence,President Johnson urged, “in the strongest terms Iknow—that unions and business firms exercisethe most rigorous restraint in their wage and pricedeterminations” (Economic Report of the Presidentfor 1967, p. 20). Throughout the 1960s theEconomic Report published detailed wage andprice “guideposts” defining the extent to whichwage and price increases were “justifiable.”

Monetarists dismissed the notion of cost-pushinflation, arguing that inflation is “always andeverywhere a monetary phenomenon.” Non-monetarists generally accepted that “cost-pushmay involve increases in money supply, moneyincome, and money expenditures, particularly ifdecreases in output and employment are to beavoided” (Bronfenbrenner and Holzman, 1963, p. 614). Nonetheless, many economists foundmonetary explanations of inflation wanting,claiming that inflation can arise through wage andprice setting independent of shocks to aggregate



demand. The short-run linkages from money toinflation were considered to be tenuous at best.7

Economists generally did acknowledge thepotential for restrictive monetary policy to elimi-nate cost-induced inflation. The apparent down-ward rigidity of prices and wages, however, con-vinced many that using monetary policy to arresteven a moderate inflation would entail a substan-tial and unacceptable increase in unemployment.The Economic Report of the President for 1961 (p. 47) claimed that “an attempt to restrict aggre-gate demand so severely as to eliminate all risk ofan increase in the general price level might wellinvolve keeping the economy far below full em-ployment.”8 High unemployment was simply anunacceptable cost of reducing inflation. In hisintroduction to the 1967 Report (p. 20), PresidentJohnson argued, “Dealing with inflation by creat-ing a recession or persistent slack is succumbingto the disease—not curing it. The experience of1957 and 1958—when the unemployment ratereached 7 12 percent and consumer prices still rose5 percent—is a clear reminder of the large costs ofsuch a policy and of its limited effectiveness inhalting a spiral in motion. This is a course which Ireject.”

To fight inflation, some mainstream econo-mists advocated incomes policies; others favoredpolicies aimed at enhancing the competitivenessof product and labor markets and policies aimedat raising productivity. Monetary policy, manyargued, should focus on maintaining full employ-ment by keeping interest rates low.

Many Federal Reserve officials expressed simi-lar qualms about using monetary policy to controlinflation. For example, Charles Partee, a Fed staffeconomist who later became a Fed governor,argued in 1970 that “The question is whethermonetary policy could or should do anything tocombat a persistent residual rate of inflation The answer, I think, is negative.” He added that“Product markets generally are substantiallyunderutilized and labor appears to be readilyavailable It seems to me that we should regardcontinuing increases [in the price level] as a struc-tural problem not amenable to macro-economicmeasures” (FOMC Minutes, April 1970, pp. 385-86,379, 396 [quoted in Mayer (1999), p. 99]). FederalReserve Board Chairman Arthur Burns also arguedthat “Monetary policy could do very little to arrestan inflation that rested so heavily on wage-costpressures . . . A much higher rate of unemploy-ment produced by monetary policy would not

moderate such pressures appreciably” (FOMCMinutes, June 8, 1971, p. 51).

The Long-Run Phillips Curve

Wage and price rigidity and the possibility ofcost-induced inflation suggested to manyobservers that using monetary policy to containinflation would invariably cause higher unemploy-ment. Monetarists did not deny this, but arguedthat the tightening of monetary policy would havemerely a temporary adverse impact on unemploy-ment. Andersen (1973), for example, argued that“our economic system is such that disturbingforces, including even changes in money growth,are rather rapidly absorbed and output willnaturally revert to its long-run growth path follow-ing a disturbance” (p. 7).

Some economists, however, argued that usingmonetary or fiscal policy to achieve price stabilitymight cause unemployment to increase perma-nently. Keynesians frequently interpreted theGreat Depression as indicating that privatedemand might be insufficient to generate fullemployment output in the face of downwardlyrigid wages and prices, thereby leaving the econo-my mired permanently at less than full employ-ment. Thus, many economists believed that monetary and fiscal policy should ensure thataggregate demand is sufficient to generate fullemployment, even if that requires some inflation.Samuelson (1960, p. 265), for example, arguedthat “With important cost-push forces assumed tobe operating, there are many models in which itcan be shown that some sacrifice in the require-ment for price stability is needed if short- andlong-term growth are to be maximized, if averagelong-run unemployment is to be minimized, ifoptimal allocation of resources as between differ-ent occupations is to be facilitated.”

The Fed often was accused of paying “exces-sive” attention to price stability. In summarizing asymposium on recent monetary policy, Harris(1960, p. 245) wrote, “In general the disagree-

7Ackley (in Perlman, 1965, p. 47), for example, wrote that “I do notconsider the change in money supply of much short-run impor-tance.” Weintraub (1960, p. 280) contended that “contrary to thewidespread belief that there is a direct tie of money supplies toprice levels, the modus operandi of monetary policy is different: itsimmediate effect is upon consumption and investment demands,thereby upon employment levels, and only indirectly affecting thegeneral level of money wages” (emphasis in the original).

8 The Council of Economic Advisors at this time consisted of WalterHeller, Kermit Gordon, and James Tobin.


R E V I E W

ments of [participating] economists with FederalReserve policy have stemmed primarily from afear that the interest in the stability of the currencyhas been at the expense of growth and employ-ment.”9 Not only was the tradeoff between infla-tion and unemployment widely viewed as persist-ent, but some economists argued that policies toachieve price stability in the short-run might makethe tradeoff less favorable over time. Samuelsonand Solow (1960), for example, believed that poli-cies directed at limiting inflation in the short-runmight increase structural unemployment. Thelong-run tradeoff between inflation and unem-ployment would worsen because an increase instructural unemployment would raise the size ofthe increase in inflation that would be needed toachieve a given reduction in the unemploymentrate. Perry (1966, p. 119) even suggested that poli-cies aimed at maintaining low unemployment andminimizing short-run cyclical variation in outputcould moderate wage and price increases.10

The Impact of Monetary Policy

Economists’ conviction that policymakerscould manipulate aggregate demand to stabilizethe growth of real output reached its zenith in the1960s and early 1970s. The apparent failure oflow interest rates to revive the economy duringthe Great Depression, however, was taken as evi-dence that monetary policy is less potent than fis-cal policy. The 1950s witnessed the developmentof new theories about the impact of monetary pol-icy, with the dominant view being that policy iseffective through its influence on both the costand availability of credit.11 Still, even in the 1960s,the mainstream view was that monetary policy,though capable of having some impact, was lesspowerful than fiscal policy.12

Monetarists, by contrast, argued that changesin the quantity of money exert a powerful influ-ence on economic activity. Friedman’s work dur-ing the 1950s helped establish the foundation forlater studies of the link between monetary policyand the economy (e.g., Friedman, 1956). Hisexamination of monetary policy and the businesscycle is reflected in his testimony to the JointEconomic Committee in March 1958.13 At thattime, most Fed officials believed that short-terminterest rates and the quantity of bank credit werethe appropriate instruments of monetary policy.Minutes of FOMC meetings reveal that policymak-ers generally rejected the notion that movements

in the money supply affect economic activity,much less that the Fed can control the moneystock. Although one or two FOMC memberswarned persistently that fluctuations in moneygrowth could cause undue fluctuations in the realeconomy, these concerns largely were ignored.14

Outside the Fed, by contrast, monetarist viewsabout the impact of fluctuations in money stockgrowth were receiving considerable attention.Friedman and Meiselman’s (1963) “The RelativeStability of Monetary Velocity and the InvestmentMultiplier in the United States, 1897-1958,” forexample, stirred much debate. Associated with theCommission on Money and Credit’s inquiry intothe structure of the financial system, this paperwas controversial because it rejected a core ingre-dient in the Keynesian theoretical structure—thevalidity of the expenditure multiplier. Friedman

9 Angell (1960, p. 248) argued similarly, stating that “As to aggregategrowth, a good many students feel—as do I —not only that mone-tary policy has not done much to promote it, but that the intermit-tent restrictions imposed to fight instability and inflation haveprobably retarded it substantially.” Hansen (1960, pp. 255-56) pro-posed that “Monetary policy should seek to achieve a low long-runrate of interest” to raise permanently the ratio of investment to out-put and thus real growth, while fiscal policy could “offset theinflationary pressures caused by the increase in investment inci-dent to rapid technological advance and low interest rates.”

10 Policymakers often agreed with such assessments. The EconomicReport of the President for 1965 concluded “Rising prices thatoriginate from such a [cost-push] process can affect expectations,jeopardize the stability and balance of an expansion, and createinequities and distortions just as readily as demand inflation. Butmeasures to restrain these price increases by reducing over-alldemand will enlarge unemployment and impair the productivityrecord so important to cost-price stability over the longer run” (p.179). The Council of Economic Advisors at this time consisted ofGardner Ackley, Otto Eckstein, and Arthur Okun.

11 The “Availability Doctrine” posits that small changes in interestrates can have large economic effects by affecting banks’ willing-ness to supply loans. The theory was developed by New York Fedeconomist Robert Roosa (1956) and was the dominant view of thetransmission mechanism within the Fed at the time. See Johnson(1962) for a survey of current thinking on monetary theory andpolicy effectiveness as of the early 1960s.

12 The consensus view is perhaps well represented by Ando et al.(1963, p. 2), who concluded “the effect of monetary policy on theflow of expenditures is far from overwhelming, though it exists andis of a magnitude worth exploiting in the interests of economicstability Our findings on fiscal policy are primarily that varia-tions in disposable income, either through transfer payments orpersonal income tax changes, can operate as a powerful short-runstabilizer.”

13 This testimony was based on on-going research with Anna J.Schwartz at the National Bureau of Economic Research. Thisresearch was subsequently published in three volumes: seeFriedman and Schwartz (1963, 1970, 1982).

14 In the late 1950s and early 1960s, Malcolm Bryan, President of theFederal Reserve Bank of Atlanta, argued that the Fed should targetthe growth rate of total reserves, and minimize fluctuations in themoney stock. See Meigs (1976) and Hafer (1999).



and Meiselman’s empirical analysis also foundmoney demand to be relatively more stable thanmoney supply, suggesting that observed move-ments in the money stock and economic activityare dominated by Fed policy actions rather thanby volatility in the public’s demand for money.

