Monetary and Fiseal Actionsin Macroeconomic Models*

by KEITH M. CAULSON

rCONTROVERSY persists in macroeconomics. Thisstatement sounds trite and almost immediatelyprompts the response, “What else is new?” With ref-erence to the “monetarist-fiscalist” controversy, thisdisinterested attitude is probably on the rise. ProfessorJames Tobin, for example, has written:

“If the monetarists and the neo-Keynesians couldagree as to which values of which parameters inwhich behavior relations imply which policy conclu-sions, then they could concentrate on the evidenceregarding the values of those parameters.”

In other words, if there were agreement on a commontheoretical apparatus, the controversy about relativeroles of monetary and fiscal policies could be reducedto an econometric debate about empirical magnitudes.

There are many who believe that the monetarist-fiscalist debate centers on empirical questions. Forexample, Professor Milton Friedman indicated his“belief that the basic differences among economistsare empirical, not theoretical.”2 But Professor Tobinis not willing to accept this characterization of thedebate. In fact, Tobin expresses disappointment inFriedman’s theoretical framework, citing several caseswhere Friedman displays inconsistency with his ear-lier works.3

°Tbis paper is essentially unchanged from its original form asprepared for the Fourth Annual Konstanzer Conference onMonetary Theory and Policy, Konstanz, West Germany,June 1973. Though not folly reflected in this paper, I sincehave benefited from comments by Professors John Pippinger,Ronald Sutherland, and Jai-Hoon Yang.

1James Tobin, “Friedman’s Theoretical Framework,” Journalof Political Economy (September/October 1972), p. 852-

2~4iltonFriedman, “A Theoretical Framework for Monetary

Analysis,” Journal of Political Economy (March/April 1970),p. 234. Many other examples could be cited suggesting thatthis view is common in the profession. Typical is the follow-ing statement by Professor Crouch [Robert L. Crouch, Macro-economics (New York: Harcourt Brace Jovanovich, 1972),p. vilil: “... macroeconomists are separated only by theassumptions they make concerning price flexibility, moneyillusion, expectations, and distribution effects- Therefore, tothe extent that macroeconomists are divided into factions,they are divided over empirical questions and not thetheory-”

~Tobin,“Friedman’s Theoretical Framework.”

Since there is confusion as to the nature of themonetarist-fiscalist controversy, it is not surprising thatthe debate persists. Until there is at least agreementas to the nature of the controversy, we cannot expectmuch progress toward resolving the central issues.4

Professor Karl Brunner has grouped the central is-sues of macroeconomics under four topics: the natureof the transmission mechanism, the inherent stabilityof the economic system, the nature of impulses gen-erating economic income fluctuations, and the ap-proximate separation of allocative and aggregativeforces,5

The focus of this paper is on the monetarist-fiscalistcontroversy primarily as it relates to (1) the nature ofpolicy impulses and the business cycle and (2) thenature of the transmission mechanism. As background,the historical development of the controversy istraced, albeit cursorily. Next, the current nature ofthe controversy is examined in greater detail and theBrunner-Meltzer view of the transmission mechanismis discussed in juxtaposition with the well-knownHicksian model. Alternative views of the transmissionmechanism can provide some insights into the issuesrelevant to the monetarist-fiscalist controversy.

~Several articles have appeared since this paper was first draftedwhich have attempted to identify the issues in the contro-versy. One is Axel Leijonhufvud, “Effective Demand Fail-ures,” Swedish Journal of Economics (March 1973), pp. 27-48, where he argues that the central issue concerns the self-regulatory capabilities of market systems. Another is RobertH. Rasche, “A Comparative Static Analysis of Some Mone-tarist Propositions,” this Review (December 1973), pp. 15-23,where he suggests that the issues revolve on the assumptionsabout price perceptions by economic units. Professor Rascheconcludes that the debate over the relative stability of mone-tary velocity vs. the autonomous expenditure multiplier hasbeen misdirected. Also see Leonall C. Andersen, “The Stateof the Monetarist Debate,” and the accompanying commentaryby Lawrence R. Klein and Karl Brunner, this Review (Sep-tember 1973), pp. 2-14. Important earlier surveys of the issuesare Karl Brunner, “A Survey of Selected Issues in MonetaryTheory,” Schweizerische Zeitschrift fur Volkswlrtschaft undStatistik/(Winter 1971), pp. 1-146, and David I. Fand, “SomeIssues in Monetary Economics,” this Review (January 1970),pp. 10-27.

tmSee Karl Brunner’s review of Bert C. Hickman, ci, Econ-ometric Models of Cyclical Behavior, Journal of Econo-metric Literature (September 1973), pp. 927-33, and “A Sur-vey of Selected Issues in Monetary Theory.”

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DEVELOPMENT OF THECONTR.OVERSD AN OVERVIEW

Development of the controversy between mone-tarists and fiscalists during the post-\Vorld War IIperiod is divided into four periods.6 Though theseperiods are not precise and well defined, it is usefulto associate evolving opinions and beliefs with thepassage of time. Central to the discussion is the inter-play of economic experience with economic thinking.Specific economic episodes are capable of havingpronounced effects on prevailing macroeconomicthought which rival in importance the effects of care-fully prepared theoretical analyses or detailed econo-metric studies.

Pre-1961.

The post-World War II period prior to 1961 can becharacterized as the period marking the developmentof the Keynesian orthodoxy. This orthodoxy centerson the income-expenditure model as the basic analyt-ical framework of macroeconomic analysis.7 That is,the “C + I ± G” approach tended to dominatemacroeconomic thinking, and paralleled closely thedevelopment of the national income accounts.

This school of macroeconomic thought developedquite independently of economic experience. For ex-ample, during the middle and late l950s economicpolicy involved very little experimentation in effortsto achieve the goals of the Employment Act of 1946.As a result, there were few direct tests of macro-economic propositions on the economic policy front.As near as economists could tell, monetary and fiscalpolicies were being conducted on the basis of certainestablished patterns of behavior, with little interplaybetween economists and policymakers.8 One of thegreat “missions” of macroeconomists seemed to be

JANUARY 1974

that of convincing policymakers that there were othergoals besides balancing the Federal budget. The rea-sons underlying this lack of interplay between policyand economic thought can be traced to the state ofdevelopment of economic information at the time andthe relatively undeveloped means of processing whatinformation was available. Inability to monitor closelyeconomic conditions contributed to a division betweeneconomic thought and policy.

