The Polıcy Rule of Aesthetatunis

FEDERAL RESERVE BANK OF ST.
LOUIS
The Rise and Fall of a stability (e.g., Barro, 1996). Monetary policymak-
ing, however, both in the United States and else-
Policy Rule: where, is often concerned with the short-run.
Policymakers meet frequently: the Federal
Monetarism at the Reserve’s Open Market Committee (FOMC) meets
eight times a year, for example, and a vote is taken
St. Louis Fed, at each meeting on whether to maintain or change
the current stance of policy. While price stability is
1968-1986 widely acknowledged as the appropriate long-run
objective of monetary policy, many economists
argue that policymakers should respond to fluctu-
R. W. Hafer and David C. Wheelock ations in real output or employment as part of
their strategy to achieve price stability and, ulti-
mately, to support maximum sustainable econom-
“Once the quantity theory regained academic ic growth.1
respectability, it was obliged to resume respon- To help guide them in their deliberations,
sibility for the short-run forecasting of aggre- policymakers and their economic advisors rely on
gate movements of prices and quantities both complex economic and econometric models
This it has begun to do, most importantly and on simple rules-of-thumb based on empirical
through the research work of the Federal regularities observed in macroeconomic data.
Reserve Bank of St. Louis, and with appreciable Indeed, simple rules, such as the so-called Taylor
success; but it has been lured into playing in a rule (Taylor, 1993), which describes the response of
new ballpark, and playing according to a differ- the federal funds rate to past deviations of inflation
ent set of rules than it initially established for and output from target values, often appear
itself [I]ts own success is likely to be transi- to explain well how policymakers set policy in the
tory, precisely because it has relied on the same short-run. Economists generally conclude that
mechanisms of intellectual conquest as the rules-based policies are preferable to those relying
[Keynesian] revolution itself and has also solely on the discretion of policymakers. The trans-
espoused a methodology that has put it in con- parency of rules reduces uncertainty about the
flict with long-run trends in the development of
responsiveness of policy to economic change and
can enhance the accountability of policymakers.
the subject.”—Harry Johnson (1971, pp. 12-13)
Monetarists have long advocated the use of
rules to guide monetary policy, with Friedman’s
(1960) proposal for a constant money stock
M
acroeconomists today generally agree that
monetary policy cannot permanently growth rate being the most famous example. At
increase the rate of economic growth the time it was made, Friedman’s proposal was
above its potential or decrease the rate of unem- sharply at odds with the prevailing mainstream
ployment below its market clearing, or “natural,” view that monetary policy was best conducted by
level (e.g., De Long, 2000; Woodford, forthcoming). manipulating interest rates to strike a balance
In the long run, monetary policy affects only the between inflation and unemployment. At the time,
rate of inflation, and many economists argue that economists widely believed in the power of
monetary policy can best promote maximum sus- activist monetary and, especially, fiscal policy to
tainable economic growth by ensuring price level limit fluctuations in economic activity and to
ensure sufficient demand to provide full employ-
R. W. Hafer is a professor of economics and finance, and Director,
ment economic growth over extended periods.
Office of Economic Education and Business Research, Southern Friedman’s “monetarist” policy rule thus attracted
Illinois University Edwardsville. David C. Wheelock is an assistant considerable attention. Moreover, a growing body
vice president and economist at the Federal Reserve Bank of St.
Louis. Heidi L. Beyer provided research assistance. The authors
of empirical work by Friedman and others show-
thank Anatol Balbach, Rachel Balbach, Michael Bordo, Keith ing the potential for money supply shocks to have
Carlson, Brad DeLong, Bill Dewald, Jerry Dwyer, Milton Friedman, large short-run impacts on output and employ-
Gail Heyne Hafer, Joe Haslag, Bob Hetzel, Ali Kutan, Thomas Mayer,
and Anna Schwartz for comments on an earlier draft. The authors 1
also thank Gloria Valentine of the Hoover Institution for her assis- For a recent argument along these lines, see Mishkin (2000) and the
tance with the Friedman papers. references cited therein.
J A N UA RY / F E B R UA RY 2 0 0 1 1
REVIEW
ment led to the development of an alternative The year 1986 marked the appearance of the final
framework for conducting stabilization policy version of that model (Carlson, 1986). We show
based on targeting growth of the money stock. how research conducted at the Federal Reserve
The Federal Reserve Bank of St. Louis played Bank of St. Louis extended earlier monetarist
an important and highly visible role in the devel- analysis that had focused on the role of money in
opment and advocacy of stabilization policy based explaining economic activity in the long run.
on the targeting of monetary aggregates. This arti- Their success in finding apparently robust, stable
cle examines the development of the monetarist- relationships in both long- and short-run data led
based stabilization policy framework advocated by monetarists to apply long-run propositions to
the St. Louis Bank between the late 1960s and the short-run policy questions, effectively competing
1980s, with an eye toward identifying lessons with alternative views of the time. When the
from that experience for the conduct of stabiliza- short-run correlation between money and eco-
tion policy in general.2 nomic activity went astray in the early 1980s,
This article also illustrates how the Federal however, the efficacy of the monetarist rule and
Reserve System’s decentralized structure fosters a appeals for targeting monetary aggregates to
climate of internal debate. Beginning in the 1960s, achieve economic stabilization quickly lost credi-
the monetary policy actions advocated by the St. bility.
Louis Bank in its research publications, in public
forums, and in the participation of the Bank’s
THE SETTING: FINE-TUNING THE
presidents in policy meetings often were sharply
at odds with the policies adopted by the Federal ECONOMY
Reserve System. The Fed’s decentralized structure The 1960s were the glory days of activist,
permitted the development of alternative policy short-run stabilization policy. Policymakers had
views and the exploration of new ideas within the confidence in their ability to achieve full employ-
System (Wheelock, 2000). Policy debates often ment using fiscal and monetary policy to “fine
took place within System publications. We tune” or manage aggregate demand. For a time,
describe the public debate as we trace the evolu- their confidence seemed justified: Before the pres-
tion of the St. Louis Fed’s monetarist policy, and ent expansion, the 1960s witnessed the longest
the criticism of that policy by other Fed officials, uninterrupted expansion in U.S. history, with the
in the Federal Reserve Bank of St. Louis Review, economy operating at full employment (defined
other System publications, and in the public then as a civilian unemployment rate of 4 percent
speeches of Darryl Francis, President of the Fed- or less) from 1966 to 1969.
eral Reserve Bank of St. Louis from 1966 to 1976. Beginning in 1965, however, rising inflation
To provide a backdrop to our discussion, the and an increasing balance of payments deficit
next section summarizes the dominant policy reflected the cost of expansionary macroeconom-
positions taken by economists during the 1960s ic policies. Policymakers felt increasing pressure
and early 1970s about the causes of inflation and to control inflation but were hesitant to take
the role of monetary policy. We point out key actions that might reduce employment and real
issues where monetarists disagreed with the con- output growth. Because policymaking was viewed
ventional wisdom. In the subsequent two sections as striking a balance between inflation and unem-
we review the research and policy positions taken ployment, disagreements about policy, according
by St. Louis Fed economists and officials from the to one Fed governor, boiled down to one’s prefer-
1960s through the early 1980s. We limit our dis- ences between the two outcomes.3 Because un-
cussion mainly to the period 1968-86. In 1968, employment frequently was viewed as a more
the Federal Reserve Bank of St. Louis published an
econometric analysis of the relative impacts of 2
The defining characteristics, technical aspects, and legacy of mone-
monetary and fiscal policy on economic activity. tarism in general have been explored elsewhere, e.g., DeLong
That article, by Andersen and Jordan (1968), (2000), Melzter (1998), Rasche (1993), and Woodford (forthcoming).
became one of the most cited papers in econom- 3