The debate that ensued was so important thatthe American Economic Review devoted an entireissue to critical appraisals of the Friedman-Meiselman (1963) study by Ando and Modigliani(1965) and DePrano and Mayer (1965) and aresponse by Friedman and Meiselman (1965).15

Two issues were key to the attacks and rejoinder.One was Friedman and Meiselman’s finding thatvelocity is relatively more stable than theKeynesian expenditure multiplier. In other words,output appeared to be related more to movementsin money than to other measures of autonomousexpenditure.

The other issue, one that is more important forwhat would later be the attack on the St. Louisapproach, was the procedure Friedman andMeiselman used to produce that finding. Thedebate displayed a fundamental difference inviews about how to estimate economic relation-ships for policy purposes. Friedman andMeiselman, whose work was grounded in the tra-dition of the Quantity Theory of Money, basedtheir conclusions on simple reduced-form rela-tions observed in the data. Ando and Modigliani(1965) argued that such simple regressions, notmuch more than correlations, were inferior to theoutput of the large-scale, structural models thencoming into vogue to evaluate policy. In otherwords, though different approaches may producedifferent results, only the most sophisticated isuseful for policy analysis.16

Many Federal Reserve officials embraced theuse of large-scale econometric models then beingdeveloped. Board staff participated with econo-mists from the Massachusetts Institute ofTechnology in constructing the FRB-MIT model,which was used for policy analysis and evaluationat the Board. Such models were widely judgedsuperior to single-equation or small-model sys-tems for studying the effects of policy actions oneconomic activity. An official of the FederalReserve Bank of New York argued that large-scalemodels produced “quantitative estimates of thetiming and magnitude of the effects of centralbank actions on the money supply and otherfinancial magnitudes and the subsequent effects,in turn, of these variables on each of the variousmajor components of aggregate demand” (Davis,

1968, p. 73). Thus, large structural modelsappeared to give policymakers the informationthey needed to make short-term, fine-tuning poli-cy adjustments to stabilize economic activity.

Monetary Policy Target

Alongside large-scale macroeconometric mod-els, the 1960s witnessed the development ofincreasingly complex analyses of the effects ofmonetary policy actions, interacting with financialregulatory policies, on financial flows and interestrates. With the exception of monetarists, manymacroeconomists believed that monetary policywas not represented accurately by the behavior ofany single variable, such as the rate of interest, thequantity of bank credit, or the stock of money.This view was reflected in the Economic Report ofthe President for 1968:

In the formulation of monetary policy,careful attention should be paid to inter-est rates and credit availability as influ-enced by and associated with the flows ofdeposits and credit to different types offinancial institutions and spending units.Among the financial flows generally con-sidered to be relevant are: the total offunds raised by nonfinancial sectors ofthe economy, the credit supplied by com-mercial banks, the net amount of newmortgage credit, the net changes in thepublic’s holdings of liquid assets, changesin time deposits at banks and other thriftinstitutions, and changes in the moneysupply. Some consideration should begiven to all of these financial flows aswell as to related interest rates in formu-lating any comprehensive policy programor analysis of financial conditions. (p. 89)

The Report also dismissed monetarist appealsfor focusing on money stock growth. In responseto calls for setting monetary policy according to a

15 This is the so-called AM-FM or “radio” debate. Hester (1964) wasalso critical of the Friedman-Meiselman approach.

16 Brunner (1986) provides an excellent and wide-ranging overview ofthis debate. He defends the Friedman-Meiselman (1963) approach,arguing that “the use of a single equation with a single independentvariable should now be clear. It was the appropriate choice for anassessment of the core class [of hypotheses]. It did not represent asingle equation model or a [direct] disposition to favor simple, asagainst sophistical models” (p. 41, emphasis in original). Rather,Brunner suggests (p. 40) that “the strong assertions conveyed bythe basic core of the income-expenditure approach, which fre-quently spilled over into categorical policy statements, were thusshown to have little substantive foundation.”


R E V I E W

fixed-growth rule for the money stock, the Reportargued (p. 92) that “given the complex role ofinterest rates in affecting various demand cate-gories and the likely variations in so many otherfactors, any such simple policy guide could proveto be quite unreliable.” Similar reasoning wasreflected in the analysis of Federal Reserve Boardeconomists. In a paper published in the FederalReserve Bulletin, Gramley and Chase (1965, pp.1403-04) wrote that “the money stock [is] anuntrustworthy indicator of the effects of policyactions on financial asset prices and yields Financial market behavior is too complex for sim-ple monetary rules to work.”17

Monetarists, of course, disagreed that the com-plexity of financial markets made targeting amonetary aggregate infeasible. In an article in theJournal of Political Economy, Federal Reserve Bankof St. Louis economist Leonall Andersen (1968)presented evidence that the Fed could use openmarket operations to smooth fluctuations in totaland free (i.e., excess less borrowed) reserves and,by implication, in the monetary base.18 AlbertBurger (1971), another St. Louis Fed economist,presented a detailed analysis of how the monetarybase can be manipulated so as to control themoney stock.

The Fed’s ability to control monetary aggre-gates and the efficacy of monetary control for eco-nomic stabilization remained hotly debated issues.They also were central research themes at theFederal Reserve Bank of St. Louis throughout the1960s and 1970s.

ST. LOUIS—THE LONG-RUN VIEW

Under the leadership of its director ofresearch, Homer Jones, the Federal Reserve Bankof St. Louis emerged as the center of monetaristeconomics within the Federal Reserve System inthe early 1960s.19 The Bank’s Review, which thenappeared monthly, tracked the behavior of theeconomy and the money stock in nearly everyissue. Review articles often described the recentbehavior of the money stock and related it tomonetary growth during previous expansions. Forexample, the June 1962 article, “MonetaryDevelopments,” compared graphically the recentbehavior of bank reserves and the money stock(M1) with their patterns during the 1953-57 and1957-60 cycles. This type of chart, used byFriedman in his 1958 Senate testimony and inFriedman and Schwartz (1963), provided a visual

analysis of expansionary and contractionarymovements of the money stock.

A companion article in the June 1962 Reviewprovided one of the first monetarist explanationsfrom the St. Louis Fed of how monetary policyactions are transmitted to changes in nominalincome and prices. The article, “Changes in theVelocity of Money: 1951-1962,” addressed one ofthe more difficult questions monetarists faced inattempting to use the Quantity Theory to explainhow monetary policy affects the economy in theshort-run. If velocity is highly variable, then theconnection between changes in the money supplyand nominal income is uncertain at best. The arti-cle provided a “tentative and exploratory analysis”of the behavior of velocity. The analysis showedthat a “rapid change in money [is] to be matchedtemporarily by an opposite change in velocity”(p. 13). Over time, however, “as the public recog-nized the change in its [money] balances therewas an increase in spending, and velocity movedupward” (p. 13). Using this pattern to explain theeffects of past policies, the article noted that“Within a few months after money began expand-ing at a rapid rate in 1954, 1958, and 1961,spending and the velocity of money began rising”(p. 13).

The article is an early example of the researchcoming out of St. Louis in support of the mone-tarist position that changes in nominal incomelargely reflect prior movements in the money sup-ply. Even though velocity might vary, its variabilityappeared to be less than that of money supply.Hence, monetarists argued, observed cycles in

17 It was a long-standing view among Board officials that monetarypolicy should not focus on any one variable. For example, as earlyas 1932, Governor Eugene Meyer stated: “Our credit machinery isentirely too delicate and responsive to too many influences to makeit desirable to have any one indicator, whether it be the price levelor the level of member bank reserves, be the sole guide in determin-ing credit policy” (quoted by A. James Meigs in a letter to MiltonFriedman: Friedman Papers, Hoover Library, Stanford University,Box 30, Folder 17).

18 See also Meigs (1966), who reviews the debate about whether finan-cial innovation had made control of the money stock infeasible orinefficacious.

19 Jones was hired by the St. Louis Fed in 1958. At that time, the Bank’sresearch staff consisted of one Ph.D. economist, two graduate stu-dents, an agricultural economist, a geographer and several juniorstaff members. During 1958, Jones corresponded regularly withFriedman concerning potential hires for the department (FriedmanPapers, Hoover Library, Stanford University, Box 28, Folder 36). Inrecognition of Jones’ accomplishments, in 1976 a special issue ofthe Journal of Monetary Economics was devoted to papers in hishonor.



nominal income growth are caused mainly bychanges in the money supply—over which theFed has some control—rather than by changes invelocity.

As inflation worsened over the 1960s, Reviewarticles reflected an increasingly aggressive appli-cation of monetarist arguments by St. Louis Fedeconomists, as critical reviews of policy replacedtentative and exploratory studies. For example, aJuly 1966 article, titled “Total Demand andInflation,” stated that “Excessively stimulativeGovernment policies lead to marked increases inthe price level. Rapid monetary expansion isregarded by many as a means of stimulating totaldemand” (p. 1). In the same issue, Keran (1966)studied the relationship between nominal and realoutput in eight countries. He concluded that infla-tion results when total demand—nominalincome—rises faster than the economy’s potentialrate of real output growth, suggesting that “If therecent acceleration in total demand is continuedat a time of high-level resource utilization, priceswill probably begin to rise even faster” (p. 12). Inaddition, Keran hinted at the possibility of usingmonetary policy for short-run stabilization, notingthat “To the extent that policy tools control thegrowth in total demand they are useful in achiev-ing cyclical stability in the economy because year-to-year movements in real output can be influencedby changes in total demand” (p. 12, emphasisadded). These and other Review articles, many ofwhich were written anonymously, reflect clearlythe monetarist-oriented research and policy analy-sis carried out by St. Louis Fed economists in theearly-to-mid 1960s.