The development of macroeconomic thought priorto 1961 was decidedly Keynesian in the “C +1 + G”sense, with little emphasis on monetary policy, Thenotion of compensatory fiscal policy became a fixturein textbooks long before it was considered at all seri-ously by policymakers. About the only dissentingvoices during this period were those of Clark War-burton and Milton Friedman.°Insofar as the Keyne-sian model and the ascending role for fiscal policy wasconcerned, this dissenting challenge was not a seriousone. Even though the Warburton-Friedman challengewas strongly supported with statistical evidence, thedeveloping Keynesian orthodoxy was not about tobackstep to an analysis with classical underpinnings.

1961 to 1966

The year 1961 is chosen as the beginning of the nextera in macroeconomic thinking primarily because oftwo significant developments — one dealing with eco-nomic policy and the other with a controversial con-tribution to the economic literature. The policy de-velopment was the formation of the “Heller Council,”and the “sale” of the Keynesian model to Congressand the public.10 A significant development in theliterature was the publication of a study on quantitytheory vs. Keynesian theory for the Commission onMoney and Credit by Professors Friedman andMeiselman.’1

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6Foravery readable summary of the development of the con-troversy, see A. James Meigs, Money Matters: Economics,Markets, Politics (New York: Harper and Row, 1972), esp.part 4. See also Beryl W. Sprinkel, Money and Markets: AMonetarirt View (Homewood, Illinois: Irwin, 1971), asp.pp. 1-17.

7The Keynesian orthodoxy, or tradition, is defined in the senseof Axel Leijonhufvud, On Keynesian Economics and the Eco-nomics of Keynes (New York: Oxford University Press, 1968).In contrast to Leijonhufvud, whose book focuses on specifictheoretical issues, the purpose of this section of the paper isto discuss the interplay between economic policy experienceand macroeconomic thought in a very general way.8For discussion of the role of the economist in the evolution ofeconomic policy in the post-World War II period up to 1961,see Herbert Stein, The Fiscal Revolution in America (Chi-cago: University of Chicago Press, 1969), pp. 197-371. Seealso Hugh S. Norton, The Role of the Economist in Gov-eminent: A Study of Economic Advice Since 1920 (Berkeley:McCutchan Publishing Corporation, 1969).

0The most relevant contributions can be found in MiltonFriedman, The Optimum Quantity of Money and Other Es-says (Chicago: Aldine Publishing Company, 1969) andClark Warburton, Depression, Inflation and Monetary Pol-icies, Selected Papers 1945-53 (Baltimore: Johns HopkinsUniversity Press, 1969). ‘l’here were, of course, others whoquestioned developing trends in macroeconomic theory duringthis period.

105ee Stein, The Fiscal Revolution, pp. 372-453. The state ofprevailing opinion among macroeconcimists as of 1961 isprobably best summarized in U.S. Congress, Joint EconomicCommittee, Current Economic Situation and Short-Run Out-look Hearings, 86th Congress, 2nd Session (December 1960),and January 1961 Economic Report of the President andthe Economic Situation and Outlook: Hearings, 87th Con-gress, 1st Session (1961).

liMilton Friedman and David Meiselman, “The Relative Sta-bility of Monetary Velocity and the Investment Multi-plier in the United States, 1897-1958,” in Commission on

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With reference to applied Keynesian economics, therecord and contributions of Professor Walter Hellerand his colleagues are familiar.12 The notion of “fiscaldrag” was developed and eventually Congress wassold on the need for a tax cut to eliminate this“drag.” There were few dissenting views within theeconomics profession during this period of appliedKeynesianism. Almost all macroeconomists felt thetime was ripe for stimulative policy, and recommenda-tions for expansionary fiscal policy assumed “matter-of-factly” that monetary policy was to be accommoda-tive, maintaining stable money market conditionswhen the Federal Government required funds tofinance the deficit.’3

The 1964 tax cut was considered an unqualifiedsuccess by most analysts at that time, and the stabili-zation potential of fiscal policy was enhanced by theacceleration of depreciation allowances and the im-plementation of an investment tax credit, both in1962,14 In fact, by late 1965 the faith in fiscal policywas apparently so strong that it was felt that anysignificant move toward restraint could be postponeduntil the last possible moment so as to get maximumadvances in output before turning to the problem ofchecking inflation.’5

The other development, the Friedman-Meiselman(F-M) study, was creating substantial discussion inacademic circles during the 1961 to 1966 period.16

The F-M study represented a statistical challenge tothe Keynesian orthodoxy. The F-M study really didnot present evidence which was inconsistent withKeynesian theory, but, rather, the statistical evidencewas presented as also being consistent with quantitytheory.

Money and Credit, Stabilization Policies (Englewood Cliffs,N.J.: Prentice-Hall, Inc. 1963), pp. 165-266.

12For an informative accounting of the accomplishments of theHeller Council, see Walter ‘W. Heller, New Dimensions ofPolitical Economy (Cambridge, Mass.: Harvard UniversityPress, 1966).

13See any of the Annual Reports of the Council of EconomicAdvisers from 1962 through 1966.

‘4For an example of one of the few dissenting views at thattime, see Allan H. Meltzer, “The Money Managers and theBoom,” Challenge (March/April 1966), pp. 5-7.

t5The following quotation is typical: “Consultations betweenthe Federal Reserve and the Administration continue, help-ing to assure that monetary and fiscal policy together willprovide appropriately for sustained and balanced expansion.Both are keenly aware of uncertainty in the outlook andare prepared to respond to emerging developments.” TheAnnual Report of the Council of Economic Advisers (Wash-ington: U.S. Govemment Printing Office, 1986), p. 80.

‘6For the relevant references, see Ronald L. Teigen, “A Crit-ical Look at Monetarist Economics,” this Review (January1972), pp. 10-25.