Governor Sherman Maisel argued at an FOMC meeting on October
ics in the past 40 years. In 1970, the Bank pub- 20, 1970, “that at least some of the Committee’s differences on pol-
lished the first version of its monetarist model for icy reflected difference in basic value judgments regarding the rela-
tive importance of various conflicting goals—for example, regard-
gauging the impact of monetary policy actions on ing the appropriate trade-off between employment and price stabil-
economic activity (Andersen and Carlson, 1970). ity” (FOMC Minutes, October 20, 1970, p. 41).
2 J A N UA RY / F E B R UA RY 2 0 0 1
FEDERAL RESERVE BANK OF ST. LOUIS
serious concern than inflation, for many years the minimizing variability in money stock growth
Fed opted for maintaining an inflationary bias in around a moderate trend. In public forums,
monetary policy to avoid higher rates of unem- Francis made the case that growth of the money
ployment. Fed officials, like other government stock was the most accurate reflection of monetary
officials, argued that the inflation-unemployment policy and that excessive monetary growth was
tradeoff could be improved only through the coop- the fundamental cause of inflation. Francis was
eration of business and labor in the setting of supported in his policy views by St. Louis Fed
prices and wages or, if necessary, by the use of economists, whose research findings were largely
anti-trust and other polices to make price setting in accord with those of other monetarists but
more competitive. Alternatively, inflation could be sharply at odds with the conventional wisdom of
controlled through explicit regulation of wages and the times, including the views about monetary
prices policy held in most quarters of the Federal
Juxtaposed against this mainstream view was Reserve System.
an alternative associated with the work of Milton
Friedman, Anna Schwartz, Karl Brunner, Allan Mainstream Views About Monetary
Meltzer, and other so-called monetarists. Monetar- Policy in the 1960s
ism was rooted in the Quantity Theory of Money.
A review of monetarism and all of its differ-
The core of the Quantity Theory is that, in the long
ences with mainstream Keynesian macroeconom-
run, inflation reflects excessive growth of the
ics of the 1960s is beyond the scope of this article.
money stock relative to real output growth, the lat-
ter determined fundamentally by non-monetary Sharp theoretical differences about the cause or
forces such as population growth and productivity. causes of inflation and economic fluctuations, as
An important component of this position is the sta- well as methodological differences about the
bility of the public’s demand for money. empirical analysis of the effects of policy actions
Monetarists amassed empirical evidence showing on economic activity, however, are fundamental to
the demand for money to be more stable than understanding why St. Louis Fed research and poli-
money supply or, equivalently, that velocity is sta- cy positions were controversial. These differences
ble.4 Stability of velocity supported monetarists’ include whether a tradeoff exists between inflation
view that short-run fluctuations in economic activ- and unemployment, either in the short or the long
ity often are caused by fluctuations in money sup- run, and whether such a tradeoff is exploitable by
ply growth—fluctuations brought about by central policymakers. A related question is whether mone-
bank policy actions.5 Monetarists concluded that tary policy can, or should, be used to fight inflation
central bank attempts to manipulate interest rates when the economy is at less-than-full employ-
had led to destabilizing fluctuations in money sup- ment. Monetarists and non-monetarists divided
ply growth and, therefore, in economic activity. also over the measures that best reflect the impact
Hence, monetarists argued that monetary policy- of monetary policy actions—monetary aggregates
makers should minimize the variation of the or interest rates and credit aggregates. Finally,
growth rate of the money stock both in the short- monetarists and non-monetarists debated the tools
run and over time. Lags in assessing economic and methods for identifying the impact of mone-
conditions and in the effects of policy actions on tary policy on the economy.
economic activity, they argued, made attempts at
“fine tuning” a balance between inflation and
4
unemployment futile. Instead, monetarists argued Velocity was stable not as an arithmetic constant, but in the sense
for a policy that maintained growth of the money that its behavior was related predictably to changes in the opportu-
nity cost of holding money and to changes in income or wealth of
stock at a low, fixed rate, irrespective of the busi- individuals.
ness cycle. 5 Perhaps the most famous statement and evidence of this proposi-
The Federal Reserve Bank of St. Louis was the tion is Friedman and Schwartz (1963).
center of monetarism within the Federal Reserve 6 Consider Friedman’s (1992) appraisal: “The interesting thing to me
System from the 1960s into the 1980s.6 Darryl has always been that the most important contributions to under-
Francis, who became president of the St. Louis standing of monetary theory and monetary institutions have not
come from Washington during the decades in which I’ve been
Bank in 1966, was an especially strong advocate active. The Federal Reserve Bank of St. Louis in the 1950s, ’60s and
of monetarist policy prescriptions. At FOMC ’70s was by far and away the pre-eminent producer of significant
meetings, he argued frequently for a policy of monetary research within the System.”
REVIEW
Inflation and the Phillips Curve increases in production costs, in contrast to