The St. Louis Bank’s visibility increased signifi-cantly, however, with the publication of articles byAndersen and Jordan (1968) and by Andersen andCarlson (1970). These articles provided two ofmonetarism’s most challenging attacks on policyorthodoxy and mainstream Keynesian macroeco-nomics. The former presented an econometricevaluation of the relative impacts of monetary andfiscal policy on economic activity. The latteroffered a small monetarist econometric modelthat the authors proposed as an alternative tool tosimulate alternative policy scenarios. Both papersconcluded that changes in the growth of nominalincome and inflation are linked closely to changesin the growth rates of monetary aggregates.Although such relationships had been demonstrat-ed over relatively long time-horizons, these two articles suggested that they hold over even the

short time horizons of concern to policymakers.The articles were instrumental in developing themonetarist policy rule as an alternative to the con-ventional interest rate and fiscal-policy orientedideas of the time.

The Andersen-Jordan Equation

Andersen-Jordan (1968) (hereafter, AJ) is anintellectual and analytical descendant ofFriedman-Meiselman (1963).20 Andersen andJordan, like Friedman and Meiselman, were inter-ested in isolating statistically the impact of moneyon nominal income. AJ went further, however.They provided a straightforward empirical test ofa related and critical policy issue—the relativeimpacts of monetary and fiscal impulses on nomi-nal income. Rather than building a complexeconometric model like those in vogue at thetime, AJ took a relatively simple approach toassessing alternative policies. They estimated asingle empirical relation—a “reduced-form”model—between income and different measuresof monetary and fiscal policy actions. Their equa-tion can be written as:

(1)

where Y represents nominal gross national prod-uct, M is the money stock (M1 or the monetarybase), and E is a measure of fiscal policy actions.The variables were measured as changes in theirlevels. In their estimation, AJ accounted for lags inthe effect of policy actions on economic activityusing a new econometric technique that con-strained the estimated parameters to lie along apredetermined polynomial. This was thought toprovide more precise estimation of the effects ofchanges in the policy variables.21

∆ ∆ ∆Y M Et ii

t i jj

t j t= ∑ + ∑ +=

−=

− β δ ε0

3

0

3

20 Jordan (1986) refers to it as a “sequel” to Friedman-Meiselman(1963), though it clearly is linked to earlier work by Karl Brunner.This is evident in the statement by AJ that their purpose is not to“test rival economic theories [i.e., Keynesian vs. Monetarist] of themechanism by which monetary and fiscal actions influence eco-nomic activity” (AJ, 1986, p. 29). A decade earlier Brunner wasexamining the logical structure of empirically testing betweenKeynesian models, in which money played a very minor role, andmonetary models, in which “money matters.” For example,Brunner and Balbach (1959) present a structure of models in whichthey test empirically the relative roles of money and fiscal policyactions.

21 See Batten and Thornton (1986) and the articles cited therein for adiscussion of this and other technical issues regarding the estima-tion of equation (1).


R E V I E W

Using quarterly data covering the period 1952to mid-1968, AJ estimated equation (1) to testthree hypotheses. By comparing the sizes of theestimated impacts of fiscal and monetary policyon GNP, AJ rejected the hypothesis that outputresponds more to fiscal policy actions than tochanges in the money stock. Comparison of thestatistical significance of the coefficient estimatesfor monetary and fiscal policy actions led AJ toreject the hypothesis that fiscal actions have amore “reliable” impact on GNP than monetaryactions. Finally, comparison of coefficient esti-mates on lagged monetary and fiscal policyactions, led AJ to reject the hypothesis that fiscalactions affect GNP faster than do monetary policyactions. They succinctly summed up their evi-dence: “The response of economic activity tomonetary actions compared with that of fiscalactions is (I) larger, (II) more predictable, and (III)faster” (p. 22).

Early Criticism of Andersen-Jordan(1968)

Andersen-Jordan (1968) was subject to imme-diate and critical analysis by economists insideand outside of the Federal Reserve System.Technical criticisms have been dealt with at lengthelsewhere.22 Of interest here is the fact that muchof the early debate over the usefulness and theconclusions of the article took place among Fedeconomists within the pages of System publica-tions. For example, the first published criticism ofthe AJ approach and findings was by DeLeeuwand Kalchbrenner (1969), both of whom were orhad been with the Board of Governors.23 Theircomment was published in the Federal ReserveBank of St. Louis Review, along with a response byAJ. DeLeeuw and Kalchbrenner (hereafter, DK)raised several technical issues, but focused on AJ’suse of the monetary base as the appropriatemeasure of monetary policy. DK argued that theFed controls neither the borrowed reserves ofmember banks nor the currency stock. Hence,they argued, the base is not statistically independ-ent of the model’s dependent variable—changesin GNP. DK reestimated the AJ equation, using thebase less borrowed reserves and currency as themonetary policy variable, and found that,although monetary policy appeared “to exert apowerful influence” on GNP, money was not asdominant as AJ’s results had suggested. DK notedalso that their results were more consistent with

the output from large-scale econometric models,suggesting that their results were more plausiblethan those of AJ.

Another early criticism of AJ appeared in theMonthly Review of the Federal Reserve Bank ofNew York (Davis, 1969). That study defended theview that monetary policy affects income throughinterest rates, not the money stock or monetarybase, with its author noting that the St. Louisequation “portrays a world in several respects[that is] sharply at variance with the expectationsof most of us” (p. 121). Like DK, Davis reestimatedthe AJ equation using different measures of mone-tary policy, as well as different polynomial lagspecifications and different sample periods.Davis’s analysis led him to conclude that “we can’taccept the St. Louis equations at face valuebecause neither money nor the total reserve basemay be sufficiently exogenous” (p. 126). The onlyrecourse, he suggested, is to build a structuralmodel (like the FRB-MIT model) and reject thereduced-form approach used by AJ. The onus formonetarists, he implied, was to put their ideasinto a structural model that details the transmis-sion mechanism of monetary policy.

The controversy generated by the appearanceof AJ marked an abrupt change in the “monetaryversus fiscal policy” debate. Despite criticism ofthe AJ study, the earlier view that business cycleevidence relating money and income was “theprovince of an obscure sect with headquarters inChicago” (Davis, 1969, p. 119) was changed bytheir results. Monetary aggregates now were con-sidered plausible alternatives to interest rates andfiscal policy as tools for short-run economic stabi-lization.

Darryl Francis and the Andersen-Jordan Results

While the technical analysis, criticism, andresponses of the AJ equation took place in bothSystem and academic publications, its policy im-plications were being disseminated in publicforums. Darryl Francis, the president of the St.Louis Bank, used the AJ results to promote the role

22 Reviews include Meyer and Rasche (1980), Batten and Thornton(1986), McCallum (1986), and Brunner (1986).

23 DeLeeuw, then a Senior Staff Member at the Urban Institute, hadbeen the Chief of the Special Studies Section, Division of Researchand Statistics at the Board of Governors and a principal in thedesign and development of the FRB-MIT model. Kalchbrenner wasan economist in the Special Studies Section.



of monetary aggregates in setting stabilization pol-icy. Francis (1968, p. 8) rejected the use of fiscalactions as a tool for stabilization, arguing that“monetary actions are a major determinant ofshort-run movements in total spending.” He alsorejected the common view that interest rates andbank credit reflect accurately the stance of mone-tary policy. Francis (1968) argued that “move-ments in interest rates should be viewed no differ-ently than movements in commodity prices” (p. 8). Instead, Francis pushed for the “primaryand consistent use of monetary aggregates” in set-ting policy, noting that “all of these aggregates canbe rather precisely controlled by monetaryauthorities” (p. 8). This approach would serve thedual purpose of holding the authorities account-able for their actions and instituting “scientificmethodology and modern quantitative analysis”to monetary policy (p. 7).

At an FOMC meeting on February 4, 1969,Francis reviewed how the Committee had beenmisled by the behavior of interest rates and bankcredit:

For about four years the Committeehad been led into unintended inflationarymonetary expansion while followinginterest rate, net [free] reserves, and bankcredit objectives If the Committeemeant business now, it should try someother guides. Not only could the oldguides lead to further inflation as long asdemands for credit continued to rise, butwhen and if contrary trends set in theycould lead to an undue contraction oftotal spending.

Francis also made clear his preferred policyguides: “He urged the Committee to give some evi-dence that it was exercising restraint by limitingthe growth of bank reserves, the monetary base,and the narrow measure of money supply” (FOMCMinutes, February 4, 1969, p. 47).

Francis believed strongly that inflation wasthe consequence of excessive monetary growth,and that the Fed had erred in pursuing policiesthat resulted in accelerating growth of the mone-tary aggregates. In essence, Francis attacked thedominant view that policy should be aimed at sta-bilizing short-run variation in economic activity,as reflected in the unemployment rate, at theexpense of higher inflation. At an FOMC meeting

on May 11, 1971, Francis reviewed the course ofmonetary policy and inflation over the previous20 years:

During the ten-year period ending in late1962, money grew at an average annualrate of 1.5 per cent With the econom-ic sluggishness of the early 1960’s monetary stimulation was increased, andmoney rose at a 3.5 per cent averageannual rate from late 1962 to the end of1966 [T]hat rate of monetary expan-sion resulted in a gradual increase ininflation to a 3 per cent rate. Followingthe credit crunch of 1966 money growthwas again accelerated, producing a 6.3per cent average annual rate from early1967 to the present [A] 6 per centtrend rate of monetary expansion implieda sustained 4 per cent rate of inflation. Ineach case the rate of growth in moneywas accelerated in order to overcomeweakness in the economy. Despite thoseprogressively more stimulative monetaryactions, the rate of unemployment hadaveraged about the same whether thetrend growth of money was 6 per cent,3.5 per cent, or 1.5 per cent. The trendgrowth had had its chief impact on prices,whereas fluctuations around the trendhad had the greatest impact on produc-tion and employment. (FOMC Minutes,May 11, 1971, pp. 57-58)

Francis’s perspective reflected his monetaristoutlook: He argued that inflation is primarilydetermined by the rate of growth of the moneystock and that, in the long run, real output growthand the unemployment rate are unaffected bymonetary policy. In other words, the long runPhillips curve is vertical.24 Francis also arguedthat while monetary policy has no effect on realgrowth or employment in the long run, fluctua-tions in monetary growth could have substantialeffects on these variables in the short-run. Heused the Andersen and Jordan (1968) results, andthose of other Bank economists, to support hisclaim.