The F-NI study prompted a reaction in defense ofthe Keynesian model, as well as a challenge to themethodology of the F-M study. In general, after thesmoke had cleared and scores of words had appeared,both sides emerged believing they had won.” Anduntil 1965 or 1966, Keynesian supporters could citeapparent successes in applied Keynesianism as addi-tional evidence buttressing their position.

Late 1965 could be characterized as a low point forquantity theorists, or more generally for anyone whobelieved in the potency of monetary actions.’5 It wasnot that economic conditions were inconsistent withthe tenets of the quantity theory, but rather that fiscalpolicy appeared to be so successful that monetarypolicy was cast in a minor supporting role. For ex-ample, the 1966 article by Professor Allan Meltzerchallenged the success of the 1964 tax cut, but thereis no evidence in the literature indicating that Melt-zer’s challenge was taken seriously.

This brief period is noted primarily because ofeconomic events and not the development of eco-nomic literature,’9 Late 1985 and early 1966 markeda significant shift in economic policy. Fiscal policy wasstimulative in late 1965. In fact, there was an overtmove toward stimulus with an excise tax cut as well asan unplanned stimulus from Vietnam War expendi-tures. As the fiscal stimulus continued and the econ-omy approached capacity, the Federal Reserve movedindependently, announcing a policy of restraint andincreasing the discount rate in December 1965. Mon-etary restraint became effective by spring 1966 whengrowth in the money stock came to a halt. The resultof this combination of stimulative fiscal actions andrestrictive monetary actions is well known; in late1966 the economy slipped into a mini-recession.

tTFor example, in Teigen, “A Critical Look,” p. 10, says, “Theempirical evidence presented in support of this ‘quantitytheory’ viewpoint was subjected to criticism so severe thatthe evidence has never been taken very seriously.”

18Note the following statement from Heller, New Dimensions,p. 9: “The basic structure of the Keynesian theory of in-come and employment — and even the basic strategies ofHaasenian policy for stable full employment — are now thevillage common of the economics community. When MiltonFriedman, the chief guardian of the laissez-faire traditionin American economics, said not long ago, ‘We are all Key-nesians now,’ the profession said ‘Amen,’”

‘°Civen normal publication lags, as well as recognition lags byeconomists, it is probably impossible to detect any trends ineconomic literature for a period as short as two or threeyears. To gain insights into economic thinking on policy is-sues during short periods, testimony before CongressionalCommittees is probably the best source, rather than theprofessional journals,

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rIDERAI. RZflRVI flNK or ST. LOUIS JANUARY 1574

Within the economics profession, but chiefly amongpolicymalcers, the power of monetary restraint wasquickly recogn.ized.2° In fact, out of fear of a majorrecession, monetary actions turned stimulative inearly 1967, The response of the economy was veryrapid. In combination with conti.nuing fiscal stimulus,the turn to monetary stimulus very quickly led to are-emergence of inflation.

This short experience of about two years resultedin a more eclectic view of monetary and fiscal policyamong macroeconomists. General belief in the powerof fiscal policy continued, hut now monetary policywas recognized for its potential contribution, Thisexperience, however, was not viewed as a defeat forfiscal policy and the Keynesian model. Rather, theexperience suggested that the economy had movedinto the “classical range” of the LM curve — the rangein which monetary actions have their greatest potencyrelative to fiscal actions,

This short period from 1966 to early 1968 can bedubbed as the “emergence of eclecticism.” Interest inthe Friedman-~Meiselmaucontroversy waned becausethat controversy implied that one of two extreme posi-tions should be accepted. The experience of 1966 to1968, though demonstrating a dominant role formonetary actions, led to the general conclusion thatboth monetary and fiscal policy “mattered.” The de-velopment of the FRB-MIT model at this time wasconsistent with such an eclectic position2’

The final period of review begins with the imple-mentation of the tax surcharge of 1968, which wasalso accompanied by legislated controls on Federalspending. Faith in the success of this fiscal action wasso great that monetary policy was shifted toward easeto avoid “overkifi.” Monetary expansion was rapidwell into 1969, and inflation accelerated. Acceleratinginflation in the face of fiscal restraint was a setback forthe advocates of fiscal policy. If monetary restraintcould slow the economy in 1966 in the face of fiscalstimulus, why could not the tables be turned? After

~O”1,i particular, the power of tight money as a tool of restraint— as well as its uneven impact — was demonstrated beyondany reasonable doubt.” Tha Annual Report of the Council ofEconomic Advisers (Washington: US. Government PrintingOffice, 1967), p. 38.

2’Frank deLeeuw and Edward M. Gramnlich, “The FederalReserve — MIT Econometric Model,” Federal Reserve Bul-letin (January 1968), pp. 11-40, and “The Channels ofMoaetary Policy: A Further Report on the Federal Reserve- MIT Econometric Model,” Federal Reserve Bulletin (June1969), pp. 472-91.

the fact, the explanation offered by the supporters ofKeynesian theory was that the surcharge vras viewedby economic units as temporary.22 The damage tothe “fiscalist position” was especially significant be-cause it marked the first policy setback for Keyne-sianism since its serious application began in 1963..

At about the same time that doubt was begincingto emerge as to the effectiveness of the 1968 tax sur-charge, the Andersen-Jordan (A-fl study was pub-lished.2~The initial reaction by Keynesians was thatthe A-J results were simply a rerun of the Friedman-Meisclmnan estimates, except that more sophisti.catedprocedures were used in estimating the lags in theresponse of economic activi.ty to monetary and fiscalacti.ons,24 But conti-oversy started building up as thesuccess of the 1968 surcharge became more and moresuspect.

The A-J results were impressive, and to the limitedextent that Keynesians attempted to “beat” them attheir own game, the A-J .results stood up remarkablywe1l.2~As it became difficult to counter the A-J re-sults on statistical grounds, the “black box” notiondeveloped.26 That is, the old “correlation is not causa-tion” argument appeared, and Keynesians said, “Whereis your theory?” Such criticism had been lingeringunused among the Keynesians for several years, butthe new challenge to the Keynesians provoked a re-incarnation of the black box.

225ee Teigen, “A Critical Look,” footnote 4 and the referencescited therein.

23Leonall C. Andersen and Jerry L. Jordan, “Monetary andFiscal Actions A Test of Their Relative hnportance inEconomic Stabilization,” this Review (November 1968),pp. 11-24.