“demand-pull” inflation caused by increases in
The Phillips curve—the inverse relationship aggregate demand. Cost-push forces were thought
between unemployment and wage growth in to explain how inflation could occur at less than
British historical data observed by Phillips full employment. The “essence of the problem,”
(1958)—was a key empirical regularity at the heart according to Samuelson and Solow (1960, p. 181),
of macroeconomic policy discussions in the stems from the absence of perfect competition in
1960s. The Phillips curve was viewed as a con- factor and product markets and was, Bronfen-
straint on stabilization policy; policymakers with brenner and Holzman (1963) noted, associated
both unemployment and inflation goals had to with the power of “economic pressure groups,”
choose a feasible combination of the two because such as labor unions and monopolistic firms.
policies that, say, reduced inflation would invari- If a powerful union extracts a real wage increase,
ably slow economic activity and increase unem- the quantity of labor demanded falls. If affected
ployment. Perry (1966, p. 3) noted that firms have pricing power, they pass along a por-
a fairly general consensus exists among econ- tion of the increase in wages to consumers in the
omists [that s]uccessively higher levels of form of higher prices. If perfect competition exists
activity are associated, roughly at least, with in other industries and labor markets, prices and
correspondingly larger rates of price increase. wages fall to offset the increases in the first indus-
In this situation, the more traditional problem try. If wages are downwardly rigid throughout the
of adjusting aggregate demand so as to reach economy, however, the aggregate price level might
full employment without overshooting into rise alongside an increase in unemployment.
the area of inflation must be replaced with the Throughout the 1960s, the Economic Report of
dual problems of deciding what combination the President blamed inflation on “excessive” wage
of unemployment and inflation to aim at and and price increases. The clear implication was that
then adjusting aggregate demand to reach this monetary and fiscal policies were not responsible
for inflation when the economy was at less than
point.
full employment. The Economic Report for 1965
Fed governor Sherman Maisel (1973, p. 14) explained that “in a world where large firms and
observed succinctly: “There is a trade-off between large unions play an essential role, the cost-price
idle men and a more stable value for the dollar. record will depend heavily upon the responsibility
A conscious decision must be made as to how with which they exercise the market power that
much unemployment and loss of output is accept- society entrusts to them” (1966, p. 179). Hence,
able in order to get smaller price rises.” President Johnson urged, “in the strongest terms I
Although many influential economists know—that unions and business firms exercise
believed that the hyperbolic shape and negative the most rigorous restraint in their wage and price
slope of the Phillips curve were fixed, it was clear determinations” (Economic Report of the President
that the position of the Phillips curve could move for 1967, p. 20). Throughout the 1960s the
over time. The U.S. experience of 1955-58 was Economic Report published detailed wage and
widely discussed: In 1955-57, the unemployment price “guideposts” defining the extent to which
rate hardly changed when the inflation rate wage and price increases were “justifiable.”
increased sharply; in 1958, when inflation abated, Monetarists dismissed the notion of cost-push
the increase in the unemployment rate seemed inflation, arguing that inflation is “always and
disproportionately high. Concern arose that the everywhere a monetary phenomenon.” Non-
U.S. economy had an “inflation bias,” meaning monetarists generally accepted that “cost-push
that inflation, perhaps accelerating inflation, was may involve increases in money supply, money
necessary to achieve and maintain full employ- income, and money expenditures, particularly if
ment (Wheelock, 1998). decreases in output and employment are to be
The experience of 1955-58 gave prominence avoided” (Bronfenbrenner and Holzman, 1963,
to the notions of “cost-push” inflation and “wage- p. 614). Nonetheless, many economists found
price spirals.” The term cost-push inflation was monetary explanations of inflation wanting,
used to define an ongoing increase in the general claiming that inflation can arise through wage and
level of prices caused by firms passing along price setting independent of shocks to aggregate
demand. The short-run linkages from money to moderate such pressures appreciably” (FOMC
inflation were considered to be tenuous at best.7 Minutes, June 8, 1971, p. 51).
Economists generally did acknowledge the
potential for restrictive monetary policy to elimi- The Long-Run Phillips Curve
nate cost-induced inflation. The apparent down- Wage and price rigidity and the possibility of
ward rigidity of prices and wages, however, con- cost-induced inflation suggested to many
vinced many that using monetary policy to arrest observers that using monetary policy to contain
even a moderate inflation would entail a substan- inflation would invariably cause higher unemploy-
tial and unacceptable increase in unemployment. ment. Monetarists did not deny this, but argued
The Economic Report of the President for 1961 that the tightening of monetary policy would have
(p. 47) claimed that “an attempt to restrict aggre- merely a temporary adverse impact on unemploy-
gate demand so severely as to eliminate all risk of ment. Andersen (1973), for example, argued that
an increase in the general price level might well
“our economic system is such that disturbing
involve keeping the economy far below full em-
forces, including even changes in money growth,
ployment.”8 High unemployment was simply an
are rather rapidly absorbed and output will
unacceptable cost of reducing inflation. In his
naturally revert to its long-run growth path follow-
introduction to the 1967 Report (p. 20), President
ing a disturbance” (p. 7).
Johnson argued, “Dealing with inflation by creat-
Some economists, however, argued that using
ing a recession or persistent slack is succumbing
monetary or fiscal policy to achieve price stability
to the disease—not curing it. The experience of
might cause unemployment to increase perma-
1957 and 1958—when the unemployment rate
1 nently. Keynesians frequently interpreted the
reached 7 2 percent and consumer prices still rose
Great Depression as indicating that private
5 percent—is a clear reminder of the large costs of
demand might be insufficient to generate full
such a policy and of its limited effectiveness in
employment output in the face of downwardly
halting a spiral in motion. This is a course which I
rigid wages and prices, thereby leaving the econo-
reject.”
my mired permanently at less than full employ-
To fight inflation, some mainstream econo-
ment. Thus, many economists believed that
mists advocated incomes policies; others favored
monetary and fiscal policy should ensure that
policies aimed at enhancing the competitiveness
aggregate demand is sufficient to generate full
of product and labor markets and policies aimed
employment, even if that requires some inflation.
at raising productivity. Monetary policy, many
Samuelson (1960, p. 265), for example, argued
argued, should focus on maintaining full employ-
that “With important cost-push forces assumed to
ment by keeping interest rates low.
be operating, there are many models in which it
Many Federal Reserve officials expressed simi-
can be shown that some sacrifice in the require-
lar qualms about using monetary policy to control
ment for price stability is needed if short- and
inflation. For example, Charles Partee, a Fed staff
long-term growth are to be maximized, if average
economist who later became a Fed governor,
long-run unemployment is to be minimized, if
argued in 1970 that “The question is whether
optimal allocation of resources as between differ-
monetary policy could or should do anything to
ent occupations is to be facilitated.”
combat a persistent residual rate of inflation
The Fed often was accused of paying “exces-
The answer, I think, is negative.” He added that
sive” attention to price stability. In summarizing a
“Product markets generally are substantially
symposium on recent monetary policy, Harris
underutilized and labor appears to be readily
(1960, p. 245) wrote, “In general the disagree-
available It seems to me that we should regard
continuing increases [in the price level] as a struc- 7
Ackley (in Perlman, 1965, p. 47), for example, wrote that “I do not
tural problem not amenable to macro-economic consider the change in money supply of much short-run impor-
measures” (FOMC Minutes, April 1970, pp. 385-86, tance.” Weintraub (1960, p. 280) contended that “contrary to the
379, 396 [quoted in Mayer (1999), p. 99]). Federal widespread belief that there is a direct tie of money supplies to
price levels, the modus operandi of monetary policy is different: its
Reserve Board Chairman Arthur Burns also argued immediate effect is upon consumption and investment demands,
that “Monetary policy could do very little to arrest thereby upon employment levels, and only indirectly affecting the
an inflation that rested so heavily on wage-cost general level of money wages” (emphasis in the original).
pressures . . . A much higher rate of unemploy- 8 The Council of Economic Advisors at this time consisted of Walter
ment produced by monetary policy would not Heller, Kermit Gordon, and James Tobin.
REVIEW
ments of [participating] economists with Federal in the money supply affect economic activity,
Reserve policy have stemmed primarily from a much less that the Fed can control the money
fear that the interest in the stability of the currency stock. Although one or two FOMC members
has been at the expense of growth and employ- warned persistently that fluctuations in money
ment.”9 Not only was the tradeoff between infla- growth could cause undue fluctuations in the real
tion and unemployment widely viewed as persist- economy, these concerns largely were ignored.14
ent, but some economists argued that policies to Outside the Fed, by contrast, monetarist views
achieve price stability in the short-run might make about the impact of fluctuations in money stock
the tradeoff less favorable over time. Samuelson growth were receiving considerable attention.
and Solow (1960), for example, believed that poli- Friedman and Meiselman’s (1963) “The Relative
cies directed at limiting inflation in the short-run Stability of Monetary Velocity and the Investment
might increase structural unemployment. The Multiplier in the United States, 1897-1958,” for
long-run tradeoff between inflation and unem- example, stirred much debate. Associated with the
ployment would worsen because an increase in Commission on Money and Credit’s inquiry into
structural unemployment would raise the size of the structure of the financial system, this paper
the increase in inflation that would be needed to was controversial because it rejected a core ingre-
achieve a given reduction in the unemployment dient in the Keynesian theoretical structure—the
rate. Perry (1966, p. 119) even suggested that poli- validity of the expenditure multiplier. Friedman
cies aimed at maintaining low unemployment and
minimizing short-run cyclical variation in output 9 Angell (1960, p. 248) argued similarly, stating that “As to aggregate
could moderate wage and price increases.10 growth, 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 have
The Impact of Monetary Policy probably retarded it substantially.” Hansen (1960, pp. 255-56) pro-
posed that “Monetary policy should seek to achieve a low long-run
Economists’ conviction that policymakers rate of interest” to raise permanently the ratio of investment to out-
put and thus real growth, while fiscal policy could “offset the
could manipulate aggregate demand to stabilize inflationary pressures caused by the increase in investment inci-
the growth of real output reached its zenith in the dent to rapid technological advance and low interest rates.”
1960s and early 1970s. The apparent failure of 10
Policymakers often agreed with such assessments. The Economic
low interest rates to revive the economy during Report of the President for 1965 concluded “Rising prices that
originate from such a [cost-push] process can affect expectations,
the Great Depression, however, was taken as evi- jeopardize the stability and balance of an expansion, and create
dence that monetary policy is less potent than fis- inequities and distortions just as readily as demand inflation. But
cal policy. The 1950s witnessed the development measures to restrain these price increases by reducing over-all
demand will enlarge unemployment and impair the productivity
of new theories about the impact of monetary pol- record so important to cost-price stability over the longer run” (p.
icy, with the dominant view being that policy is 179). The Council of Economic Advisors at this time consisted of
Gardner Ackley, Otto Eckstein, and Arthur Okun.
effective through its influence on both the cost
11
and availability of credit.11 Still, even in the 1960s, The “Availability Doctrine” posits that small changes in interest
rates can have large economic effects by affecting banks’ willing-
the mainstream view was that monetary policy, ness to supply loans. The theory was developed by New York Fed
though capable of having some impact, was less economist Robert Roosa (1956) and was the dominant view of the
powerful than fiscal policy.12 transmission mechanism within the Fed at the time. See Johnson
(1962) for a survey of current thinking on monetary theory and
Monetarists, by contrast, argued that changes policy effectiveness as of the early 1960s.
in the quantity of money exert a powerful influ- 12
The consensus view is perhaps well represented by Ando et al.
ence on economic activity. Friedman’s work dur- (1963, p. 2), who concluded “the effect of monetary policy on the
ing the 1950s helped establish the foundation for flow of expenditures is far from overwhelming, though it exists and
is of a magnitude worth exploiting in the interests of economic
later studies of the link between monetary policy stability Our findings on fiscal policy are primarily that varia-
and the economy (e.g., Friedman, 1956). His tions in disposable income, either through transfer payments or
personal income tax changes, can operate as a powerful short-run
examination of monetary policy and the business stabilizer.”
cycle is reflected in his testimony to the Joint 13
This testimony was based on on-going research with Anna J.
Economic Committee in March 1958.13 At that Schwartz at the National Bureau of Economic Research. This
time, most Fed officials believed that short-term research was subsequently published in three volumes: see
interest rates and the quantity of bank credit were Friedman and Schwartz (1963, 1970, 1982).
14
the appropriate instruments of monetary policy. In the late 1950s and early 1960s, Malcolm Bryan, President of the
Federal Reserve Bank of Atlanta, argued that the Fed should target
Minutes of FOMC meetings reveal that policymak- the growth rate of total reserves, and minimize fluctuations in the
ers generally rejected the notion that movements money stock. See Meigs (1976) and Hafer (1999).
and Meiselman’s empirical analysis also found 1968, p. 73). Thus, large structural models
money demand to be relatively more stable than appeared to give policymakers the information
money supply, suggesting that observed move- they needed to make short-term, fine-tuning poli-
ments in the money stock and economic activity cy adjustments to stabilize economic activity.
are dominated by Fed policy actions rather than
by volatility in the public’s demand for money. Monetary Policy Target
The debate that ensued was so important that
the American Economic Review devoted an entire Alongside large-scale macroeconometric mod-
issue to critical appraisals of the Friedman- els, the 1960s witnessed the development of
Meiselman (1963) study by Ando and Modigliani increasingly complex analyses of the effects of
(1965) and DePrano and Mayer (1965) and a monetary policy actions, interacting with financial
response by Friedman and Meiselman (1965).15 regulatory policies, on financial flows and interest
Two issues were key to the attacks and rejoinder. rates. With the exception of monetarists, many
One was Friedman and Meiselman’s finding that macroeconomists believed that monetary policy
velocity is relatively more stable than the was not represented accurately by the behavior of
Keynesian expenditure multiplier. In other words, any single variable, such as the rate of interest, the
output appeared to be related more to movements quantity of bank credit, or the stock of money.
in money than to other measures of autonomous This view was reflected in the Economic Report of
expenditure. the President for 1968:
The other issue, one that is more important for In the formulation of monetary policy,
what would later be the attack on the St. Louis careful attention should be paid to inter-
approach, was the procedure Friedman and est rates and credit availability as influ-
Meiselman used to produce that finding. The enced by and associated with the flows of
debate displayed a fundamental difference in deposits and credit to different types of
views about how to estimate economic relation- financial institutions and spending units.
ships for policy purposes. Friedman and Among the financial flows generally con-
Meiselman, whose work was grounded in the tra- sidered to be relevant are: the total of
dition of the Quantity Theory of Money, based funds raised by nonfinancial sectors of
their conclusions on simple reduced-form rela- the economy, the credit supplied by com-
tions observed in the data. Ando and Modigliani mercial banks, the net amount of new
(1965) argued that such simple regressions, not mortgage credit, the net changes in the
much more than correlations, were inferior to the public’s holdings of liquid assets, changes
output of the large-scale, structural models then in time deposits at banks and other thrift
coming into vogue to evaluate policy. In other institutions, and changes in the money
words, though different approaches may produce supply. Some consideration should be
different results, only the most sophisticated is given to all of these financial flows as
useful for policy analysis.16 well as to related interest rates in formu-
Many Federal Reserve officials embraced the lating any comprehensive policy program
use of large-scale econometric models then being or analysis of financial conditions. (p. 89)
developed. Board staff participated with econo- The Report also dismissed monetarist appeals
mists from the Massachusetts Institute of for focusing on money stock growth. In response
Technology in constructing the FRB-MIT model, to calls for setting monetary policy according to a
which was used for policy analysis and evaluation
at the Board. Such models were widely judged 15
This is the so-called AM-FM or “radio” debate. Hester (1964) was
superior to single-equation or small-model sys- also critical of the Friedman-Meiselman approach.
tems for studying the effects of policy actions on 16
Brunner (1986) provides an excellent and wide-ranging overview of
economic activity. An official of the Federal this debate. He defends the Friedman-Meiselman (1963) approach,
Reserve Bank of New York argued that large-scale arguing that “the use of a single equation with a single independent
models produced “quantitative estimates of the variable should now be clear. It was the appropriate choice for an
assessment of the core class [of hypotheses]. It did not represent a
timing and magnitude of the effects of central single equation model or a [direct] disposition to favor simple, as
bank actions on the money supply and other against sophistical models” (p. 41, emphasis in original). Rather,
financial magnitudes and the subsequent effects, Brunner suggests (p. 40) that “the strong assertions conveyed by
the basic core of the income-expenditure approach, which fre-
in turn, of these variables on each of the various quently spilled over into categorical policy statements, were thus
major components of aggregate demand” (Davis, shown to have little substantive foundation.”
REVIEW
fixed-growth rule for the money stock, the Report analysis of expansionary and contractionary
argued (p. 92) that “given the complex role of movements of the money stock.
interest rates in affecting various demand cate- A companion article in the June 1962 Review
gories and the likely variations in so many other provided one of the first monetarist explanations
factors, any such simple policy guide could prove from the St. Louis Fed of how monetary policy
to be quite unreliable.” Similar reasoning was actions are transmitted to changes in nominal
reflected in the analysis of Federal Reserve Board income and prices. The article, “Changes in the
economists. In a paper published in the Federal Velocity of Money: 1951-1962,” addressed one of
Reserve Bulletin, Gramley and Chase (1965, pp. the more difficult questions monetarists faced in
1403-04) wrote that “the money stock [is] an attempting to use the Quantity Theory to explain
untrustworthy indicator of the effects of policy how monetary policy affects the economy in the
actions on financial asset prices and yields short-run. If velocity is highly variable, then the
Financial market behavior is too complex for sim- connection between changes in the money supply
ple monetary rules to work.”17 and nominal income is uncertain at best. The arti-
Monetarists, of course, disagreed that the com- cle provided a “tentative and exploratory analysis”