24 The distinction between short- and long-run Phillips curves was for-malized by Friedman (1968) and Phelps (1967).


R E V I E W

Although some members of the Committeeshared Francis’s views, the chairman and a majori-ty of others did not. In one of the most frank dec-larations of the opposing view, Chairman WilliamMcChesney Martin stated at the October 7, 1969,FOMC meeting that he “did not accept the mone-tarist’s position regarding the critical importanceof the specific rate of change in the money supply.In particular, he did not agree that the conse-quences of deviating significantly from some pre-ferred rate for a period of time would be as disas-trous as the monetarists believed” (1969, p. 1100).Board economists Gramley and Chase (1965, p.1403) went even farther, arguing, “there is littledoubt that such a simple rule [based on changesin the money stock] for appraisal of central bankoperations is no longer appropriate.”25

Francis cited Federal Reserve Bank of St. Louisresearch often and at least once entered St. Louisstaff forecasts of real output and inflation underalternative money stock growth rates into the for-mal record of FOMC deliberations. His first record-ed reference came at the December 17, 1968,meeting when he discussed “a recent study done atthe St. Louis Reserve Bank [which] indicated thatwith the existing stance of fiscal policy, if moneycontinued to grow at a 6 per cent annual ratethroughout the coming year, gross national prod-uct would rise at an excessive 8 per cent annualrate” (FOMC Minutes, December 17, 1968, p. 54).

Francis’s discussion illustrates that St. LouisFed officials (and monetarists in general) hadbegun to actively engage the prevailing wisdom onits own short-run grounds. The AJ results, ineffect, provided a platform by which monetaristpolicy prescriptions, oriented to the behavior ofthe monetary aggregates, could be discussed interms of short-run stabilization issues. With oneeye cocked to the longer-term inflationary effectsof policy, something that the conventional viewdid not provide, monetarists could also discuss theshort-run effects of monetary policy.

Francis’s use in FOMC meetings of researchconducted by St. Louis Fed economists illustrateshow the Fed’s decentralized organizational struc-ture can affect policy deliberations. The participa-tion of Federal Reserve Bank presidents in mone-tary policymaking provides an outlet for alterna-tive perspectives to be heard, including direct criti-cism of System policy. In addition to bringing theresearch findings of his staff to FOMC delibera-

tions, Francis also promoted St. Louis Fed researchin his numerous public appearances. Citing “forth-coming articles,” Francis often talked about lags inthe impact of monetary policy and how theymade attempts to “fine tune” a balance betweeninflation and unemployment difficult, if notimpossible.26 Even so, the behavior of the econo-my in the late 1960s gave credence to the claimthat nominal spending responded, albeit with alag, more to changes in money supply growththan to fiscal policy. The “mini-recession” of 1966and the failure of tax increases in 1968 to halt theupward march of inflation seemed to support theefficacy of monetary over fiscal policy. Whilesome of his FOMC colleagues had urged tighterfiscal policy to stem inflation in 1968, and sup-ported the temporary tax increase that had beenenacted, Francis contended that the tax increasewas unlikely to have a significant effect on eco-nomic activity.27 As Francis predicted, the tempo-rary fiscal measures adopted in 1968 had minimalimpact on economic activity.

THE ST. LOUIS MODEL: MONETARISMFOR THE SHORT-RUN

The predictive success of the St. Louis (AJ)equation and the apparent failure of fiscal policyto stem the inflation of the late 1960s gave mone-tarists credibility in policy discussions. The behav-ior of the money stock began to get more consid-

25 Gramley recalls the policy debates this way: “ if the FederalReserve had appreciated how serious the inflationary problem wasgoing to become, they would have paid more attention to thegrowth of the monetary aggregates and relied less on money mar-ket conditions if you weren’t worried too much about long-runinflation you were inclined therefore not to pay sufficient attentionto what was happening to those aggregates” (quoted in Mayer,1995, pp. 7-8).

26 For example, at an FOMC meeting on March 9, 1971, he noted that“In the past the System had, on occasion, persisted in a policycourse too long. Knowledge of current developments in the econo-my was available only with a delay, and the effects of monetaryactions on spending, production, prices and employment contin-ued for months” (FOMC Minutes, March 9, 1971, p. 66).

27 As Francis summarized his position before the FOMC, “Over thepast year the System had aggressively advocated fiscal restraint as anecessity to rational stabilization policy. Yet now that such restraintappeared likely, there seemed to be growing fear of its destabilizingimpact. [He] did not share those views Those fiscal measureswere generally expected to be temporary, and thus much of the taxburden on consumers would probably come from reduced savingand much of the burden on corporations would probably comefrom increased borrowing The tax measure, because of its tem-porary nature, might actually cause some acceleration of invest-ment spending” (FOMC Minutes, June 18, 1968, pp. 87-88).



eration in the setting of stabilization policy.28 Butsome observers, even Homer Jones, the St. LouisBank’s research director when the St. Louis modelwas developed, sounded a note of caution:

Our own econometric studies at St. Louishave long indicated strong, roughly pre-dictable, relations between monetary action,intentional or unintentional, and the courseof the economy does this mean we canexpect to engage usefully in active monetarymanagement in the future? I concludethat we cannot in the near future engage intel-ligently in short-run manipulative monetarymanagement. (1970, p.15, emphasis added)

Darryl Francis also warned against using mone-tary policy to fine-tune economic activity. Thesuccess of the AJ equation and the building empir-ical evidence in support of monetarist views, how-ever, led to a greater focus on the short-run. In hisretrospective of the equation’s development anduse, Jordan (1986, p. 8) notes that “The [AJ] arti-cle’s impact on economic policymaking wouldhave been more favorable had it not led to anincreased reliance on monetary over fiscal policy,but had it instead contributed to a general de-emphasis of fine-tuning attempts by policymak-ers.”

The increasingly short-run emphasis undoubt-edly reflected, in part, the natural focus of policy-making at the central bank. Dewey Daane, aFederal Reserve governor, noted that the FOMCwas “always concentrating on what’s the immedi-ate problem over the next four to six weeks andnot really thinking in terms of long-run forecastsand inflation” (quoted in Mayer, 1995, p. 16).Governor Andrew Brimmer’s recollection corrobo-rates this view, noting that there was “clearly ashort-term horizon. [Chairman] Martin put a lot ofemphasis on the long run, but that was unusual”(quoted in Mayer, 1995, p. 4).

In April 1970, the Federal Reserve Bank of St.Louis published “A Monetarist Model forEconomic Stabilization,” by Andersen and Carlson(hereafter, AC). The AC, or “St. Louis” model as ithas become known, reflected the latest stage inthe development of an empirical model of mone-tarist propositions and expanded the on-goingdebate over the role of money in determiningaggregate spending and inflation in an importantway. Unlike the large-scale macroeconometric

models being developed elsewhere, the St. Louismodel built upon previous research at the Bank inwhich the money stock is the central focus of sta-bilization policy.

The original St. Louis model consisted of eightequations, only four of which were estimated: thetotal spending equation—the AJ equation, a priceequation, an equation for the long-term interestrate, and an unemployment equation. Theremaining equations are definitions.29 The interestrate equation, based on earlier work by Yohe andKarnosky (1969), reflected the view that interestrates are determined by past inflation and pastchanges in money growth. The unemploymentequation was essentially that developed by Okun(1962). The price equation rejected the typicalwage-price markup approach popular at the time.Instead, AC specified the change in the price levelas a function of demand pressures and anticipatedprice changes.

The St. Louis model is “monetarist” in that themoney stock is treated as exogenous and its effecton total spending is central to the workings of themodel.30 As AC state:

The change in total spending is combinedwith potential (full employment) output toprovide a measure of demand pressure.Anticipated price change, which dependson past price changes, is combined withdemand pressure to determine the changein the price level. The total spending iden-tity enables the change in output to bedetermined, given the change in totalspending and the change in prices. (p.10)

28 In reviewing the discussion of monetary policy at a recent confer-ence, Friedman wrote to Homer Jones in July 1969 that “I, too,have been very much impressed with the evidence that a new dayhas dawned I almost fell over when he [Board Governor DeweyDaane] started talking about the importance of paying attention tomonetary aggregates” (Friedman Papers, Box 28, Folder 36).

29 The original model is summarized in the Appendix. Carlson (1986)provides a comparison of the original version and the then “cur-rent” version which reflects modifications over the interveningyears.

30 AC determine real output as a residual; that is, output is deter-mined as the difference between total spending and the price level.As they note, “This method of determining the change in totalspending and its division between output change and price changediffers from most econometric models. A standard practice ineconometric model building is to determine output and prices sep-arately, then combine them to determine total spending” (p.10).


R E V I E W

The structure of the model meant that for agiven change in the money supply or governmentexpenditures, one could solve for changes in totalspending, prices, real output, the unemploymentrate, and interest rates. The model was simple incomparison with the complex structural modelsused by the Board staff and elsewhere. For exam-ple, whereas the Wharton model, a representativeKeynesian structural model, had 43 exogenousvariables, the St. Louis model had just three. Themodel also omitted details about specific sectorsfor the simplicity of determining the impact of achange in money growth on the economy broadly.This development fit nicely with the view of manymonetarists that “the Federal Reserve should beconcerned with the aggregate effects of policy,and should leave the allocative details to the oper-ation of the market” (Francis 1973, p. 9).31 AsCarlson (1986, p. 18) recollects the developmentof the model,

we wanted a model that was small enoughthat the interrelationships among the varablescould be understood easily We were notconcerned about respecifying behavioralequations [and] we wanted to captureempirical relationships between a relativelyfew key macroeconomic variables that wereimplicitly grounded in economic theory.

AC state explicitly that their statistical analysisis used “to estimate the response of output andprices to monetary and fiscal actions, not to test ahypothesized structure” (pp. 10-11).32 The originalestimates appeared to support the monetarist viewof the world: an increase in the money supplyleads first to an immediate increase in nominalspending and real output, and only after pricesadjust to the higher demand pressure does theprice level rise to stifle the increase in real output.

Using the Model for Short-RunAnalysis

Andersen and Carlson used the St. Louismodel to simulate nominal spending, real output,inflation, and the unemployment rate for differenthypothesized growth paths for money. They alsocompared their monetarist model’s forecastingability with that of the Wharton model during1963-64, a period that included a major fiscalaction—the tax cut of 1964. How would the St.