2~Frank deLeeuw and John Kalchbrenner, “Monetary andFiscal Actions: A Test of Their Relative Importance in Eco-nomic Stabilization — Comment,” this Review (April 1969),pp. 6-11.

255ee F. Gerald Corrigan, “The Measurement and Importanceof Fiscal Policy Changes,” Federal Reserve Bank of NewYork Monthly Review (June 1970), pp. 113-45. Moresignificant, however, were probably the corroborative studiesof Michael W. Keran. See his “Monetary and Fiscal Influ-ences on Economic Activity — The Historical Evidence,”this Review (November 1969), pp. 5-24, and ~‘Monetaryand Fiscal Influences on Economic Activity: The ForeignExperience,” this Review (February 1970), pp. 16-28. Thereader is also referred to Thomas 0. Nitsch, “A FurtherAdjustment in a Test of the Relative Importance of Mon-etary and Fiscal Actions in Economic Stabilization,” Ne-traska Journal of Economics and Business (Winter 1972),pp. 11-24.

26See Meigs, Money Matters: Economics, Markets, Politics,for an expanded discussion. Also see Richard C. Davis,“How Mach Does Money Matter? A Look at Some RecentEvidence,” Federal Reserve Bank of New York MonthlyReview (Jane 1989), pp. 119-31, and Edward hi. Gram-lich, “The Usefulness of Monetary and Fiscal Policy as Dis-cretionary Stabilization Tools,” Journal of Money, Credit,and Banking (May 1971), pp. 506-32.

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The nature of the controversy has continued alongthese lines up to the present. There have been noperiods since 1968 when monetary and fiscal actionshave moved sharply and persistently in opposite di-rections, so direct tests of the relative potency ofmonetary and fiscal actions are generally unavailablefrom late 1969 to early 1973.27

~ A NI)

i1’1~~1:i1l(l()Nl1’it(I)VERSY

Over the last five years there has been considerableconfusion as both monetarist and fiscalist factions havebeen guilty of distorting the opposing faction’s modelin order to make a point. For example, the discussionhas run from “money doesn’t matter vs. money mat-ters” to “money matters vs. money only matters,” andrecently it has been suggested that the issue is really“fiscal matters vs. fiscal doesn’t matter.”28

Associated with the development of the monetarist-fiscalist controversy has been the question of appro-priate research methodology. The evidence in supportof monetarist propositions has been based in largemeasure on a reduced-form approach to the estima-tion and testing of statistical relationships betweenmonetary and fiscal variables and economic activity.The fiscalist participants in the controversy, on theother hand, have relied on a structural model ap-proach to the estimation and testing of relationshipsregarding the economic impact of policy variables.29

The purpose of this section is to discuss these method-ological questions as they bear on the controversy.

vs S

nine .iSSiiiaeniliC yy2norP

Several side issues have developed in the contro-versy over the Andersen-Jordan article, The A-J study

consisted of the formulation and testing of severalmacroeconomic propositions. These hypotheses in-volved various characteristics of the response ofnominal CNP to monetary and fiscal actions. The testincluded direct estimation of equations with changesin GNP as the dependent variable and measures ofmonetary and fiscal actions as independent variables.This method of testing was called the reduced formapproach.

Use of the term “reduced form” is unfortunate, be-cause the term has an alternative meaning in appliedeconometric analysis. To most of the profession, “re-duced form” is automatically associated with a struc-tural model, that is, a set of equations serving as arepresentation of the behavior of the economic system.Commonly accepted procedure in macroeconomefricanalysis in 1968, and continuing to the present is to:

(1) Collect data and make point estimates of theparameters in the structural equations;

(2) Assume (a) the model is correct, (b) the back-ground conditions are true, and (c) the pointestimates of the structural parameters are thetrue values;

(3) Use data for the exogenous variables, outsideof the sample period, and generate values forthe endogenous variables;

(4) Compare forecasted values of the endogenousvariables with actual values;

(5) Draw conclusions about the validity of the

model on the basis of this comparison.30

The Andersen-Jordan study, on the other hand, didnot follow commonly accepted procedure in appliedeconometrics. Their study reported the results of sev-eral tests of hypotheses concerning the characteristicsof the response of GNP to monetary and fiscal actions.They did not test a particular model depicting theoperation of the economic system. Their estimatedequations were reduced forms in that they were rela-tionships between one endogenous variable and anumber of exogenous variables, but the form of theseequations was not derived from an explicitly statedstructural system.

275prinkel, Money and Markets: A Moaetarist View, pp. 15-16, indicates there were two other episodes of contrastingpolicy change in 1969 and 1970, but these cases are not asclearcut as the episodes of 1966 and 1968.

25For discussion of “money” issues see Paul San,aelson, “TheRole of Money in National Economic Pohcy,” in ControllingMonetary Aggregates (Proceedings of the Moaetary Con-ference Held on Nantucket Island, Sponsored by FederalReserve Bank of Boston, June 8-10, 1969), pp. 7-13. Fordiscussion of “fiscal” issues, see Ronald L. Teigen, “SomeObservations on Monetarist Analysis,” Kredit und Kapital,3 (1971), pp. 243-63, and Warren L. Smith, “A Neo-Keynesian View of Monetary Policy,” in Controlling Mon-etary Aggregates, pp. 105-26, and Corri~an, “Measurementand Importance of Fiscal Pohcy Changes.’

29For a readable account of the distinction between statisticalestimation and hypothesis testing, which seems to be arelevant issue underlying the reduced fonn vs. structuralcontroversy, see R. L. Basmann, “The Role of the EconomicHistorian in Predictive Testing of Proffered ‘EconomicLaws,’ ‘ in Ralph L. Andreano, ed., The New EconomicHistory: Recent Papers on Methodology (New York, JohnWiley and Sons, 1970), pp. 17~42.