plexity of financial markets made targeting a of the behavior of velocity. The analysis showed
monetary aggregate infeasible. In an article in the that a “rapid change in money [is] to be matched
Journal of Political Economy, Federal Reserve Bank temporarily by an opposite change in velocity”
of St. Louis economist Leonall Andersen (1968) (p. 13). Over time, however, “as the public recog-
presented evidence that the Fed could use open nized the change in its [money] balances there
market operations to smooth fluctuations in total was an increase in spending, and velocity moved
and free (i.e., excess less borrowed) reserves and, upward” (p. 13). Using this pattern to explain the
by implication, in the monetary base.18 Albert effects of past policies, the article noted that
Burger (1971), another St. Louis Fed economist, “Within a few months after money began expand-
presented a detailed analysis of how the monetary ing at a rapid rate in 1954, 1958, and 1961,
base can be manipulated so as to control the spending and the velocity of money began rising”
money stock. (p. 13).
The Fed’s ability to control monetary aggre- The article is an early example of the research
gates and the efficacy of monetary control for eco- coming out of St. Louis in support of the mone-
nomic stabilization remained hotly debated issues. tarist position that changes in nominal income
They also were central research themes at the largely reflect prior movements in the money sup-
Federal Reserve Bank of St. Louis throughout the ply. Even though velocity might vary, its variability
1960s and 1970s. appeared to be less than that of money supply.
Hence, monetarists argued, observed cycles in
ST. LOUIS—THE LONG-RUN VIEW
17
Under the leadership of its director of It was a long-standing view among Board officials that monetary
policy should not focus on any one variable. For example, as early
research, Homer Jones, the Federal Reserve Bank as 1932, Governor Eugene Meyer stated: “Our credit machinery is
of St. Louis emerged as the center of monetarist entirely too delicate and responsive to too many influences to make
economics within the Federal Reserve System in it desirable to have any one indicator, whether it be the price level
or the level of member bank reserves, be the sole guide in determin-
the early 1960s.19 The Bank’s Review, which then ing credit policy” (quoted by A. James Meigs in a letter to Milton
appeared monthly, tracked the behavior of the Friedman: Friedman Papers, Hoover Library, Stanford University,
economy and the money stock in nearly every Box 30, Folder 17).
issue. Review articles often described the recent 18
See also Meigs (1966), who reviews the debate about whether finan-
behavior of the money stock and related it to cial innovation had made control of the money stock infeasible or
inefficacious.
monetary growth during previous expansions. For
19
example, the June 1962 article, “Monetary Jones was hired by the St. Louis Fed in 1958. At that time, the Bank’s
Developments,” compared graphically the recent research staff consisted of one Ph.D. economist, two graduate stu-
dents, an agricultural economist, a geographer and several junior
behavior of bank reserves and the money stock staff members. During 1958, Jones corresponded regularly with
(M1) with their patterns during the 1953-57 and Friedman concerning potential hires for the department (Friedman
1957-60 cycles. This type of chart, used by Papers, Hoover Library, Stanford University, Box 28, Folder 36). In
recognition of Jones’ accomplishments, in 1976 a special issue of
Friedman in his 1958 Senate testimony and in the Journal of Monetary Economics was devoted to papers in his
Friedman and Schwartz (1963), provided a visual honor.
nominal income growth are caused mainly by short time horizons of concern to policymakers.
changes in the money supply—over which the The articles were instrumental in developing the
Fed has some control—rather than by changes in monetarist policy rule as an alternative to the con-
velocity. ventional interest rate and fiscal-policy oriented
As inflation worsened over the 1960s, Review ideas of the time.
articles reflected an increasingly aggressive appli-
cation of monetarist arguments by St. Louis Fed
economists, as critical reviews of policy replaced The Andersen-Jordan Equation
tentative and exploratory studies. For example, a Andersen-Jordan (1968) (hereafter, AJ) is an
July 1966 article, titled “Total Demand and intellectual and analytical descendant of
Inflation,” stated that “Excessively stimulative Friedman-Meiselman (1963).20 Andersen and
Government policies lead to marked increases in Jordan, like Friedman and Meiselman, were inter-
the price level. Rapid monetary expansion is ested in isolating statistically the impact of money
regarded by many as a means of stimulating total on nominal income. AJ went further, however.
demand” (p. 1). In the same issue, Keran (1966) They provided a straightforward empirical test of
studied the relationship between nominal and real a related and critical policy issue—the relative
output in eight countries. He concluded that infla- impacts of monetary and fiscal impulses on nomi-
tion results when total demand—nominal nal income. Rather than building a complex
income—rises faster than the economy’s potential econometric model like those in vogue at the
rate of real output growth, suggesting that “If the time, AJ took a relatively simple approach to
recent acceleration in total demand is continued assessing alternative policies. They estimated a
at a time of high-level resource utilization, prices single empirical relation—a “reduced-form”
will probably begin to rise even faster” (p. 12). In model—between income and different measures
addition, Keran hinted at the possibility of using of monetary and fiscal policy actions. Their equa-
monetary policy for short-run stabilization, noting tion can be written as:
that “To the extent that policy tools control the
3 3
growth in total demand they are useful in achiev- (1) ∆Yt = ∑ βi ∆Mt − i + ∑ δ j ∆Et − j + ε t
ing cyclical stability in the economy because year- i =0 j =0
to-year movements in real output can be influenced where Y represents nominal gross national prod-
by changes in total demand” (p. 12, emphasis uct, M is the money stock (M1 or the monetary
added). These and other Review articles, many of base), and E is a measure of fiscal policy actions.
which were written anonymously, reflect clearly The variables were measured as changes in their
the monetarist-oriented research and policy analy- levels. In their estimation, AJ accounted for lags in
sis carried out by St. Louis Fed economists in the the effect of policy actions on economic activity
early-to-mid 1960s. using a new econometric technique that con-
The St. Louis Bank’s visibility increased signifi- strained the estimated parameters to lie along a
cantly, however, with the publication of articles by predetermined polynomial. This was thought to
Andersen and Jordan (1968) and by Andersen and provide more precise estimation of the effects of
Carlson (1970). These articles provided two of changes in the policy variables.21
monetarism’s most challenging attacks on policy
orthodoxy and mainstream Keynesian macroeco- 20
Jordan (1986) refers to it as a “sequel” to Friedman-Meiselman
nomics. The former presented an econometric (1963), though it clearly is linked to earlier work by Karl Brunner.
evaluation of the relative impacts of monetary and This is evident in the statement by AJ that their purpose is not to
fiscal policy on economic activity. The latter “test rival economic theories [i.e., Keynesian vs. Monetarist] of the
mechanism by which monetary and fiscal actions influence eco-
offered a small monetarist econometric model nomic activity” (AJ, 1986, p. 29). A decade earlier Brunner was
that the authors proposed as an alternative tool to examining the logical structure of empirically testing between
simulate alternative policy scenarios. Both papers Keynesian models, in which money played a very minor role, and
monetary models, in which “money matters.” For example,
concluded that changes in the growth of nominal Brunner and Balbach (1959) present a structure of models in which
income and inflation are linked closely to changes they test empirically the relative roles of money and fiscal policy
in the growth rates of monetary aggregates. actions.
Although such relationships had been demonstrat- 21
See Batten and Thornton (1986) and the articles cited therein for a
ed over relatively long time-horizons, these two discussion of this and other technical issues regarding the estima-
articles suggested that they hold over even the tion of equation (1).
REVIEW
Using quarterly data covering the period 1952 the output from large-scale econometric models,
to mid-1968, AJ estimated equation (1) to test suggesting that their results were more plausible
three hypotheses. By comparing the sizes of the than those of AJ.
estimated impacts of fiscal and monetary policy Another early criticism of AJ appeared in the
on GNP, AJ rejected the hypothesis that output Monthly Review of the Federal Reserve Bank of
responds more to fiscal policy actions than to New York (Davis, 1969). That study defended the
changes in the money stock. Comparison of the view that monetary policy affects income through
statistical significance of the coefficient estimates interest rates, not the money stock or monetary
for monetary and fiscal policy actions led AJ to base, with its author noting that the St. Louis
reject the hypothesis that fiscal actions have a equation “portrays a world in several respects
more “reliable” impact on GNP than monetary [that is] sharply at variance with the expectations
actions. Finally, comparison of coefficient esti- of most of us” (p. 121). Like DK, Davis reestimated
mates on lagged monetary and fiscal policy the AJ equation using different measures of mone-
actions, led AJ to reject the hypothesis that fiscal tary policy, as well as different polynomial lag
actions affect GNP faster than do monetary policy specifications and different sample periods.
actions. They succinctly summed up their evi- Davis’s analysis led him to conclude that “we can’t
dence: “The response of economic activity to accept the St. Louis equations at face value
monetary actions compared with that of fiscal because neither money nor the total reserve base
actions is (I) larger, (II) more predictable, and (III) may be sufficiently exogenous” (p. 126). The only
faster” (p. 22). recourse, he suggested, is to build a structural
model (like the FRB-MIT model) and reject the
Early Criticism of Andersen-Jordan reduced-form approach used by AJ. The onus for
(1968) monetarists, he implied, was to put their ideas
into a structural model that details the transmis-
Andersen-Jordan (1968) was subject to imme- sion mechanism of monetary policy.
diate and critical analysis by economists inside The controversy generated by the appearance
and outside of the Federal Reserve System. of AJ marked an abrupt change in the “monetary
Technical criticisms have been dealt with at length versus fiscal policy” debate. Despite criticism of
elsewhere.22 Of interest here is the fact that much the AJ study, the earlier view that business cycle
of the early debate over the usefulness and the evidence relating money and income was “the
conclusions of the article took place among Fed province of an obscure sect with headquarters in
economists within the pages of System publica- Chicago” (Davis, 1969, p. 119) was changed by
tions. For example, the first published criticism of their results. Monetary aggregates now were con-
the AJ approach and findings was by DeLeeuw sidered plausible alternatives to interest rates and
and Kalchbrenner (1969), both of whom were or fiscal policy as tools for short-run economic stabi-
had been with the Board of Governors.23 Their lization.
comment was published in the Federal Reserve
Bank of St. Louis Review, along with a response by Darryl Francis and the Andersen-
AJ. DeLeeuw and Kalchbrenner (hereafter, DK) Jordan Results
raised several technical issues, but focused on AJ’s
use of the monetary base as the appropriate While the technical analysis, criticism, and
measure of monetary policy. DK argued that the responses of the AJ equation took place in both
Fed controls neither the borrowed reserves of System and academic publications, its policy im-
member banks nor the currency stock. Hence, plications were being disseminated in public
they argued, the base is not statistically independ- forums. Darryl Francis, the president of the St.
ent of the model’s dependent variable—changes Louis Bank, used the AJ results to promote the role
in GNP. DK reestimated the AJ equation, using the
base less borrowed reserves and currency as the 22
Reviews include Meyer and Rasche (1980), Batten and Thornton
monetary policy variable, and found that, (1986), McCallum (1986), and Brunner (1986).
although monetary policy appeared “to exert a 23
DeLeeuw, then a Senior Staff Member at the Urban Institute, had
powerful influence” on GNP, money was not as been the Chief of the Special Studies Section, Division of Research
and Statistics at the Board of Governors and a principal in the
dominant as AJ’s results had suggested. DK noted design and development of the FRB-MIT model. Kalchbrenner was
also that their results were more consistent with an economist in the Special Studies Section.
of monetary aggregates in setting stabilization pol- on May 11, 1971, Francis reviewed the course of
icy. Francis (1968, p. 8) rejected the use of fiscal monetary policy and inflation over the previous
actions as a tool for stabilization, arguing that 20 years:
“monetary actions are a major determinant of
During the ten-year period ending in late
short-run movements in total spending.” He also
1962, money grew at an average annual
rejected the common view that interest rates and
rate of 1.5 per cent With the econom-
bank credit reflect accurately the stance of mone-
ic sluggishness of the early 1960’s
tary policy. Francis (1968) argued that “move-
monetary stimulation was increased, and
ments in interest rates should be viewed no differ-
money rose at a 3.5 per cent average
ently than movements in commodity prices”
annual rate from late 1962 to the end of
(p. 8). Instead, Francis pushed for the “primary
1966 [T]hat rate of monetary expan-
and consistent use of monetary aggregates” in set-
sion resulted in a gradual increase in
ting policy, noting that “all of these aggregates can
inflation to a 3 per cent rate. Following
be rather precisely controlled by monetary
the credit crunch of 1966 money growth
authorities” (p. 8). This approach would serve the
was again accelerated, producing a 6.3
dual purpose of holding the authorities account-
per cent average annual rate from early
able for their actions and instituting “scientific
1967 to the present [A] 6 per cent
methodology and modern quantitative analysis”
trend rate of monetary expansion implied
to monetary policy (p. 7).
a sustained 4 per cent rate of inflation. In
At an FOMC meeting on February 4, 1969,
each case the rate of growth in money
Francis reviewed how the Committee had been
was accelerated in order to overcome
misled by the behavior of interest rates and bank
weakness in the economy. Despite those
credit:
progressively more stimulative monetary
For about four years the Committee actions, the rate of unemployment had
had been led into unintended inflationary averaged about the same whether the
monetary expansion while following trend growth of money was 6 per cent,
interest rate, net [free] reserves, and bank 3.5 per cent, or 1.5 per cent. The trend
credit objectives If the Committee growth had had its chief impact on prices,
meant business now, it should try some whereas fluctuations around the trend
other guides. Not only could the old had had the greatest impact on produc-
guides lead to further inflation as long as tion and employment. (FOMC Minutes,
demands for credit continued to rise, but May 11, 1971, pp. 57-58)
when and if contrary trends set in they
could lead to an undue contraction of Francis’s perspective reflected his monetarist
total spending. outlook: He argued that inflation is primarily
determined by the rate of growth of the money
Francis also made clear his preferred policy
stock and that, in the long run, real output growth
guides: “He urged the Committee to give some evi-
dence that it was exercising restraint by limiting and the unemployment rate are unaffected by
the growth of bank reserves, the monetary base, monetary policy. In other words, the long run
and the narrow measure of money supply” (FOMC Phillips curve is vertical.24 Francis also argued
Minutes, February 4, 1969, p. 47). that while monetary policy has no effect on real
Francis believed strongly that inflation was growth or employment in the long run, fluctua-
the consequence of excessive monetary growth, tions in monetary growth could have substantial
and that the Fed had erred in pursuing policies effects on these variables in the short-run. He
that resulted in accelerating growth of the mone- used the Andersen and Jordan (1968) results, and
tary aggregates. In essence, Francis attacked the those of other Bank economists, to support his
dominant view that policy should be aimed at sta- claim.
bilizing short-run variation in economic activity,
as reflected in the unemployment rate, at the 24
The distinction between short- and long-run Phillips curves was for-
expense of higher inflation. At an FOMC meeting malized by Friedman (1968) and Phelps (1967).
REVIEW
Although some members of the Committee tions, Francis also promoted St. Louis Fed research
shared Francis’s views, the chairman and a majori- in his numerous public appearances. Citing “forth-
ty of others did not. In one of the most frank dec- coming articles,” Francis often talked about lags in
larations of the opposing view, Chairman William the impact of monetary policy and how they
McChesney Martin stated at the October 7, 1969, made attempts to “fine tune” a balance between
FOMC meeting that he “did not accept the mone- inflation and unemployment difficult, if not
tarist’s position regarding the critical importance impossible.26 Even so, the behavior of the econo-
of the specific rate of change in the money supply. my in the late 1960s gave credence to the claim
In particular, he did not agree that the conse- that nominal spending responded, albeit with a
quences of deviating significantly from some pre- lag, more to changes in money supply growth
ferred rate for a period of time would be as disas- than to fiscal policy. The “mini-recession” of 1966
trous as the monetarists believed” (1969, p. 1100). and the failure of tax increases in 1968 to halt the
Board economists Gramley and Chase (1965, p. upward march of inflation seemed to support the
1403) went even farther, arguing, “there is little efficacy of monetary over fiscal policy. While
doubt that such a simple rule [based on changes some of his FOMC colleagues had urged tighter
in the money stock] for appraisal of central bank fiscal policy to stem inflation in 1968, and sup-
operations is no longer appropriate.”25 ported the temporary tax increase that had been
Francis cited Federal Reserve Bank of St. Louis enacted, Francis contended that the tax increase
research often and at least once entered St. Louis was unlikely to have a significant effect on eco-
staff forecasts of real output and inflation under nomic activity.27 As Francis predicted, the tempo-
alternative money stock growth rates into the for- rary fiscal measures adopted in 1968 had minimal
mal record of FOMC deliberations. His first record- impact on economic activity.
ed reference came at the December 17, 1968,
meeting when he discussed “a recent study done at THE ST. LOUIS MODEL: MONETARISM
the St. Louis Reserve Bank [which] indicated that FOR THE SHORT-RUN
with the existing stance of fiscal policy, if money
continued to grow at a 6 per cent annual rate The predictive success of the St. Louis (AJ)
throughout the coming year, gross national prod- equation and the apparent failure of fiscal policy
uct would rise at an excessive 8 per cent annual to stem the inflation of the late 1960s gave mone-
rate” (FOMC Minutes, December 17, 1968, p. 54). tarists credibility in policy discussions. The behav-
Francis’s discussion illustrates that St. Louis ior of the money stock began to get more consid-
Fed officials (and monetarists in general) had
begun to actively engage the prevailing wisdom on 25
Gramley recalls the policy debates this way: “ if the Federal
its own short-run grounds. The AJ results, in Reserve had appreciated how serious the inflationary problem was
going to become, they would have paid more attention to the
effect, provided a platform by which monetarist growth of the monetary aggregates and relied less on money mar-
policy prescriptions, oriented to the behavior of ket conditions if you weren’t worried too much about long-run
inflation you were inclined therefore not to pay sufficient attention
the monetary aggregates, could be discussed in to what was happening to those aggregates” (quoted in Mayer,
terms of short-run stabilization issues. With one 1995, pp. 7-8).
eye cocked to the longer-term inflationary effects 26
For example, at an FOMC meeting on March 9, 1971, he noted that
of policy, something that the conventional view “In the past the System had, on occasion, persisted in a policy
did not provide, monetarists could also discuss the course too long. Knowledge of current developments in the econo-
my was available only with a delay, and the effects of monetary
short-run effects of monetary policy. actions on spending, production, prices and employment contin-
Francis’s use in FOMC meetings of research ued for months” (FOMC Minutes, March 9, 1971, p. 66).
conducted by St. Louis Fed economists illustrates 27