Louis model, in which fiscal policy plays a minorrole, fare in comparison with the Wharton modelin which fiscal policy has a much larger role thanmoney? The St. Louis model’s simulations werebetter (i.e., produced lower root-mean-squarederrors) than the Wharton model for nominal GNPand the unemployment rate, about the same forreal GNP, and worse for the price level. The upshotwas that this small, monetarist-oriented modelcould prove as valuable to policymakers as thelarge-scale Keynesian models then in use.Importantly, it seemed to demonstrate the useful-ness of a small monetarist model for currentanalysis. As AC state, “The purpose of the follow-ing statistical section is to estimate the response ofoutput and prices to monetary and fiscal actions,not to test a hypothesized structure. The focus ison the response in the short run—periods of two orthree years—but the long-run properties also areexamined” (1970, pp. 10-11, emphasis added).

The success of the St. Louis model was impor-tant to monetarism’s growing impact on policydiscussions. It also appeared soon after Friedman(1968) and Phelps (1967) provided theoreticalmodels in which the popular Phillips curve trade-off between inflation and unemployment (and,hence, real output growth) was shown to be transi-tory. The Phillips curve, a version of whichappears in the St. Louis model, was a critical com-ponent of most Keynesian macro-models of thetime. The results of AC provided an empiricaldemonstration that although expansionary mone-tary policy might produce a short-run increase inreal output growth and a dip in the unemploy-ment rate, these effects would vanish over time asinflation increased and unemployment and outputgrowth returned to their “natural” or trend rates.

The St. Louis model enabled monetarists toproduce short-run forecasts of alternative policyscenarios, thereby putting them on similar footing

31 A recurrent theme in discussions about the role of policy was therecognition that policy actions sometimes affected certain indus-tries—most notably housing—more than others. Such attentionwas disruptive to the working of market forces, Francis believed. Henoted that “Regulation of interest rates paid by commercial banksand thrift institutions unduly disrupts the allocation function ofmarkets. Furthermore, excessive concern for the well-being ofthese institutions and the housing industry has caused monetaryauthorities to expand the money stock at a rapid rate during muchof the current inflationary period” (1968, p. 9).

32 Francis (1973, p. 8) makes the point that “The bewildering strug-gles that occur between model builders over specification errors,structural versus reduced-form models, recursive versus non-recur-sive systems, etc., are meaningless to most policymakers.”



with other mainstream economists, both in andoutside of the Federal Reserve System. Dewald(1988, p. 6) contends that with the development ofthe St. Louis model, “monetarism was widely inter-preted as providing an alternative to short-runKeynesian model forecasts.” The St. Louis model,though grounded in the long-run conditions of theQuantity Theory, increasingly was used to counterthe short-run policy prescriptions coming fromthe larger structural models in use at the Board.The St. Louis model, estimated using quarterlyobservations and with the money stock—notinterest rates—as the policy instrument, led manyobservers to conclude that the money stock couldbe an effective tool for economic stabilization.

The shifting emphasis at the St. Louis Banktoward short-run policy analysis can be found incomments of participants in the model’s develop-ment. Carlson (1972, p. 25) warned against usingthe model for anything but interpreting the “gen-eral time path” of important macroeconomic vari-ables. Even so, analysis of the short-run impact ofalternative policies is precisely what the modelcame to be used for. His own admonition aside,Carlson (1972, p. 20) noted that the model “pres-ents a set of simulations using alternative steadygrowth rates which can aid in assessing the eco-nomic impact over several quarters of differenttrend growth rates of money” (emphasis added).In keeping with this view, his analysis of themodel’s performance was based on a six-quarterhorizon, hardly the long run used by early mone-tarist studies. But such a use for the modelappeared justified by the empirical results: “themodel succeeded in roughing out the average timepaths of total spending, real product, prices,unemployment, and interest rates during the peri-od from late 1969 to mid-1971” (Carlson, 1972, p.26, emphasis added).

The model’s success as a forecast tool gavesupport to monetarist calls for a policy aimed atstable money growth. In reviewing the debate overstabilization policy, Andersen (1973, p. 3) summa-rized the model’s success at forecasting real outputand inflation, stating that “The key proposition isthat changes in money dominate other short-runinfluences on output and other long-run influenceson the price level and nominal aggregate demand”(emphasis added). The St. Louis model suggestedthat stable money growth would lessen anymonetary-induced instability in the real economywhile promoting price stability in the long run.

Research from St. Louis continued to provide along-term, inflation-oriented perspective on mon-etary policy actions, reflecting rising inflation ofthe early 1970s. At the same time, the Review con-tained numerous studies, often authored byAndersen or Keran, of the short-run response ofthe economy to changes in the growth of themonetary aggregates. The allure of short-runanalysis perhaps is best illustrated by Carlson’s(1975) estimation of the St. Louis equation usingmonthly data. Replacing nominal GNP with per-sonal income, Carlson found that the lag fromchanges in the growth of money to nominalincome was completed in about one year, similarto that found by AJ, though slower than reportedin other studies.33 The implication of this findingwas clear: Carlson (1975, p. 17) suggests that the“Use of monthly data thus appears to carry thepotential for evaluating the thrust of monetaryand fiscal actions before quarterly data on GNPbecome available.”

In the late 1960s, public interest in mone-tarism rose as inflation continued to increase.Monetarists were called upon by the incomingNixon administration for advice. Milton Friedmanwrote a regular column for Newsweek alongsideone by Paul Samuelson, who had been a leadingadvisor to the previous two administrations and aleading architect of the so-called New Economics.Increased attention, however, brought more stri-dent criticism. By 1972 there already were claimsthat monetarism had “failed.” For example, in hisNewsweek column of August 2, 1971, Samuelsonobjected to the monetarist claim that rapid moneygrowth in 1971 would subsequently lead to fasternominal GNP growth. He suggested that “the fore-casting ability of monetarism is selling at a hugediscount on the markets of informed opinion”(Samuelson 1971, p. 70) and that the “pseudoposi-tivism which prevails among monetarists. . . [is]still another reason why the peculiar tenets ofmonetarism have to be rejected” (quoted inFrancis, 1972, p. 32).

Members of the Board of Governors also criti-cized the policy advice of monetarists. For exam-ple, Andrew Brimmer, echoing arguments madeduring the previous two decades, rejected any pol-icy based on control of the monetary aggregates:“I am convinced that it would be a disastrous

33 Another example of attempts to model the short-run effects ofmoney on the economy is Laffer and Ransom (1971). Unlike the St.Louis results, Laffer and Ransom report that monetary actions leadto an immediate and permanent effect on the level of GNP.


R E V I E W

error for the Federal Reserve to try to conductmonetary policy on the basis of a few simple rulesgoverning the rate of expansion of the moneysupply” (1972, p. 351).

Francis (1972, p. 32) considered such attacks“strident,” “doctrinaire,” and “no more precisethan in the past.” He answered these criticisms bypointing to the St. Louis model’s ability to forecasteconomic activity over the short-run. He com-pared income, inflation, and unemployment pre-dictions for 1969, 1970, and 1971 derived fromthe St. Louis model to those of the consensusLivingston forecasts. The overall forecasting abilityof the St. Louis model compared favorably withthe consensus forecasts. Although Francis main-tained that policy should take a longer-term viewto be effective, he focused on a few years of fore-casting results to justify applying the model toshorter time horizons.

Refining the Model

As the 1970s progressed, neither Keynesianmodels based on the Phillips curve and interestrates, nor simple monetarist models based ongrowth of the money stock, successfully forecastthe rapid inflation and higher unemployment thatactually occurred. Monetarists faced the task ofexplaining why inflation had increased so dramat-ically without a similar-sized increase in moneystock growth. Monetarists, including St. Louis Fedofficials, responded that their critics had confusedchanges in the aggregate price level, which arecaused by monetary policy, with changes in rela-tive prices brought on by special factors. Francispresented the Bank’s position in a series ofspeeches in 1974. He pointed out that the increasein inflation was due largely to an increase inmoney growth over the preceding few years. Anyinflation over and above the underlying monetarygrowth rate was caused by the removal of wageand price controls and the increase in oil prices bythe OPEC nations.34

St. Louis Fed economists soon integrated suchspecial factors in their studies. Karnosky (1976)demonstrated that money growth continued toexplain longer-term movements of inflation oncethe oil price shock effects were accounted for.Rasche and Tatom (1977) extended this idea intheir examination of the effects of supply shockson the economy and how they could distort thestatistical relationship between money andincome in the short-run. Although aspects ofthese works were criticized, they suggested that

the money supply remained useful for stabiliza-tion purposes.

The Breakdown of the Monetarist Rule

Kane (1990) observes that as the rate of inflationcontinued to increase over the 1970s, the growingweight of evidence supporting the monetarist posi-tion pushed the FOMC to incorporate money stockgrowth into their policy deliberations and evalua-tions. This was quite a change from their position ofa decade earlier when “they treated monetarism asan eccentric and quasi-religious belief system thatno responsible macroeconomist or public officialcould possibly take seriously”(p. 292).

Monetarism as a policy approach, however,had a relatively short stay in the limelight. InOctober 1979, the Federal Reserve adopted newoperating procedures that it claimed wouldenhance its control of the money stock. Highlyrestrictive policies also were enacted to reduceinflation, which had reached double-digit levels.Although inflation eventually declined significant-ly, the more immediate effect was to send theeconomy into the deepest recession of the post-war period. Critics associated the policy withmonetarism, referring to the policy as the Fed’s“monetarist experiment,” and this perception con-tributed to the widespread discounting of mone-tarism as a viable policy option. Monetaristsprotested that the Fed had not, in fact, adoptedtheir preferred policy of slow and steady moneygrowth. Rather, they noted, the variability ofmoney growth actually increased after 1979 andgave rise to increased fluctuations in real econom-ic activity without any appreciable short-run effecton inflation.35

34 Francis argued similarly in FOMC deliberations. At a meeting onJanuary 22, 1974, for example, Francis contended that “the actualand prospective slowdown in economic activity resulted whollyfrom capacity, supply, and price-distorting constraints and not froma weakening in demand. Therefore, to ease [monetary] policy andallow a faster rate of monetary growth would be to increase infla-tionary pressures without expanding real output or reducing unem-ployment” (FOMC Minutes, January 22, 1974, p. 102).