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~oThis method of evaluating an econometric model is calledthe “method of forecasting test.” See James L. Murphy,“An Appraisal of Repeated Predictive Tests on an Econo-metric Model,” Southern Economic Journal (April 1969),pp. 293-307, and Introductory Econometrics (Hoiaewood,Ill.: Irwin, 1973). Basmann comments oa the procedure asfollows: “The tendency of policy-oriented ecoaoinetricianshas been to formulate models, to argue in a more or lessAristotelian fashion for the plausibility of the undedyingassumptions, and to trust to the efficacy of asymptoticallyefficient (viz., large-sample) methods of statistical estima-tion to bring them somewhere near knowing the true valuesof economic parameters.” [Basmann, “The Role of theEconomic Historian,” p. 161.j

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The nature of the A-J results caused considerableconfusion. At the time, there were certain notions (orvague hypotheses) about the operation of the eco-nomic system that prevailed among macroeconomists.These notions were, of course, carryovers from theFriedmau-Meiselman controversy earlier in the dec-ade. The A-J results appeared to be consistent withthe quantity theory and not consistent with the Key-nesian theory. The “implications” of the Keynesiantheory were that fiscal actions were more powerfulthan monetary actions, so the A-J results were viewedas a challenge to the existing Keynesian orthodoxy.

In retrospect, this association of the A-J results withtentative acceptance or rejection of particular models,though probably inevitable, was also unfortunate.These results set off discussions which were not rele-vant to the issues at hand, naniely, “How can weaccept your results until we see your theory?”

To isolate the issues which are relevant, considerfirst the irrelevant issues. One irrelevant issue iswhether the A-J test is a test of a quantity theory vs.a Keynesian thcory. Andersen and Jordan did notdevelop and test explanatory models of the mecha-nism describing the transmiss~ouof monetary and fiscalimpulses to the economic system. The A-J testsyielded some interesting implications for the quantityvs. Keynesian theory question, but as presented, theA-J article did not represent a direct test of thesealternative theories.

A second irrelevant issue is whether structural orreduced forms are the appropriate methodology. Theterms “structural form” and “reduced fonn” do notrepresent competing methodologies. If the modelbuilder is interested in describing one possible systemthat is useful in forecasting and simulating economicexperience, then a structural form may be most ap-propriate. On the other hand, if the model builder isinterested in policy recommendations or evaluations,a theoretical interpretation of parameters is required.And such an interpretation requires the formulationand testing of hypotheses; an integral part of thisprocedure is the definition of regions of acceptanceand rejection in terms of the reduced formparamueters.at

It is certainly true that the A-J study did notfollow procedure that svas commonly accepted at

a I For extensive discussion of this alternative method of eval-uating econmnetric models, which is called the “method ofpredictive testing,” sec Murphy, “Repeated Predictive Testson an Econometric Model,” and the references to Basmnann’sother works cited therein.

the time. But this point is fundamental: the A-Jstudy reflected dissatisfaction with existing proce-dures in assessing the impact of monetary and fiscalactions. Over the years, monetary and fiscal multi-pliers, which were derived from models assumed to betrue, had come to be accepted as approximations ofreality,32 The A-J propositions, simple as they were,were direct tests of alternative hypotheses about theresponse of the economic system to monetary andfiscal actions.

What issues relating to the A-J study are relevant?First, the statistical properties of the estimated equa-tions used in the A-J study require close scrutiny. Toa considerable extent this scrutinizing has been doneby examining in detail the choice of combinations ofmonetary and fiscal variahles.aa Also, the “endogeneityof money” issue is relevant to the extent that a bias ispresent in the estimated coefficients. Though it

should be pointed out that the question of moneyendogeneity has little to do with the formulation ofthe hypothesis about monetary influence,a4

A second issue that seems relevant to the discussionis an examination of the derived reduced form mul-tipliers for the Keynesian models in light of the di-rectly estimated A-J multipliers. In other words, oncethe estimated A-J equations have been checked outfor their statistical properties, it seems logical for theKeynesians to develop their systems in such a waythat they could he tested as an interdependent unit,rather than accepting point estimates of structuralparameters as a basis for calculating policy mnultipliers.Rigid attachment to this method of calculating policymultipliers has been a stumbling block to raising thelevel of discussion relating to the A-J results.1~The

32For further discussion of this point, see Meigs, MoneyMatters: Ecor,omics, Markets, Politics, and John Deaver,“Monetan’ Model Building,” Business Economics, (Septem-ber 1969), pp. 29-32.

°Scc deLeeuw and Kalchbrcnner, “Monetary and FiscalActions — Comment,” Davis, “How Mach Does Money Mat-ter,” and Corrigan, “Measurement and Importance of FiscalPolicy Changes.”

3’See Christopher A. Sims, “Money, Income, and Casuality,”

American Economic Renew (September 1972), pp. 540-52an interesting unpublished paper by J. W. Elliott, “TheInfluence of Monetary and Fiscal Actions on Total Spend-ing: The St. Louis Model Re-visited” (December 1972),presents evidence supporting the notion that govemmentspcnding is ‘‘endogenous” rather than money. For furtherdiscussion of endogenous stabilization actions, sce Stephen M.Coldfeld and Alan S. Blinder, ‘Some Implications of Endo—genous Stabilization Policy,” Brookings Papers on Economic

rActinity, 3(1972), pp. 585-640.(i ~Eor an example of the serious misuse and misinterpretation~-~vff the A—J equation, the reader is referred to Franco Nlodig—

liani, “Monetary Policy and Consumption: Linkages viaInterest Rate and Wealth Effects in the FMP Model,

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Keynesian model had been used so often and so longby macroeconomic anal.ysts that it evolved into con-ventional xrusdom without being tested except on apiece-meal basis.