As Francis summarized his position before the FOMC, “Over the
how the Fed’s decentralized organizational struc- past year the System had aggressively advocated fiscal restraint as a
necessity to rational stabilization policy. Yet now that such restraint
ture can affect policy deliberations. The participa- appeared likely, there seemed to be growing fear of its destabilizing
tion of Federal Reserve Bank presidents in mone- impact. [He] did not share those views Those fiscal measures
were generally expected to be temporary, and thus much of the tax
tary policymaking provides an outlet for alterna- burden on consumers would probably come from reduced saving
tive perspectives to be heard, including direct criti- and much of the burden on corporations would probably come
from increased borrowing The tax measure, because of its tem-
cism of System policy. In addition to bringing the porary nature, might actually cause some acceleration of invest-
research findings of his staff to FOMC delibera- ment spending” (FOMC Minutes, June 18, 1968, pp. 87-88).
eration in the setting of stabilization policy.28 But models being developed elsewhere, the St. Louis
some observers, even Homer Jones, the St. Louis model built upon previous research at the Bank in
Bank’s research director when the St. Louis model which the money stock is the central focus of sta-
was developed, sounded a note of caution: bilization policy.
Our own econometric studies at St. Louis The original St. Louis model consisted of eight
have long indicated strong, roughly pre- equations, only four of which were estimated: the
dictable, relations between monetary action, total spending equation—the AJ equation, a price
intentional or unintentional, and the course equation, an equation for the long-term interest
of the economy does this mean we can rate, and an unemployment equation. The
expect to engage usefully in active monetary remaining equations are definitions.29 The interest
management in the future? I conclude rate equation, based on earlier work by Yohe and
that we cannot in the near future engage intel- Karnosky (1969), reflected the view that interest
ligently in short-run manipulative monetary rates are determined by past inflation and past
management. (1970, p.15, emphasis added) changes in money growth. The unemployment
equation was essentially that developed by Okun
Darryl Francis also warned against using mone-
(1962). The price equation rejected the typical
tary policy to fine-tune economic activity. The
wage-price markup approach popular at the time.
success of the AJ equation and the building empir-
Instead, AC specified the change in the price level
ical evidence in support of monetarist views, how-
as a function of demand pressures and anticipated
ever, led to a greater focus on the short-run. In his
price changes.
retrospective of the equation’s development and
The St. Louis model is “monetarist” in that the
use, Jordan (1986, p. 8) notes that “The [AJ] arti-
money stock is treated as exogenous and its effect
cle’s impact on economic policymaking would
on total spending is central to the workings of the
have been more favorable had it not led to an
model.30 As AC state:
increased reliance on monetary over fiscal policy,
but had it instead contributed to a general de-
The change in total spending is combined
emphasis of fine-tuning attempts by policymak-
with potential (full employment) output to
ers.”
provide a measure of demand pressure.
The increasingly short-run emphasis undoubt- Anticipated price change, which depends
edly reflected, in part, the natural focus of policy- on past price changes, is combined with
making at the central bank. Dewey Daane, a demand pressure to determine the change
Federal Reserve governor, noted that the FOMC in the price level. The total spending iden-
was “always concentrating on what’s the immedi- tity enables the change in output to be
ate problem over the next four to six weeks and determined, given the change in total
not really thinking in terms of long-run forecasts spending and the change in prices. (p.10)
and inflation” (quoted in Mayer, 1995, p. 16).
Governor Andrew Brimmer’s recollection corrobo-
28
rates this view, noting that there was “clearly a In reviewing the discussion of monetary policy at a recent confer-
ence, Friedman wrote to Homer Jones in July 1969 that “I, too,
short-term horizon. [Chairman] Martin put a lot of
have been very much impressed with the evidence that a new day
emphasis on the long run, but that was unusual” has dawned I almost fell over when he [Board Governor Dewey
(quoted in Mayer, 1995, p. 4). Daane] started talking about the importance of paying attention to
monetary aggregates” (Friedman Papers, Box 28, Folder 36).
In April 1970, the Federal Reserve Bank of St.
29
Louis published “A Monetarist Model for The original model is summarized in the Appendix. Carlson (1986)
provides a comparison of the original version and the then “cur-
Economic Stabilization,” by Andersen and Carlson rent” version which reflects modifications over the intervening
(hereafter, AC). The AC, or “St. Louis” model as it years.
has become known, reflected the latest stage in 30
AC determine real output as a residual; that is, output is deter-
the development of an empirical model of mone- mined as the difference between total spending and the price level.
tarist propositions and expanded the on-going As they note, “This method of determining the change in total
spending and its division between output change and price change
debate over the role of money in determining differs from most econometric models. A standard practice in
aggregate spending and inflation in an important econometric model building is to determine output and prices sep-
way. Unlike the large-scale macroeconometric arately, then combine them to determine total spending” (p.10).
REVIEW
The structure of the model meant that for a Louis model, in which fiscal policy plays a minor
given change in the money supply or government role, fare in comparison with the Wharton model
expenditures, one could solve for changes in total in which fiscal policy has a much larger role than
spending, prices, real output, the unemployment money? The St. Louis model’s simulations were
rate, and interest rates. The model was simple in better (i.e., produced lower root-mean-squared
comparison with the complex structural models errors) than the Wharton model for nominal GNP
used by the Board staff and elsewhere. For exam- and the unemployment rate, about the same for
ple, whereas the Wharton model, a representative real GNP, and worse for the price level. The upshot
Keynesian structural model, had 43 exogenous was that this small, monetarist-oriented model
variables, the St. Louis model had just three. The could prove as valuable to policymakers as the
large-scale Keynesian models then in use.
model also omitted details about specific sectors
Importantly, it seemed to demonstrate the useful-
for the simplicity of determining the impact of a
ness of a small monetarist model for current
change in money growth on the economy broadly.
analysis. As AC state, “The purpose of the follow-
This development fit nicely with the view of many ing statistical section is to estimate the response of
monetarists that “the Federal Reserve should be output and prices to monetary and fiscal actions,
concerned with the aggregate effects of policy, not to test a hypothesized structure. The focus is
and should leave the allocative details to the oper- on the response in the short run—periods of two or
ation of the market” (Francis 1973, p. 9).31 As three years—but the long-run properties also are
Carlson (1986, p. 18) recollects the development examined” (1970, pp. 10-11, emphasis added).
of the model, The success of the St. Louis model was impor-
tant to monetarism’s growing impact on policy
we wanted a model that was small enough discussions. It also appeared soon after Friedman
that the interrelationships among the varables (1968) and Phelps (1967) provided theoretical
could be understood easily We were not models in which the popular Phillips curve trade-
concerned about respecifying behavioral off between inflation and unemployment (and,
equations [and] we wanted to capture hence, real output growth) was shown to be transi-
empirical relationships between a relatively tory. The Phillips curve, a version of which
few key macroeconomic variables that were appears in the St. Louis model, was a critical com-
implicitly grounded in economic theory. ponent of most Keynesian macro-models of the
time. The results of AC provided an empirical
AC state explicitly that their statistical analysis demonstration that although expansionary mone-
is used “to estimate the response of output and tary policy might produce a short-run increase in
prices to monetary and fiscal actions, not to test a real output growth and a dip in the unemploy-
hypothesized structure” (pp. 10-11).32 The original ment rate, these effects would vanish over time as
estimates appeared to support the monetarist view inflation increased and unemployment and output
of the world: an increase in the money supply growth returned to their “natural” or trend rates.
leads first to an immediate increase in nominal The St. Louis model enabled monetarists to
spending and real output, and only after prices produce short-run forecasts of alternative policy
adjust to the higher demand pressure does the scenarios, thereby putting them on similar footing
price level rise to stifle the increase in real output.
31
A recurrent theme in discussions about the role of policy was the
Using the Model for Short-Run recognition that policy actions sometimes affected certain indus-
Analysis tries—most notably housing—more than others. Such attention
was disruptive to the working of market forces, Francis believed. He
Andersen and Carlson used the St. Louis noted that “Regulation of interest rates paid by commercial banks
and thrift institutions unduly disrupts the allocation function of
model to simulate nominal spending, real output, markets. Furthermore, excessive concern for the well-being of
inflation, and the unemployment rate for different these institutions and the housing industry has caused monetary
hypothesized growth paths for money. They also authorities to expand the money stock at a rapid rate during much
of the current inflationary period” (1968, p. 9).
compared their monetarist model’s forecasting
32
ability with that of the Wharton model during Francis (1973, p. 8) makes the point that “The bewildering strug-
gles that occur between model builders over specification errors,
1963-64, a period that included a major fiscal structural versus reduced-form models, recursive versus non-recur-
action—the tax cut of 1964. How would the St. sive systems, etc., are meaningless to most policymakers.”
with other mainstream economists, both in and Research from St. Louis continued to provide a
outside of the Federal Reserve System. Dewald long-term, inflation-oriented perspective on mon-
(1988, p. 6) contends that with the development of etary policy actions, reflecting rising inflation of
the St. Louis model, “monetarism was widely inter- the early 1970s. At the same time, the Review con-
preted as providing an alternative to short-run tained numerous studies, often authored by
Keynesian model forecasts.” The St. Louis model, Andersen or Keran, of the short-run response of
though grounded in the long-run conditions of the the economy to changes in the growth of the
Quantity Theory, increasingly was used to counter monetary aggregates. The allure of short-run
the short-run policy prescriptions coming from analysis perhaps is best illustrated by Carlson’s
the larger structural models in use at the Board. (1975) estimation of the St. Louis equation using
The St. Louis model, estimated using quarterly monthly data. Replacing nominal GNP with per-
observations and with the money stock—not sonal income, Carlson found that the lag from
interest rates—as the policy instrument, led many changes in the growth of money to nominal
observers to conclude that the money stock could income was completed in about one year, similar
to that found by AJ, though slower than reported
be an effective tool for economic stabilization.
in other studies.33 The implication of this finding
The shifting emphasis at the St. Louis Bank
was clear: Carlson (1975, p. 17) suggests that the
toward short-run policy analysis can be found in
“Use of monthly data thus appears to carry the
comments of participants in the model’s develop-
potential for evaluating the thrust of monetary
ment. Carlson (1972, p. 25) warned against using and fiscal actions before quarterly data on GNP
the model for anything but interpreting the “gen- become available.”
eral time path” of important macroeconomic vari- In the late 1960s, public interest in mone-
ables. Even so, analysis of the short-run impact of tarism rose as inflation continued to increase.
alternative policies is precisely what the model Monetarists were called upon by the incoming
came to be used for. His own admonition aside, Nixon administration for advice. Milton Friedman
Carlson (1972, p. 20) noted that the model “pres- wrote a regular column for Newsweek alongside
ents a set of simulations using alternative steady one by Paul Samuelson, who had been a leading
growth rates which can aid in assessing the eco- advisor to the previous two administrations and a
nomic impact over several quarters of different leading architect of the so-called New Economics.
trend growth rates of money” (emphasis added). Increased attention, however, brought more stri-
In keeping with this view, his analysis of the dent criticism. By 1972 there already were claims
model’s performance was based on a six-quarter that monetarism had “failed.” For example, in his
horizon, hardly the long run used by early mone- Newsweek column of August 2, 1971, Samuelson
tarist studies. But such a use for the model objected to the monetarist claim that rapid money
appeared justified by the empirical results: “the growth in 1971 would subsequently lead to faster
model succeeded in roughing out the average time nominal GNP growth. He suggested that “the fore-
paths of total spending, real product, prices, casting ability of monetarism is selling at a huge
unemployment, and interest rates during the peri- discount on the markets of informed opinion”
od from late 1969 to mid-1971” (Carlson, 1972, p. (Samuelson 1971, p. 70) and that the “pseudoposi-
26, emphasis added). tivism which prevails among monetarists. . . [is]
The model’s success as a forecast tool gave still another reason why the peculiar tenets of
support to monetarist calls for a policy aimed at monetarism have to be rejected” (quoted in
stable money growth. In reviewing the debate over Francis, 1972, p. 32).
stabilization policy, Andersen (1973, p. 3) summa- Members of the Board of Governors also criti-
rized the model’s success at forecasting real output cized the policy advice of monetarists. For exam-
and inflation, stating that “The key proposition is ple, Andrew Brimmer, echoing arguments made
that changes in money dominate other short-run during the previous two decades, rejected any pol-
icy based on control of the monetary aggregates:
influences on output and other long-run influences
“I am convinced that it would be a disastrous
on the price level and nominal aggregate demand”
(emphasis added). The St. Louis model suggested 33
Another example of attempts to model the short-run effects of
that stable money growth would lessen any
money on the economy is Laffer and Ransom (1971). Unlike the St.
monetary-induced instability in the real economy Louis results, Laffer and Ransom report that monetary actions lead
while promoting price stability in the long run. to an immediate and permanent effect on the level of GNP.
REVIEW
error for the Federal Reserve to try to conduct the money supply remained useful for stabiliza-
monetary policy on the basis of a few simple rules tion purposes.
governing the rate of expansion of the money
supply” (1972, p. 351). The Breakdown of the Monetarist Rule
Francis (1972, p. 32) considered such attacks Kane (1990) observes that as the rate of inflation
“strident,” “doctrinaire,” and “no more precise continued to increase over the 1970s, the growing
than in the past.” He answered these criticisms by weight of evidence supporting the monetarist posi-
pointing to the St. Louis model’s ability to forecast tion pushed the FOMC to incorporate money stock
economic activity over the short-run. He com- growth into their policy deliberations and evalua-
pared income, inflation, and unemployment pre- tions. This was quite a change from their position of
dictions for 1969, 1970, and 1971 derived from a decade earlier when “they treated monetarism as
the St. Louis model to those of the consensus an eccentric and quasi-religious belief system that
Livingston forecasts. The overall forecasting ability no responsible macroeconomist or public official
of the St. Louis model compared favorably with could possibly take seriously”(p. 292).
the consensus forecasts. Although Francis main- Monetarism as a policy approach, however,
tained that policy should take a longer-term view had a relatively short stay in the limelight. In
to be effective, he focused on a few years of fore- October 1979, the Federal Reserve adopted new
casting results to justify applying the model to operating procedures that it claimed would
shorter time horizons. enhance its control of the money stock. Highly
restrictive policies also were enacted to reduce
Refining the Model inflation, which had reached double-digit levels.
Although inflation eventually declined significant-
As the 1970s progressed, neither Keynesian ly, the more immediate effect was to send the
models based on the Phillips curve and interest economy into the deepest recession of the post-
rates, nor simple monetarist models based on war period. Critics associated the policy with
growth of the money stock, successfully forecast monetarism, referring to the policy as the Fed’s
the rapid inflation and higher unemployment that “monetarist experiment,” and this perception con-
actually occurred. Monetarists faced the task of tributed to the widespread discounting of mone-
explaining why inflation had increased so dramat- tarism as a viable policy option. Monetarists
ically without a similar-sized increase in money protested that the Fed had not, in fact, adopted
stock growth. Monetarists, including St. Louis Fed their preferred policy of slow and steady money
officials, responded that their critics had confused growth. Rather, they noted, the variability of
changes in the aggregate price level, which are money growth actually increased after 1979 and
caused by monetary policy, with changes in rela- gave rise to increased fluctuations in real econom-
tive prices brought on by special factors. Francis ic activity without any appreciable short-run effect
presented the Bank’s position in a series of on inflation.35
speeches in 1974. He pointed out that the increase
in inflation was due largely to an increase in 34
Francis argued similarly in FOMC deliberations. At a meeting on
money growth over the preceding few years. Any January 22, 1974, for example, Francis contended that “the actual
inflation over and above the underlying monetary and prospective slowdown in economic activity resulted wholly
from capacity, supply, and price-distorting constraints and not from
growth rate was caused by the removal of wage a weakening in demand. Therefore, to ease [monetary] policy and
and price controls and the increase in oil prices by allow a faster rate of monetary growth would be to increase infla-
the OPEC nations.34 tionary pressures without expanding real output or reducing unem-
ployment” (FOMC Minutes, January 22, 1974, p. 102).
St. Louis Fed economists soon integrated such
35
special factors in their studies. Karnosky (1976) Batten and Stone (1983) provide an overview of the issues and evi-
dence in support of the monetarist position. For contrasting assess-
demonstrated that money growth continued to ments of this episode, see B. Friedman (1984) and M. Friedman
explain longer-term movements of inflation once (1984). Charles Schultz, Chairman of the Council of Economic
the oil price shock effects were accounted for. Advisors from 1977-81, considered the monetarist experiment in
Rasche and Tatom (1977) extended this idea in this light: “What monetarism really is for the Fed (and I’m morally
certain this is what Volcker thinks, too) a political cover. They’re
their examination of the effects of supply shocks not monetarists, but it allowed them to do what they could never
on the economy and how they could distort the have done They could never have done what needed to be
statistical relationship between money and done if it looked as if they were the ones raising interest rates,
when they were targeting interest rates, per se. But with fixed
income in the short-run. Although aspects of monetary targets they could just say, ‘Who, us?’” (quoted in
these works were criticized, they suggested that Hargrove and Morely, 1984, p. 486).
Regardless of whether the Fed had in fact Figure 1