35 Batten and Stone (1983) provide an overview of the issues and evi-dence in support of the monetarist position. For contrasting assess-ments of this episode, see B. Friedman (1984) and M. Friedman(1984). Charles Schultz, Chairman of the Council of EconomicAdvisors from 1977-81, considered the monetarist experiment inthis light: “What monetarism really is for the Fed (and I’m morallycertain this is what Volcker thinks, too) a political cover. They’renot monetarists, but it allowed them to do what they could neverhave done They could never have done what needed to bedone if it looked as if they were the ones raising interest rates,when they were targeting interest rates, per se. But with fixedmonetary targets they could just say, ‘Who, us?’” (quoted inHargrove and Morely, 1984, p. 486).

Regardless of whether the Fed had in factadopted a monetarist policy in 1979, large, volatilemovements in velocity began to erode profession-al support for monetarist policies. Inflation andattendant increases in market interest ratesencouraged financial innovations that gave con-sumers more options for holding liquid balances.This, in turn, spurred regulatory changes that pro-duced sharp changes in the relative demands forliquid financial assets. At the same time, the Fed’sabrupt tightening brought a sharp decline in therate of inflation, which probably contributed to areversal of the upward trend in velocity that hadcharacterized the previous three decades.36 Assetdemand shifts and uncertainty about the Fed’scommitment to a new path for inflation probablyexplain why the velocity of traditional measuresof the money stock, especially the narrow meas-ures, such as M1, favored by officials of theFederal Reserve Bank of St. Louis, began to moveerratically. Stable velocity was crucial for thereduced-form models used at St. Louis to hold. Ifthe path of velocity changed unpredictably, thenthe predictions of the St. Louis equation andmodel could be unreliable.37 As velocity began todeviate seriously and continuously from its previ-ously stable path, monetarist policy prescriptionsbecame increasingly suspect.

As shown in Figure 1, the velocity of M1—themonetary aggregate used in the St. Louis model—maintained a fairly steady upward climb duringthe 1960s and 1970s. During the 1980s, however,M1 velocity deviated considerably from its previ-ous path. M1 velocity appeared to become “unsta-ble,” thus justifying critics’ opposition to monetarytargeting.38

As M1 velocity deviated further from its his-toric trend, St. Louis Fed researchers devotedincreasing effort to understanding velocity andmodifying their forecasting model. Meyer andVarvares (1981), for example, made two modifica-tions: one modification was to model the rate ofinflation as a direct outcome of money growthand oil price shocks; the other modification incor-porated a new Phillips curve relation. Other St.Louis Fed studies researched the lag betweenmoney and prices (Carlson, 1980), the effects offiscal policy (Hafer, 1982), and the longer-runconsequences of policy (Carlson and Hein, 1983).These studies all concluded that the reduced-formapproach continued to be a reasonable way ofmodeling the impact of monetary policy on the

economy, and early success at improving modelforecasts encouraged further research along thesame lines. But, because the shift in velocity hadoccurred only recently, and therefore affectedonly a limited number of observations used in theestimation of the model, these papers largelyignored the potential effects of the shift. Indeed,even Carlson’s (1986) version of the model, onethat made minor revisions that recognized the

1960 1970 1980 1990 20003

4

5

6

7

8

9

10

Pre-1980 Trend

M1 Velocity

Velocity of Money (M1)Quarterly Data, 1960 Through 1999



36 Gavin and Dewald (1989) show that disinflation leads to a reduc-tion in velocity once the public comes to expect that a new trendgrowth rate of money and the price level have been established.

37 This potential problem was already known. For example, Rasche(1972) noted that the successful forecasting ability of the St. Louisequation was, in part, based on the small interest elasticity of themoney demand function. As he states (p. 31): “if the short-runinterest elasticity of the money demand function is very small,then an estimated equation omitting this term [the interest rate]would most likely produce a credible forecasting record” (emphasisin original). In some sense, the constant term in equation (1) is theempirical representation of velocity. Financial innovations alteredthe underlying short-run interest elasticity of money demand andadversely affected the equation’s forecasting ability. Because nochanges along these lines were made to the model, its forecastsbegan to stray. More recent investigations of the behavior of veloci-ty include Stone and Thornton (1987), Rasche (1993), Hoffman andRasche (1996), and Laurent (1999).

38 Monetarists had long divided over whether a narrow aggregate,such as the monetary base or M1, or a broader aggregate, such asM2 or M3, was a preferable target for monetary policy. St. LouisFed officials advocated M1, while Milton Friedman favored M2.When M1 velocity began to deviate from its trend in the early1980s, M2 velocity remained relatively stable. By the early 1990s,however, M2 velocity also had deviated substantially from its long-run trend.

Figure 1


R E V I E W

impact of energy prices, wage and price controls,and several other technical changes, continued tofit the data reasonably well. Thus, for a time, mon-etarists continued to argue that nominal incomegrowth reflected changes in money growth overshort periods and that inflation reflected moneygrowth over longer periods, even during thisturbulent time. As the 1980s progressed, however,continued instability of velocity caused all but themost diehard supporters to abandon short-runmonetary aggregate targets.

LESSONS FROM THE ST. LOUISEXPERIENCE

The development and decline of the St. Louismonetarist model as a guide to short-run stabiliza-tion policy is not unlike the evolution of stabiliza-tion policies designed to exploit a tradeoffbetween inflation and unemployment. Policiesbased on the Phillips curve arose from an appar-ently robust empirical relationship between infla-tion and unemployment observed in macroeco-nomic data. As discussed in King and Watson(1994), the negative correlation between the vari-ables in the short-run suggested the presence of along-run structural relationship that could beexploited for policy purposes. Attempts to manip-ulate interest rates to increase the growth of realoutput and employment above potential, however,gave rise to what has been called “the great infla-tion” in the United States, a period encompassingthe 1960s and 1970s.39

Over the 1970s, as inflation and unemploy-ment rose simultaneously, monetarists gained astronger voice in monetary policy debates as thelong-run relations among money, prices, andnominal income seemed to hold even in theshort-run. Due in part to work at the FederalReserve Bank of St. Louis, Woodford (forthcoming,p. 18) suggests that “the monetarist viewpoint hadbecome the new orthodoxy by the mid-1970s.”

The St. Louis Bank and its officials had specialprominence because they provided an avenue formonetarist research and views to potentiallyinfluence policy deliberations. To be influential,however, monetarists had to offer a viable policyfor the short-run—a policy that could be discussedand voted on at meetings some six weeks apart.The success of the St. Louis model at forecastingoutput, nominal income, and prices over suchshort horizons during the 1970s convinced St.

Louis Fed officials that they could credibly advocatea monetarist stabilization policy for the short-run.

The Federal Reserve took a step toward mone-tary aggregate targeting in October 1979, whennew procedures were implemented to better con-trol the money stock with the goal of reducinginflation. The targeting of monetary aggregates waslargely abandoned in 1982, however, when velocity,particularly of M1—the narrow aggregate favoredby St. Louis Fed officials—proved too erratic.

Deregulation, other institutional changes, anduncertainty about the Fed’s commitment to disin-flation probably explain much of the unstablebehavior of velocity in the 1980s. The DepositoryInstitution Deregulation and Monetary Control Actof 1980 (DIDMCA) instituted a six-year processending the prohibition of interest payments ontransaction accounts at commercial banks andderegulating rates on other accounts. Thesechanges, and various financial innovations, werefollowed by volatile flows between classes offinancial assets that altered the empirical relation-ships between national income and monetaryaggregates. Monetary aggregates quickly lost favoras short-run policy targets when movements invelocity became difficult to explain or predict. Inessence, changes in the structure of the economyaltered the short-run relationships between tradi-tional monetary aggregates and policy objectives.Monetarist models, including the St. Louis model,were not equipped to handle such changes, andtheir forecasting performance suffered as a result.

Typical macroeconomic models of the 1970s,including the St. Louis model, also were notequipped to deal with the so-called “LucasCritique.” Lucas (1976) demonstrated that coeffi-cient estimates of typical forecasting models areunlikely to be stable across policy regimes. Asindividuals learn about and modify their behaviorin response to a change in regime, empirical rela-tionships among macroeconomic variables maychange. Consequently, economic projectionsbased on estimation of a model over one regimemay not be valid for a different regime. For exam-ple, the close short-run correlations amongmoney, output, and prices observed during the1960s and 1970s under a regime characterized byinterest rate targeting would not necessarily havebeen so close in a regime of monetary aggregate

39 For alternative views of this period, see DeLong (1997), Mayer(1999), Sargent (1999), Taylor (1999), or Wheelock (1998).



targeting.40

The search for robust empirical relationshipsacross different regimes has shown that money,nominal income, and inflation remain closelylinked in the long run (Dewald, 1998; Dwyer andHafer, 1999; Lucas, 1996; Rolnick and Weber,1997). There also is some evidence that the link-ages between money and economic activity arerobust even at relatively short-run frequencies.41

Monetary aggregates again may prove useful foreconomic forecasting or as guides for conductingmonetary policy. Experience has shown, however,that empirical relationships between policy vari-ables and goals can change, sometimes unpre-dictably. The experience with the monetarist ruleas developed at the St. Louis Fed councils againstoverconfidence in our ability to identify infalliblerules for conducting short-run stabilization policy.

REFERENCES

Andersen, Leonall C. “Federal Reserve DefensiveOperations and Short-Run Control of the Money Stock.”Journal of Political Economy, March/April 1968, p. 275-88.

__________. “The State of the Monetarist Debate.”Federal Reserve Bank of St. Louis Review, September1973, 55(9), pp. 2-8.

__________ and Jordan, Jerry L. “Monetary andFiscal Actions: A Test of Their Relative Importance inEconomic Stabilization [reprint].” Federal Reserve Bankof St. Louis Review, October 1986, 68(8), pp. 29-44.

__________ and __________. “Monetary andFiscal Actions: A Test of Their Relative Importance inEconomic Stabilization.” Federal Reserve Bank of St.Louis Review, November 1968, 50(11), pp. 11-24.