/ 7

Given the confusion that has arisen in connectionwith the A-J study, as well as the resulting upheavalof emnotions, what might represent an appropriate di-rection for future research? One’ possible effort, giventhe interest in the monetarist “black box,” would befor monetarists to develop and test theories relatingto the mechanism whereby monetary and fiscal im-pulses are transmitted to the economy. Such studiescould shed light on the meaning and significance ofthe monetarist propositious.°6

The following list of steps as outhued by ProfessorJames Murphy could serve as a guide to testing themodel, since the objective is to understand the modusoperandi of the effect of monetary and fiscal actionsrather than to replicate economic experience:

(1) Specify the model in structural form and formu-late postulates about its parameters;

(2) Derive the reduced form parameters as func-tions of the structural parameters;

(3) Derive the acceptance region lot’ the reducedform parameters to satisfy the identifiabilitr’hypothesis;

(4) From the structaral parameters and identifi-ability conditions, derive the acceptance regionfor the model;

(5) Define the appropriate tests for acceptance orrejection, then obtain estimates of the reducedform parameters;

Consumer Spending and Monetary Policy: The Linkages(Proceedings of a Monetary Conference Held on Nan-tucket Isiand, Sponsored by Federal Reserve Bank ofBoston, Jane 1971), esp. pp. 59-74. Modigliani performswhat he calls a Monte Carlo expedment (1) assumingthat the solution values of the Federal Reserve-MIT-Penn(FMP) model are a true representation of the economicsystem, then ( 2 ) using these solution values as “data” andrunning an A-J type equation, The results of this experimentare an A-J equation of the usual type, i.e., a money mul-tiplier equal to about 6 and a fiscal multiplier near zero.Modigliani’s interpretation of his expetiment is that reducedforms are subject to the danger of severe bias. An alter-native interpretation is that the experfinent demonstratesonly that the FMP model is a “good” forecasting model, cap-able of~genqrysjp~,~s,~p

1ted, values yemy .,gJose to actual

valuesjumitil the r MP moddfl’S”Ebsf’ed and codfliht6ff’tfltrfl,,,,,,_,,,,,,,,,,,~$explanatory economic model, such experiments carry littie i

V m meanmg.I ~r’~‘&of Some Monetarist Propositions.” Though Rasche has nottested his model, he has developed hypotheses about eco-nomic behavior which appear to provide a basis for furtherinvestigation of monetarist propositions. See also mm unpub-lished paper by Ronald J. Sutherland, “On The Effective-ness of Monetary and Fiscal Actions” (November 1973).

(6) Determine whether the relevant backgroundconditions hold, and accept or reject themodel.~3t

This stands as an ambitious list, and is, of course,much easier said than done. Attempted use of thismethod of .pred.ictive testing of alternative modelscould shed considerable light on the monetarist-fiscalist controversy, especially as it relates to thetransmission mechanism.

“s’v/fi\1,,.rvcOr(7/v xl fri I

/

One of the more interesting issues relating to thenionetam-ist-fiscalist controversy is the assumed natureof the transmission mnechanism. Even though Brunnerlists the transmission mechanism as a separate issue inmacroeconomics, it seems that the transmission issueis in a focal position so far as the controversy is con-cerned. Clarification of the assumed nature of thetransmission mechanism can provide a better under-standing of the other macroeconomic issues, in par-t.icular, the dominant impulse amid aggregative vs.aliocative issues.

.thckrwn id-Lu.!

The Hicksian IS-LM model is the fundamental ex-pository framework for virtually everyone who worksand teaches in the field of macroeconomics.ms A basiccharacteristic, of this mnodel is that the channels ofmonetary influence are restricted to interest rates andxvealth. The primary channel of influence for fiscal ac-tions, on the other hand, is via a direct effect onincome. The IS-LM model is seldom used in its sim-plest formn, but it does serve as a core model that helpsto mamtam order among the thought processes of theinvestigator. Its simplicity, as well as adaptability to alarge number of problems, has accounted for its al-most universal acceptance. Continued use of theIS-LM analysis in a form almost identical to thatpublished in 1937 attests to its durability as a tool ofmacroeconomic analysis.

Attacks on the IS-LM model have been few and farbetween over the past 36 years. What is even more

:irMurphy, “Repeated Predictive Tests on an EconometricModel,” also notes that if the model contains lagged en-dogenous variables, dynamic stabihty conditions are also apart of step (4).

18J. H. Hicks, “Mr. Keynes and the ‘Classics’: A SuggestedInterpretation,” Eeonometrica, Vol.5 (1937), pp. 147-59.See also Karl Bnmnner and Allan H. Meltrer, “Mr. Hicksand the ‘Monetarists.’” Economiea (February 1973), pp.44-59.

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surprising is that the IS-LM model has not beentested as a unified set of hypotheses. This is not to saythat individual relations embodied in the model havenot been tested and estimated, but this procedure is afar different matter than applying the Basmann-Murphy method of predictive testing.

One critique of the IS-LM analysis is found in acomment by Professor David Meiselman at the firstFederal Reserve Bank of Boston Monetary Conferencein 1969.30 Meiselman raises the following questions:

(1) Are IS and LM curves independent of each

other?(2) Is the IS curve negatively or positively sloped?

(3) How are price expectations effects taken intoaccount in the IS-LM analysis?

Meiselman’s criticisms apply to the IS-LM analysis astraditionally used. As a theoretical construct, theHicksian model is not criticized. Rather, Meiselmantends to level his attack on users of the model, not onthe model itself.

1cm summary, it appears that the Hicksian IS-LMmodel provides a convenient starting point for analyz-ing macroeconomic problems, even if it has neverbeen subjected to predictive tests. If it is found thatthe traditional use and interpretation of the modelleads to incorrect conclusions with respect to the for-mulation and implementation of stabilization policy,then there is good reason to question the usefulnessand validity of the model in its simplest form. Un-fortunately, it is difficult to point to a particular pieceof published work that gets specific and forms a policyrecommendation on the basis of the Hicksian model.This model almost always seems to be invoked after thefact.~°One would think if a model is so universallyapplicable in cx post explanation, it would be usedmore widely as a predictive tool.

~David Meiselman, “Discussion,” in Controlling MonetaryAggregates (Proceedings of the Monetary Conference Heldon Nantucket Island, Sponsored by the Federal ReserveBank of Boston, June 8-10, 1969), pp. 14a-51. MiltonFriedman was also critical of some aspects of the IS-LManalysis in “Interest Rates and the Demand for Money,”Journal of Law and Economics, (October 1966), pp. 71-85.There are, no doubt, other critiques, but the fact so fewcome to mind suggests that such critiques have been rareover the last 36 years.

40For example, Teigen, in “A Critical Look,” pp. 19-20, arguesthat observed parallel movements between money and in-terest rates are quite consistent with the basic IS-LM struc-ture. This is very common procedure: manipulating theIS-LM model in such a way as to explain economic eventsafter they happen. More often than not, these “explana~tions” are not logical implications of the model itself.