adopted a monetarist policy in 1979, large, volatile
movements in velocity began to erode profession- Velocity of Money (M1)
al support for monetarist policies. Inflation and Quarterly Data, 1960 Through 1999
attendant increases in market interest rates 10
encouraged financial innovations that gave con- Pre-1980 Trend
sumers more options for holding liquid balances. 9
This, in turn, spurred regulatory changes that pro-
duced sharp changes in the relative demands for 8
liquid financial assets. At the same time, the Fed’s
abrupt tightening brought a sharp decline in the 7
rate of inflation, which probably contributed to a

6
reversal of the upward trend in velocity that had M1 Velocity
characterized the previous three decades.36 Asset
5
demand shifts and uncertainty about the Fed’s
commitment to a new path for inflation probably
4
explain why the velocity of traditional measures
of the money stock, especially the narrow meas- 3
ures, such as M1, favored by officials of the 1960 1970 1980 1990 2000
Federal Reserve Bank of St. Louis, began to move
erratically. Stable velocity was crucial for the
reduced-form models used at St. Louis to hold. If economy, and early success at improving model
the path of velocity changed unpredictably, then forecasts encouraged further research along the
the predictions of the St. Louis equation and same lines. But, because the shift in velocity had
model could be unreliable.37 As velocity began to occurred only recently, and therefore affected
deviate seriously and continuously from its previ- only a limited number of observations used in the
ously stable path, monetarist policy prescriptions estimation of the model, these papers largely
became increasingly suspect. ignored the potential effects of the shift. Indeed,
As shown in Figure 1, the velocity of M1—the even Carlson’s (1986) version of the model, one
monetary aggregate used in the St. Louis model— that made minor revisions that recognized the
maintained a fairly steady upward climb during
36
the 1960s and 1970s. During the 1980s, however, Gavin and Dewald (1989) show that disinflation leads to a reduc-
tion in velocity once the public comes to expect that a new trend
M1 velocity deviated considerably from its previ- growth rate of money and the price level have been established.
ous path. M1 velocity appeared to become “unsta- 37
This potential problem was already known. For example, Rasche
ble,” thus justifying critics’ opposition to monetary (1972) noted that the successful forecasting ability of the St. Louis
targeting.38 equation was, in part, based on the small interest elasticity of the
As M1 velocity deviated further from its his- money demand function. As he states (p. 31): “if the short-run
toric trend, St. Louis Fed researchers devoted interest elasticity of the money demand function is very small,
then an estimated equation omitting this term [the interest rate]
increasing effort to understanding velocity and would most likely produce a credible forecasting record” (emphasis
modifying their forecasting model. Meyer and in original). In some sense, the constant term in equation (1) is the
Varvares (1981), for example, made two modifica- empirical representation of velocity. Financial innovations altered
the underlying short-run interest elasticity of money demand and
tions: one modification was to model the rate of adversely affected the equation’s forecasting ability. Because no
inflation as a direct outcome of money growth changes along these lines were made to the model, its forecasts
and oil price shocks; the other modification incor- began to stray. More recent investigations of the behavior of veloci-
porated a new Phillips curve relation. Other St. ty include Stone and Thornton (1987), Rasche (1993), Hoffman and
Rasche (1996), and Laurent (1999).
Louis Fed studies researched the lag between 38
money and prices (Carlson, 1980), the effects of Monetarists had long divided over whether a narrow aggregate,
such as the monetary base or M1, or a broader aggregate, such as
fiscal policy (Hafer, 1982), and the longer-run M2 or M3, was a preferable target for monetary policy. St. Louis
consequences of policy (Carlson and Hein, 1983). Fed officials advocated M1, while Milton Friedman favored M2.
These studies all concluded that the reduced-form When M1 velocity began to deviate from its trend in the early
1980s, M2 velocity remained relatively stable. By the early 1990s,
approach continued to be a reasonable way of however, M2 velocity also had deviated substantially from its long-
modeling the impact of monetary policy on the run trend.
REVIEW
impact of energy prices, wage and price controls, Louis Fed officials that they could credibly advocate
and several other technical changes, continued to a monetarist stabilization policy for the short-run.
fit the data reasonably well. Thus, for a time, mon- The Federal Reserve took a step toward mone-
etarists continued to argue that nominal income tary aggregate targeting in October 1979, when
growth reflected changes in money growth over new procedures were implemented to better con-
short periods and that inflation reflected money trol the money stock with the goal of reducing
growth over longer periods, even during this inflation. The targeting of monetary aggregates was
turbulent time. As the 1980s progressed, however, largely abandoned in 1982, however, when velocity,
continued instability of velocity caused all but the particularly of M1—the narrow aggregate favored
most diehard supporters to abandon short-run by St. Louis Fed officials—proved too erratic.
monetary aggregate targets. Deregulation, other institutional changes, and
uncertainty about the Fed’s commitment to disin-
LESSONS FROM THE ST. LOUIS flation probably explain much of the unstable
EXPERIENCE behavior of velocity in the 1980s. The Depository
Institution Deregulation and Monetary Control Act
The development and decline of the St. Louis of 1980 (DIDMCA) instituted a six-year process
monetarist model as a guide to short-run stabiliza- ending the prohibition of interest payments on
tion policy is not unlike the evolution of stabiliza- transaction accounts at commercial banks and
tion policies designed to exploit a tradeoff deregulating rates on other accounts. These
between inflation and unemployment. Policies changes, and various financial innovations, were
based on the Phillips curve arose from an appar- followed by volatile flows between classes of
ently robust empirical relationship between infla- financial assets that altered the empirical relation-
tion and unemployment observed in macroeco- ships between national income and monetary
nomic data. As discussed in King and Watson aggregates. Monetary aggregates quickly lost favor
(1994), the negative correlation between the vari- as short-run policy targets when movements in
ables in the short-run suggested the presence of a velocity became difficult to explain or predict. In
long-run structural relationship that could be essence, changes in the structure of the economy
exploited for policy purposes. Attempts to manip- altered the short-run relationships between tradi-
ulate interest rates to increase the growth of real tional monetary aggregates and policy objectives.
output and employment above potential, however, Monetarist models, including the St. Louis model,
gave rise to what has been called “the great infla- were not equipped to handle such changes, and
tion” in the United States, a period encompassing their forecasting performance suffered as a result.
the 1960s and 1970s.39 Typical macroeconomic models of the 1970s,
Over the 1970s, as inflation and unemploy- including the St. Louis model, also were not
ment rose simultaneously, monetarists gained a equipped to deal with the so-called “Lucas
stronger voice in monetary policy debates as the Critique.” Lucas (1976) demonstrated that coeffi-
long-run relations among money, prices, and cient estimates of typical forecasting models are
nominal income seemed to hold even in the unlikely to be stable across policy regimes. As
short-run. Due in part to work at the Federal individuals learn about and modify their behavior
Reserve Bank of St. Louis, Woodford (forthcoming, in response to a change in regime, empirical rela-
p. 18) suggests that “the monetarist viewpoint had tionships among macroeconomic variables may
become the new orthodoxy by the mid-1970s.” change. Consequently, economic projections
The St. Louis Bank and its officials had special based on estimation of a model over one regime
prominence because they provided an avenue for may not be valid for a different regime. For exam-
monetarist research and views to potentially ple, the close short-run correlations among
influence policy deliberations. To be influential, money, output, and prices observed during the
however, monetarists had to offer a viable policy 1960s and 1970s under a regime characterized by
for the short-run—a policy that could be discussed interest rate targeting would not necessarily have
and voted on at meetings some six weeks apart. been so close in a regime of monetary aggregate
The success of the St. Louis model at forecasting
output, nominal income, and prices over such 39
For alternative views of this period, see DeLong (1997), Mayer
short horizons during the 1970s convinced St. (1999), Sargent (1999), Taylor (1999), or Wheelock (1998).
targeting.40 Barro, Robert J. “Inflation and Growth.” Federal Reserve