__________ and Carlson, Keith M. “A MonetaristModel for Economic Stabilization.” Federal Reserve Bankof St. Louis Review, April 1970, 52(4), pp. 7-25.

Ando, Albert; Brown, E. Cary; Solow, Robert M. andKareken, John. “Lags in Fiscal and Monetary Policy,” inStabilization Policies: Commission on Money and Credit.Englewood Cliffs, NJ: Prentice Hall, 1963, pp. 1-164.

Ando, Albert and Modigliani, Franco. “The RelativeStability of Monetary Velocity and the InvestmentMultiplier.” American Economic Review, September 1965,pp. 693-728.

Angell, James W. “Appropriate Monetary Policies andOperations in the United States Today.” Review ofEconomics and Statistics, August 1960, pp. 247-52.

Barro, Robert J. “Inflation and Growth.” Federal ReserveBank of St. Louis Review, May/June 1996, 78(3), pp. 153-69.

Batten, Dallas S. and Stone, Courtenay C. “Are Monetaristsan Endangered Species?” Federal Reserve Bank of St.Louis Review, May 1983, 65(5), pp. 5-16.

__________ and Thornton, Daniel L. “The Monetary-FiscalPolicy Debate and the Andersen-Jordan Equation.”Federal Reserve Bank of St. Louis Review, October 1986,68(8), pp. 9-17.

Brimmer, Andrew F. “The Political Economy of Money:Evolution and Impact of Monetarism in the FederalReserve System.” American Economic Review, May 1972,pp. 344-52.

Bronfenbrenner, Martin and Holzman, Franklin D. “Surveyof Inflation Theory.” American Economic Review,September 1963, 52, pp. 593-661.

Brunner, Karl. “Fiscal Policy in Macro Theory: A Surveyand Evaluation,” in R.W. Hafer, ed. The Monetary VersusFiscal Policy Debate: Lessons from Two Decades. Totowa,NJ: Rowman and Allanheld, 1986, pp. 33-116.

__________ and Balbach, Anatol B. “An Evaluation of Two Types of Monetary Theories.” Proceedings of theThirty-Fourth Annual Conference of the WesternEconomic Association, 1959, pp. 78-84.

Burger, Albert E. The Money Supply Process. Belmont, CA:Wadsworth Publishing Co., 1971.

40 The monetarist experience, in which proponents sought to replaceone regime with another, contrasts with Taylor’s (1993) proposal forthe Fed to continue the policy rule that he found described recentpolicy well. Researchers have, however, questioned how well theTaylor rule actually represents Fed policy. Orphanides (1997), forexample, shows that a Taylor rule derived from real-time data pro-duces a federal funds rate path over the past decade that is quitedifferent from that found using revised data. Kozicki (1999) showsthat Taylor rule predictions are not robust to differences in meas-ures of inflation, the output gap, the real interest rate, and to differ-ent parameterizations. Finally, Hetzel (2000) argues that use of theTaylor rule within an activist model of monetary policy will misleadpolicymakers as they attempt to control inflation.

41 Dwyer and Hafer (1988, 1999) find that for a large cross-section ofcountries the correlation between money growth and nominalincome is close to unity even over short time horizons. Similarly,based on estimates of a small VAR model with quarterly U.S. data,Dwyer (1998) concludes that the link between money and nominalincome may be much closer than some have claimed. Finally, usinga recursive estimate of equilibrium M2 velocity, Orphanides andPorter (2000) find that monetary aggregate-based forecasts of infla-tion for the 1990s are quite accurate.


R E V I E W

Carlson, Keith M. “Projecting with the St. Louis Model: AProgress Report.” Federal Reserve Bank of St. LouisReview, February 1972, 54(2), pp. 20-26.

__________. “The St. Louis Equation and Monthly Data.”Federal Reserve Bank of St. Louis Review, January 1975,57(1), pp. 14-17.

__________. “Money, Inflation, and EconomicGrowth: Some Updated Reduced Form Results and Their Implications.” Federal Reserve Bank of St. LouisReview, April 1980, 62(4), pp. 13-19.

__________. “A Monetarist Model for EconomicStabilization: Review and Update.” Federal Reserve Bankof St. Louis Review, October 1986, 68(8), pp. 18-28.

__________ and Hein, Scott E. “Four Econometric Modelsand Monetary Policy: The Longer-Run View.” FederalReserve Bank of St. Louis Review, January 1983, 65(1),pp. 13-24.

Davis, Richard G. “The Role of the Money Supply inBusiness Cycles.” Federal Reserve Bank of New YorkMonthly Review, April 1968, pp. 63-73.

__________. “How Much Does Money Matter? A Look at Some Recent Evidence.” Federal Reserve Bankof New York Monthly Review, June 1969, pp. 119-31.

DeLeeuw, Frank and Kalchbrenner, John. “Monetary andFiscal Actions: A Test of Their Relative Importance inEconomic Stabilization—Comment.” Federal ReserveBank of St. Louis Review, April 1969, 51(4), pp. 6-11.

DeLong, J. Bradford. “America’s Only Peacetime Inflation:The 1970s,” in Christina Romer and David Romer, eds.Reducing Inflation. Chicago: University of Chicago Press,1997, pp. 247-76.

__________. “The Triumph of Monetarism?” Journal ofEconomic Perspectives, Winter 2000, pp. 83-94.

DePrano, Michael and Mayer, Thomas. “Tests of theRelative Importance of Autonomous Expenditures andMoney.” American Economic Review, September 1965,pp. 729-52.

Dewald, William G. “Monetarism is Dead; Long Live theQuantity Theory.” Federal Reserve Bank of St. LouisReview, July/August 1988, 70(3), pp. 3-18.

__________ “Historical U.S. Money Growth, Inflation andInflation Credibility.” Federal Reserve Bank of St. LouisReview, November/December 1998, 70(6), pp. 13-23.

Dwyer, Gerald P. Jr. “Is Money Growth a Leading Indicatorof Inflation?” Conference volume from the internationalconference on The Conduct of Monetary Policy, Taipei,Taiwan, June 1998 (forthcoming).

__________ and Hafer, R.W. “Is Money Irrelevant?” FederalReserve Bank of St. Louis Review, May/June 1988, 70(3),pp. 3-17.

__________ and __________. “Are Money and Inflation StillRelated?” Federal Reserve Bank of Atlanta EconomicReview, Second Quarter 1999, pp. 32-43.

Economic Report of the President (various issues).

FOMC Minutes, 1968, 1969, 1970.

Francis, Darryl. “An Approach to Monetary and FiscalManagement.” Federal Reserve Bank of St. Louis Review,November 1968, 50(11), pp. 6-10.

__________. “Has Monetarism Failed? The RecordExamined.” Federal Reserve Bank of St. Louis Review,March 1972, 54(3), pp. 32-38.

__________. “The Usefulness of Applied Econometrics tothe Policymaker: An Address.” Federal Reserve Bank ofSt. Louis Review, May 1973, 55(5), pp. 7-10.

Friedman, Benjamin M. “Lessons from the 1979-82Monetary Policy Experiment.” American EconomicReview, Papers and Proceedings, May 1984, pp. 382-87.

Friedman, Milton, ed. Studies in the Quantity Theory ofMoney. Chicago: University of Chicago Press, 1956.

__________. A Program for Monetary Stability. New York:Fordham University Press, 1960.

__________. “The Role of Monetary Policy.” AmericanEconomic Review, March 1968, pp. 1-17.

__________. “Lessons from the 1979-82 Monetary PolicyExperiment.” American Economic Review, Papers andProceedings, May 1984, pp. 397-400.

__________. “An Interview with Milton Friedman.” FederalReserve Bank of Minneapolis The Region, June 1992.



__________ and Meiselman, David. “The Relative Stabilityof Monetary Velocity and the Investment Multiplier inthe United States, 1897-1958,” in Stabilization Policies.Englewood Cliffs, NJ: Prentice Hall, 1963, pp. 165-268.

__________ and __________. “Reply to Ando andModigliani and to DePrano and Mayer.” AmericanEconomic Review, September 1965, pp. 753-85.

__________ and Schwartz, Anna J. A Monetary History ofthe United States, 1867-1960. Princeton: PrincetonUniversity Press, 1963.

__________ and __________. Monetary Statistics of theUnited States: Estimates, Sources, and Methods. New York:National Bureau of Economic Research, 1970.

__________ and __________. Monetary Trends in the UnitedStates and the United Kingdom: Their Relation to Income,Prices, and Interest Rates, 1867-1975. Chicago: Universityof Chicago Press, 1982.

Gavin, William T. and Dewald, William G. “The Effect ofDisinflationary Policies on Monetary Velocity.” The CatoJournal, Spring/Summer 1989, pp. 149-64.

Gramley, Lyle E. and Chase, Samuel B. Jr. “Time Deposits inMonetary Analysis.” Federal Reserve Bulletin, October1965, pp. 1380-404.

Hafer, R.W. “The Role of Fiscal Policy in the St. LouisEquation.” Federal Reserve Bank of St. Louis Review,January 1982, 64(1), pp. 17-22.

__________. “Against the Tide: Malcolm Bryan and theIntroduction of Monetary Aggregate Targets.” FederalReserve Bank of Atlanta Economic Review, First Quarter1999, pp. 20-37.

Hargrove, Erwin C. and Morely, Samuel A., eds. ThePresident and the Council of Economic Advisors:Interviews with CEA Chairmen. Boulder: Westview Press,1984.

Harris, Seymour E. “Controversial Issues in RecentMonetary Policy: A Symposium, Introduction andSummary.” Review of Economics and Statistics, August1960, pp. 245-47.

Hansen, Alvin H. “Appropriate Monetary Policy, 1957-1960.” Review of Economics and Statistics, August 1960,pp. 255-56.

Hester, Donald D. “Keynes and the Quantity Theory: AComment on the Friedman-Meiselman CMC Paper.”Review of Economics and Statistics, November 1964, pp.364-68.

Hetzel, Robert L. “The Taylor Rule: Is it a Useful Guide toUnderstanding Monetary Policy?” Federal Reserve Bankof Richmond Economic Quarterly, Spring 2000, pp. 1-33.