The hmunney-Meu:zcr Fi’aruet’ot-k

For a number of years Professors Brunner andMeltzer have been critical of the traditional usage ofthe IS-LM model. The general nature of their objec-tions is contained in their comment on Friedman’stheoretical framework,41 These objections are givenmore specifically in their presentation of an alternativeframework.~2 In this article, Brunner and Meltzerdevelop a model that they propose as an alternativeto the lS-LM framework.

The deficiencies of the IS-LM framework, accord-ing to Brunner and Meltzer, are as folloxvs:43

(1) Bonds and real capital are treated as a singleasset, Money substitutes only for bonds, not forexisting assets or output.

(2) The theory has uot been successfully confirmed.(3) The only simultaneous solution for the price

level and real output is the full-employment solu-tion. The problem of persistent unemploymentis not explained.

Brunner and Meltzer’s objective in their article wasto correct two of these three deficiencies, omittingconsideration of (2).

Before examining Brunuer and Meltzer’s effort tocorrect these deficiencies, consider the possible reac-tion to this short list of deficiencies. Not enough timehas passed for comments on the Brunuer-Meltzerpaper to appear, but it is not difficult to formulate apossible reaction to their characterization of the“standard model.”

(1) True, the original Hicksiau article focused onmoney-bond substitution, but the svork of Pro-fessor Tobin represents an important extensionof the 1-licksian model to include substitutionbetween money and real capital.44

4mKarl Bruaner and Allan H. Meltzer, “Friedman’s MonetaryTheory,” Journal of Political Economy (September/October1972), pp. 837-51, See also their “Mr. Hicks and the‘Monetarists.’”

12Karl Brunner and Allan Meltzer, “Money, Debt, and Eco-nomic Activity,” Journal of Political Economy (September/October 1972), pp. 951-77. i’he work of Brunner and Mcltzerrelating to this alternative framework goes hack mnany years.An early discussion of this framework, though not the first, is“The Place of Financial Intermediaries in the Transmission ofMonetary Policy,” American Economic Review, Papers andProceedings (May 1963), pp. 372-82.

43A comparison of this list with the first two pages of theirarticle, “Money, Debt, and Economic Activity,” indicatesa difference in the listing. In their article, deficiency (3) islisted under (1), and their third deficiency is that standardmacro theory has not incorporated developments in monetaryand price theory of the past two decades,

44See the relevant articles in James Tobin, Essays in Macro-eaonomics, Volume I (Chicago: Markham, 1972).

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(2) This statement is not true because currentlyexisting econometric models are essentially com-plex and detailed extensions of the IS-LMframework, and these models have provensuccessful.

(3) The inability of the IS-LM model to explainpersistent unemployment is well-known. Thismodel has long since been extended to deter-mine the price level, output, and employment.“Extended” models, permitting determinationof prices and otitput have become standard ma-terial in macroeconomic textbooks.

It is not hard to imagine the barrage of charges andcountercharges that could be set in motion if this typeof rejoinder appeared. And in the process, the sig-nificance of the Brunner-Meltzer contribution couldeasily be lost in the smoke of the argument.

The purpose of this section of the paper is to clarifya fundamental difference between the IS-LM modeland the alternative framework developed by Bruunerand Meltzer. First, the question of whether the IS-LMmodel has been confirmed is set aside in an effort tofocus on the differences in specification of the twomodels. Second, the problem of output and employ-ment determination is set aside for expository pur-poses. This procedure simplifies the problem by focus-ing on the differences between the two models as theyrelate to the determination of the demand for outputat a given price level. To ignore these issues is not tosay that they are unimportant; there should be generalagreement to the contrary.

By the process of elimination we are left with thedeficiency relating to the assumption of substitutionbetween only money and bonds. The interpretationoffered here is that this assumption is a key onedifferentiating the aggregate demand portion of theBrunuer-Meltzer framework from the “traditional”IS-LM model.45

Why are Brnnuer and Meltzer so concerned withthe money-bonds substitution assumption? The an-swer is that this assumption implies that the trans-mission mechanism from money to economic activityis limited to interest rates. The IS-LM model may beamended to include wealth effects, but the money-bonds substitution assumption places emphasis on aborrowing cost mechanism for transmitting monetary

~5The adjective “traditional” is used here to be representativeof that class of IS-LM models which is used in mnacroeco-nomic textbooks. With very few exceptions, textbook IS-LMmodels build in the assumption of “money and bonds only”substitution. Furthermore, with the exception of Tobin, recentpublished articles by neo-Keynesiaus continue to give littleemphasis to this assumption. See, for example, Teigen, “ACritical Look.”

impulses. More generally, in an attempt to representthe essence of the operation of the economic system,limiting a model to only one relative price — the in-terest rate — is considered far too restrictive. Thelogical implications for the effects of monetary andfiscal actions, as well as other factors, are seriouslylimited if such impulses are permitted to be chan-neled to economic activity through the movement ofonly one relative price — the interest rate.

The procedure followed by Brunner and Meltzerto correct the “money-bonds” deficiency in the IS-LMmodel is to add a market for existing assets, or whatthey call the market for “existing real capital.” Byadding such a market, another relative price is addedto the IS-LM model, broadening substantially itscapabilities for testing hypotheses about the effects ofmonetary and fiscal actions and other exogenousimpulses.46

By excluding the price of existing real capital, thetraditional IS-LM model must either assume (1) thatthere is a perfect capital market whereby the price ofexisting real capital is always equal to the price of newproduction, or (2) that there is uo market for existingcapital.47 The first assumption is a property of clas-sical economic mnodels where all costs of informationand adjustment vanish, and defines what is generallyknown as long-mu equilibrium. The second assump-tion, ou the other hand, is more typical of Keynesianmodels.