The search for robust empirical relationships Bank of St. Louis Review, May/June 1996, 78(3),
across different regimes has shown that money, pp. 153-69.
nominal income, and inflation remain closely
linked in the long run (Dewald, 1998; Dwyer and Batten, Dallas S. and Stone, Courtenay C. “Are Monetarists
Hafer, 1999; Lucas, 1996; Rolnick and Weber, an Endangered Species?” Federal Reserve Bank of St.
1997). There also is some evidence that the link- Louis Review, May 1983, 65(5), pp. 5-16.
ages between money and economic activity are
robust even at relatively short-run frequencies.41 __________ and Thornton, Daniel L. “The Monetary-Fiscal
Monetary aggregates again may prove useful for Policy Debate and the Andersen-Jordan Equation.”
economic forecasting or as guides for conducting Federal Reserve Bank of St. Louis Review, October 1986,
monetary policy. Experience has shown, however, 68(8), pp. 9-17.
that empirical relationships between policy vari-
ables and goals can change, sometimes unpre- Brimmer, Andrew F. “The Political Economy of Money:
dictably. The experience with the monetarist rule Evolution and Impact of Monetarism in the Federal
as developed at the St. Louis Fed councils against Reserve System.” American Economic Review, May 1972,
overconfidence in our ability to identify infallible pp. 344-52.
rules for conducting short-run stabilization policy.
Bronfenbrenner, Martin and Holzman, Franklin D. “Survey
of Inflation Theory.” American Economic Review,
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Appendix
A
The 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 the
model, see Carlson (1986).
Total Spending Equation Exogenous Variables:
1) ∆Yt = f1 ( ∆Mt ...∆Mt − n , ∆Et ...∆Et − n ) ∆Mt = change in money stock
∆Et =change in high-employment Federal
Price Equation expenditures
XtF =potential output
2) ∆Pt = f 2 ( Dt ...Dt − n , ∆P A )
Endogenous Variables:
Demand Pressure Identity ∆Yt =change in total spending (nominal GNP)
3) Dt = ∆Yt − ( XtF − Xt −1 ) ∆Pt = change in price level (GNP deflator)
Dt= demand pressure
Total Spending Identity ∆Xt = change in output (real GNP)
4) ∆Yt = ∆Pt + ∆Xt Rt = market interest rate
∆PtA = anticipated change in price level
Interest Rate Equation Ut= unemployment rate
Gt = GNP gap
5) Rt = f 3 ( ∆Mt , ∆Xt ...∆Xt − n , ∆Pt , ∆PtA )
Anticipated Price Equation

