Conference to Honor Milton Friedman on His Ninetieth Birthday
J McLane
Issue date: 11/25/02 Section: GSB News
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John B. Taylor, Under Secretary for International Affairs, U.S. Department of Treasury
The first of the conference talks, "Monetary Policy in the Post-War Economy", was given by John Taylor, Under Secretary for International Affairs at the U.S. Treasury, author of the "Taylor Rules", and an expert on international monetary policy.
Taylor reviewed three major historical monetary episodes to show just how significantly monetary policy has changed as a result of the work of Milton Friedman. The change in monetary policy was at least partially a result of a new era of monetary independence. For example, in the early 1950's the U.S. Federal Reserve regained independence previously lost to U.S. Treasury as a means to finance the Korean War. Equally important, was the end of the Bretton-Woods system of fixed exchange rates in favor of free prices - a movement very much championed by Milton Friedman. With each, the Federal Reserve, and the world's other central banks, were no longer bound to the maintenance of fixed exchange, which gave wide latitude to central banks in determining interest rates and the rate of growth of the monetary base.
From the early 1950's to the late 1960's, the world economy experienced relatively stable prices. From the late 1960's until the late 1970's, inflation was rampant worldwide, only to again be followed by a relatively stable period from the early 1980's onward. Taylor shows that that the widespread bout of inflation during the 1970's was highly correlated to equally widespread money supply growth, thus concluding that the inflation was primarily a monetary phenomenon and not a demand phenomenon. The real question Taylor posits, then, is "why did the money base increase so substantially?"
Taylor reviewed several hypotheses from the economic literature to explain the phenomenon, but the one he prefers is that the world's monetary authorities changed the theories by which they conducted monetary policy. In 1958 the Philips Curve (the hypothesized negative relation between unemployment and inflation) was first published. By the early 1960's the U.S. Council of Economic Advisors was using it as a policy tool, it was in the textbooks, and it was pervasive. The Philips Curve was so influential that monetary policy makers began increasing the money supply, and consequentially inflation, in an attempt to reduce unemployment, presumably at no cost.