Fischer Black vs. Monetarism

Tyler Cowen and ChatGPT seem to like Black

Tyler Cowen writes,

I am very familiar with Scott Sumner’s monetary theory arguments about medium of account, cash balances, and the like. I grew up with those in pretty much the same manner that Scott did. That said, after decades of watching the data, I have surrendered many of my earlier intuitions.

Cowen quotes ChatGPT, including:

Monetarism, the school of thought that posits a stable connection between the growth rate of a money aggregate and the subsequent rate of price inflation, emerged from these apparent regularities. However, in the decades since, inflation’s behavior has grown more elusive. At present, even the most sophisticated forecasting models struggle to produce accurate predictions, and this persistent difficulty has led many economists to abandon or at least sideline monetarist frameworks, even as broad conceptual approximations of what drives price-level changes.

So what is the Fischer Black view, to which Tyler alludes?

The monetarist intuition is that the value of the dollar is inversely related to the supply of dollars. But in our daily lives we have a different intuition. Our intuition is to treat the value of the dollar as stable, because otherwise our calculations become confused.

Imagine what using a map would be like if the definition of a mile were changing as you are on the go. That is what living under a regime of high and variable inflation is like.

My formulation of Fischer Black’s view is that both the money supply and the price level are consensual hallucinations. Your form of payment is acceptable to me because I believe that other people will accept it. I charge my price based on how I think other prices will behave in the near future.

We do not rely on any particular means of payment, especially with modern finance. Think of how often you use a credit card, or something like Venmo, rather than writing a check or paying with currency.

The “overall” price level is not determined by the supply of M0, M1, or any other monetary aggregate. The price level is highly path-dependent. We got to where we are, and this is where we are.

Specific prices move up and down because of market conditions. Every week, your favorite gas station posts a new price per gallon.

I would say (and here I depart from Black) that over long periods of time, overall prices will be influenced by paper wealth. Paper wealth in turn is affected by government deficits and by movements in asset prices. In recent years, paper wealth has been soaring as deficits and stock market valuations rose. In my opinion, we are due to see some inflationary impact of this increase in paper wealth.

A monetary aggregate, such as M2 (currency plus bank deposits) could predict inflation if and only if fluctuations in that aggregate accounted for most of the fluctuations in paper wealth over a given period. This is bound to happen when a government hyperinflates—covering large deficits by printing currency. Otherwise, it may or may not happen. The proportion of paper wealth held as traditional forms of money has been falling for decades, so that I would expect monetarist equations to work less well than they used to—and they never were really reliable.

Thus we have my version of non-monetarism. If by “money” you mean something that is under the direct control of the Fed, then that is different from the “money” that people use to make transactions.

People set today’s prices not based on a monetary aggregate, but based on other prices that they saw yesterday and on what they expect prices to be tomorrow. They act as if inflation will be low and stable, unless it becomes impossible to do so.

Getting the economy into a regime of high and variable inflation is difficult. But it may happen. The huge stock of paper wealth reminds me of a dry forest, capable of catching fire.

My view is at least influenced by and resembles Fischer Black’s non-monetarism, even if it is not exactly what he would have said.