6) ∆PtA = f 4 ( ∆Pt −1 ...∆Pt − n )
Unemployment Rate Equation

7) U t = f 5 ( Gt ,Gt −1 )
GNP Gap Identity

8) Gt = ( XtF − Xt ) / XtF

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FEDERAL RESERVE BANK OF ST.

became one of the most cited papers in econom- 3

Inflation and the Phillips Curve increases in production costs, in contrast to

conducted by St. Louis Fed economists illustrates 27

Regardless of whether the Fed had in fact Figure 1

rate of inflation, which probably contributed to a

targeting.40 Barro, Robert J. “Inflation and Growth.” Federal Reserve

Andersen, Leonall C. “Federal Reserve Defensive

__________. “A Monetarist Model for Economic

__________ and Hein, Scott E. “Four Econometric Models

__________. “The Role of Monetary Policy.” American

__________ and Schwartz, Anna J. A Monetary History of

__________ and __________. Monetary Statistics of the

__________. “Nobel Lecture: Monetary Neutrality.” Journal

Roosa, Robert V. Federal Reserve Operations in the Money

Sargent, Thomas J. The Conquest of American Inflation.

Stone, Courtenay C. and Thornton, Daniel L. “Solving the

Taylor, John B. “Discretion Versus Policy Rules in Practice.”

__________. “The Robustness and Efficiency of Monetary

Weintraub, Sidney. “Monetary Policy, 1957-59: Too Tight,

Wheelock, David C. “Monetary Policy in the Great

__________. “National Monetary Policy by Regional Design:

Woodford, Michael. “Revolution and Evolution in

Yohe, William P. and Karnosky, Denis S. “Interest Rates and

Anticipated Price Equation

Unemployment Rate Equation

GNP Gap Identity

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