Hoffman, Dennis and Rasche, Robert H. Aggregate MoneyDemand Functions: Empirical Applications in CointegratedSystems. Boston: Kluwer Academic Publishers, 1996.

Johnson, Harry G. “Monetary Theory and Policy.” AmericanEconomic Review, June 1962, pp. 335-84.

__________. “The Keynesian Revolution and the MonetaristCounter-Revolution.” American Economic Review, Papersand Proceedings, May 1971, pp. 1-14.

Jones, Homer. “Observations on Stabilization Management.”Federal Reserve Bank of St. Louis Review, December1970, 52(12), pp. 14-19.

Jordan, Jerry L. “The Andersen-Jordan Approach AfterNearly 20 Years.” Federal Reserve Bank of St. LouisReview, October 1986, 68(8), pp. 5-8.

Kane, Edward J. “Bureaucratic Self-Interest as an Obstacleto Monetary Reform,” in Thomas Mayer, ed. The PoliticalEconomy of American Monetary Policy. Cambridge:Cambridge University Press, 1990, pp. 283-98.

Karnosky, Denis S. “The Link Between Money and Prices—1971-76.” Federal Reserve Bank of St. Louis Review, June1976, 58(6), pp. 17-23.

Keran, Michael W. “The Effect of Total Demand on RealOutput.” Federal Reserve Bank of St. Louis Review, July 1966, 48(7), pp. 7-12.

King, Robert G. and Watson, Mark W. “The Post-War U.S.Phillips Curve: A Revisionist Econometric History.”Carnegie-Rochester Conference Series on Public Policy,December 1994, pp. 157-219.

Kozicki, Sharon. “How Useful are Taylor Rules forMonetary Policy?” Federal Reserve Bank of Kansas CityEconomic Review, Second Quarter 1999, pp. 5-33.

Laffer, Arthur B. and Ranson, R. David. “A Formal Model ofthe Economy.” The Journal of Business, July 1971, pp.247-70.


R E V I E W

Laurent, Robert D. “Is the Demise of M2 GreatlyExaggerated?” Contemporary Economic Policy, October1999, pp. 492-505.

Lucas, Robert E. Jr. “Econometric Policy Evaluation: ACritique.” Carnegie-Rochester Conference Series on PublicPolicy Vol. 1, The Phillips Curve and Labor Markets, 1976,pp. 19-46.

__________. “Nobel Lecture: Monetary Neutrality.” Journalof Political Economy, August 1996, pp. 661-82.

Maisel, Sherman J. Managing the Dollar. New York: WWNorton & Company, 1973.

Mayer, Thomas. Interviews, Special Collections, GeneralLibrary, University of California–Davis, 1995.

__________. Monetary Policy and the Great Inflation in theUnited States: The Federal Reserve and the Failure ofMacroeconomic Policy, 1965-1979. Cheltenham, UK:Edward Elgar, 1999.

McCallum, Bennett T. “Monetary Versus Fiscal PolicyEffects: A Review of the Debate,” in R.W. Hafer, ed. TheMonetary Versus Fiscal Policy Debate: Lessons from TwoDecades. Totowa, NJ: Rowman & Allanheld, 1986, pp. 9-32.

Meigs, A. James. “Recent Innovations in the Functions ofBanks.” American Economic Review, May 1966, 56,pp. 167-77.

__________. “Campaigning for Monetary Reform: TheFederal Reserve Bank of St. Louis in 1959 and 1960.”Journal of Monetary Economics, November 1976,pp. 439-53.

Meltzer, Allan H. “Monetarism: The Issues and theOutcome.” Atlantic Economic Journal, March 1998, pp. 8-31.

Meyer, Laurence H. and Rasche, Robert H. “EmpiricalEvidence on the Effects of Stabilization,” in StabilizationPolicies: Lessons from the ‘70s and Implications for the‘80s, Proceedings. St. Louis: Center for the Study ofAmerican Business and Federal Reserve Bank of St.Louis, 1980, pp. 41-102.

__________ and Varvares, Chris. “A Comparison of the St.Louis Model and Two Variations: Predictive Performanceand Policy Implications.” Federal Reserve Bank of St.Louis Review, December 1981, 63(10), pp. 13-25.

Mishkin, Frederic S. “What Should Central Banks Do?”Federal Reserve Bank of St. Louis Review,November/December 2000, 82(6), pp. 1-14.

Okun, Arthur M. “Potential GNP: Its Measurement andSignificance.” Proceedings of the Business and EconomicStatistics Section of the American Statistical Association,1962, pp. 98-104.

Orphanides, Athanasios. “Monetary Policy Rules Based onReal-Time Data.” FEDS Working Paper 1998:03, FederalReserve Board of Governors, December 1997.

__________ and Porter, Richard D. “P* Revisited: Money-Based Inflation Forecasts with a Changing EquilibriumVelocity.” Journal of Economics and Business,January/April 2000, 52(1-2), pp. 87-100.

Perlman, Richard, ed. Inflation: Demand-Pull or Cost-Push?Boston: D.C. Heath, 1965.

Perry, George L. Unemployment, Money Wage Rates, andInflation. Cambridge, MA: MIT Press, 1966.

Phelps, Edmund S. “Phillips Curves, Expectations ofInflation and Optimal Unemployment Over Time.”Economica, August 1967, pp. 254-81.

Phillips, A.W. “The Relation Between Unemployment andthe Rate of Change of Money Wage Rates in the UnitedKingdom, 1861-1957.” Economica, November 1958, 25,pp. 283-99.

Rasche, Robert H. “Comments on a Monetarist Approachto Demand Management.” Federal Reserve Bank of St.Louis Review, January 1972, 54(1), pp. 26-32.

__________. “Monetary Aggregates, Monetary Policy andEconomic Activity.” Federal Reserve Bank of St. LouisReview, March/April 1993, 75(2), pp. 1-35.

__________ and Tatom, John A. “The Effects of the NewEnergy Regime on Economic Capacity, Production andPrices.” Federal Reserve Bank of St. Louis Review, May1977, 59(5), pp. 2-12.

Rolnick, Arthur J. and Weber, Warren E. “Money, Inflation,and Output under Fiat and Commodity Standards.”Journal of Political Economy, December 1997, pp. 1308-21



Roosa, Robert V. Federal Reserve Operations in the Moneyand Government Securities Market. Federal Reserve Bankof New York, 1956.

Samuelson, Paul A. “Reflections on Monetary Policy.”Review of Economics and Statistics, August 1960, pp.263-69.

__________. Newsweek, 2 August 1971, p. 70.

__________ and Solow, Robert M. “Problem of Achievingand Maintaining a Stable Price Level: Analytical Aspectsof Anti-Inflation Policy.” American Economic Review,Papers and Proceedings, May 1960, pp. 177-94.

Sargent, Thomas J. The Conquest of American Inflation.Princeton: Princeton University Press, 1999.

Stone, Courtenay C. and Thornton, Daniel L. “Solving the1980s’ Velocity Puzzle: A Progress Report.” FederalReserve Bank of St. Louis Review, August/September1987, 69(7), pp. 5-23.

Taylor, John B. “Discretion Versus Policy Rules in Practice.”Carnegie-Rochester Conference Series on Public Policy,December 1993, pp. 195-214.

__________. “The Robustness and Efficiency of MonetaryPolicy Rules as Guidelines for Interest Rate Setting bythe European Central Bank.” Journal of MonetaryEconomics, June 1999, pp. 655-79.

Weintraub, Sidney. “Monetary Policy, 1957-59: Too Tight,Too Often.” Review of Economics and Statistics, August1960, pp. 279-82.

Wheelock, David C. “Monetary Policy in the GreatDepression and Beyond: The Sources of the Fed’sInflation Bias,” in Mark Wheeler, ed. The Economics ofthe Great Depression. Kalamazoo: The Upjohn Institute,1998, pp. 127-69.

__________. “National Monetary Policy by Regional Design:The Evolving Role of the Federal Reserve Banks inFederal Reserve System Policy,” in Jürgen von Hagen andChristopher J. Waller, eds. Regional Aspects of MonetaryPolicy in Europe. Boston: Kluwer Academic Publishers,2000, pp. 241-74.

Woodford, Michael. “Revolution and Evolution inTwentieth-Century Macroeconomics,” in P. Gifford, ed.Frontiers of the Mind in the Twenty-First Century.Cambridge, MA: Harvard University Press (forthcoming),<www.princeton.edu/~woodford/macro20C.pdf>.

Yohe, William P. and Karnosky, Denis S. “Interest Rates andPrice Level Changes, 1952-69.” Federal Reserve Bank ofSt. Louis Review, December 1969, 51(12), pp. 18-38.

R E V I E W


AThe first version of the St. Louis monetarist

model appeared in Andersen and Carlson (1970),Exhibit 1. It is summarized below. For a compari-son of the original and last versions of themodel, see Carlson (1986).

Exogenous Variables:∆Mt = change in money stock∆Et =change in high-employment Federal

expendituresXt

F =potential output

Endogenous Variables:∆Yt =change in total spending (nominal GNP)∆Pt = change in price level (GNP deflator)Dt= demand pressure∆Xt = change in output (real GNP)Rt = market interest rate∆Pt

A = anticipated change in price levelUt= unemployment rateGt = GNP gap

Appendix

Total Spending Equation

1)

Price Equation

2)

Demand Pressure Identity

3)

Total Spending Identity

4)

Interest Rate Equation

5)

∆ ∆ ∆ ∆ ∆

∆ ∆

∆

∆ ∆ ∆

∆ ∆ ∆ ∆ ∆

Y f M M E E

P f D D P

D Y X X

Y P X

R f M X X P P

t t t n t t n

t t t nA

t t tF

t

t t t

t t t t n t

=

=

= − −

= +

=

− −

−

−

−

1

2

1

3

( ... , ... )

( ... , )

( )

( , ... , , ttA

tA

t t n

t t t

t tF

t tF

P f P P

U f G G

G X X X

)

( ... )

( , )

( ) /

Anticipated Price Equation

6)

Unemployment Rate Equation

7)

GNP Gap Identity

8)

∆ ∆ ∆=

=

= −

− −

−

4 1

5 1

the rise and fall of a policy rule: monetarism at the st. louis

Documents