Friedman and Schwartz on Monetary trends: A review article

The Correlation between Money and Output in the United Kingdom: Resolution of a Puzzle

“…It is incumbent upon believers in (temporary) effects of monetary policy on output to account for this finding, and that is an aim of the present paper. As a preliminary step, it is worth considering the reconciliation suggested by Laidler (1982). The resolution that Laidler offered focuses on terms-of-trade movements.…”

“…And the events of 1920 would appear to offer a prime example of a price-level shock that amplified the nonneutrality of monetary policy. In particular, the year featured the sort of termsof-trade shock that Laidler (1982) had in mind. Phillips (1958, p. 293) refers to 19191921 as featuring a roller coaster for import prices in the United Kingdom, with rapid rises in 19191920 and a collapse in 1921, while Rose (1983) characterizes this episode as featuring a commodity price shock that was not accommodated by monetary policy.…”

“…The combination of circumstances means that the Laidler (1982) conditions were met over this period: a terms-of-trade shock increased the price level and thereby reduced real balances; the associated downward pressure on real aggregate demand and output led to a slump in output.…”

“…On this evidence, U.K. economic behavior would seem to be consistent with a simple flexible-price monetary model, in which monetary policy determines the rate of inflation with no interim effect on real variables. But the apparent implication that monetary policy is neutral for output in the U.K. business cycle is contrary to intuition, as Laidler (1982Laidler ( , 1989 forcefully argues. It flies in the face of a number of celebrated historical cases in which monetary policy is believed to have been a powerful influence on the U.K. business cycle.…”

“…For the pre-World War I period, a higher correlation between money growth and real output growth emerges once one uses output data that are considered better-quality than those used by Friedman and Schwartz (1982). For the interwar period, a factor cited by Laidler (1982Laidler ( , 1989 appears to be relevant: sizable shifts in the U.K. terms of trade prevented large increases in the nominal money stock from exerting expansionary effects on output. Once these shifts in the terms of trade are taken into account, an important relationship between monetary factors and real activity is reaffirmed.…”