By adding a market for existing real capital to theIS-LM model, the price relevant to that market isadded to the list of variables that are potential argu-ments in each of the behavioral equations of themodel. But the effect is much more significant thanjust adding another variable. One benefit is that themodel can then be written in such a way as toseparate the market for money from the market for

46Tbe question may naturally arise as to how this price ismeasured, and measurement problems have no doubt beena factor undedying the neglect of this variable in macroeco-nomic analysis. In principle, such problems should be littlegreater than measuring “the price” applicable to new pro-duction. The development of the national income accountsto the neglect of balance sheet considerations has no doubtcontributed to the development of theory bs the directionof focusing on new’ production and its related price. Butlack of data on the price of existing capital does not negateits role in the transmission mechanism. For a recent discus-sion of prices and price indices, see Annea A. Aichian andBenjamin Klein, “On a Correct Measure of Inflation,”Journal of Money, Credit and Banking (February 1973),pp. 173-91.

47See the unpublished paper, Kad Brunner and Allan H.Meltzer, “The Inflation Problem” (March 1973), for discus-sion of this point.

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credit.48 In the opinion of Brunner and Meltzer, therelative role of these two markets has been one of thechief contributing factors to the confusion surround-ing the monetarist — neo-Keynesian controversy.49

And it is this separation that leads to logical implica-tions which differ substantially from those derivedfrom the traditional IS-LM analysis.

In the traditional IS-LM analysis, the credit marketis the hidden, or “left-out,” market. Or in Patinicin’swork it is the bond market.5°On occasion, failure toexamine the implied credit market has resulted in thedevelopment of some very peculiar conditions whichdo not become obvious until the hidden market isexplicitly derived.5’

Brunner and Meltzer do not question the existenceof the hidden credit market; rather, they are con-cerned with the limited nature of the transmissionmechanism whereby monetary and fiscal actions affecteconomic activity in traditional IS-LM models. Everymultimarket model has at least one redundant market,as long as Walras’ law of markets is accepted. Brunnerand Meltrer, after adding an additional asset — exist-ing real capital — retain the option of maintaining thecredit market as the redundant market. However, theychoose to make the credit and money markets explicit,making the market for existing real capital the re-dundant market. With this choice they are able toexamine thoroughly the factors which contribute tothe nature of economic response to monetary andfiscal actions.

By examining the expanded model, the deficienciesimplicit in the use of the traditional IS-LM modelbecome apparent. Very generally, Brunner and Melt-zer conclude that the effect of monetary and fiscalactions, as well as other exogenous impulses, dependson the price of existing real capital as well as theinterest rate and the price of new production. (Recall

48It should he pointed out, however, that the term “moneymarket” is a misnomer. In a money economy money istraded in every market; there is no “market” for money.For farther discussion, see R. W. Clower, “A Reconsidera-tion of the Microfoundations of Monetary Theory,” WesternEconomic Journal (December 1967), pp. 1~8.

49For a comprehensive discussion of this essential distinction,see Albert E. Burger, The Money Supply Process (Belmont,California: Wadsworth Publishing Company, Inc., 1971).

50Don Patinkin, Money, Interest, and Prices, second edition(New York: Harper and Row, 1965).

tmmCarl Christ, “Monetary and Fiscal Policy in MacroeconomicModels,” in The Economic Outlook for 1969 (Papers pre-sented to the Sixteenth Annual Conference on the EconomicOutlook at the University of Michigan, November 14-15,1965), pp. 93~l12,and Bent Hansen, A Sureey of GeneralEquilibrium Systems (New York: McGraw Flill Book Com-pany, 1970), esp. pp. 134-37.

that throughout this discussion the price of new pro-duction has been treated as a given, and its deter-mination requires further extension of the model. Thisextension, of course, is provided by Bruuner andMeltzer.) What is implied is that the nature of theresponse of the economy to mnouetary, fiscal, and otherstimuli is conditioned by an enlarged number ofconsiderations.

More specifically, the Bruuner and Meltzer conclu-sions, as they relate to the aggregate demand portionof their model, can be summarized as follows:

(1) The interest elasticities (or slopes) of the tradi-tional IS and LM curves are neither necessarynor sufficient for determining the response ofaggregate demand for output (at a given pricelevel for such output) to monetary and fiscalactions,

(2) The role of wealth or real balance effects inmacroeconomic models is substantially changedwhen a market for existing real capital is intro-duced. In particular, the response of aggregatedemand to monetary impulses need not dependon wealth effects (or interest elasticities of ISand/or LM).

(3) A maintained govermneut deficit financed byissuing debt raises interest rates and the price ofexisting real capital. Consequently, fiscal multi-pliers are conditioned by considerations otherthan interest elasticities and wealth effects.

This is a partial restatement of Bmnner-Meltzer’sown summary. Their conclusions are more far-reach-ing than the above summary suggests. But the natureof these statements is interesting in that their conclu-sions, for the most part, list those factors that arerelevant in testing hypotheses. For example, virtuallyall of the macroeconomic textbooks characterize themonetarist model as the “extreme” case where theinterest elasticity of money demand is zero, for this isthe only way to get a fiscal multiplier of zero. Accept-ance of such a characterization of the monetarist modelimplies that the statistical significance of the interestelasticity of money demand becomes the cmcial testof the monetarist model (at least with respect to itsimplications for fiscal policy). If this elasticity is notsignificantly different from zero, the hypothesis as it

relates to fiscal impact has to be rejected. Brunnerand Meltzer, in contrast, show that a zero interestelasticity of money is not necessary in order that thefiscal multiplier be zero.

The Bruimer-Meltzer macroeconomic frameworkhas been discussed at some length, but certainly notin detail, and contrasted with the traditional IS-LM

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analysis. However, it should be emphasized that onlythe short-run aggregate demand aspect of the Brun-ner-Meltzer model has been discussed here. This focusis very limited, for they have devoted substantial ef-fort to delineating price and quantity adjustments inthe output market and to longer-run considerations.As indicated earlier, such considerations are ignoredhere, but in no way is this meant to denigrate theirimportance.

(~ONCi~DI]NGOBSEB%:FATIONS

The focus of this paper is on recent macroeconomiccontroversy. A brief review of economic events andeconomic thinking in the period since World War IIserves as background for elaboration of the nature ofthe controversy as it presently exists. A general obser-vation developing out of this review is that particulareconomic events or experiences do have a substantialimpact on the development of economic thought. Alikely consequence of this immediacy of response torecent experience is that the profession can be misledfor a considerable period of time. At all times theexperience of economic history should be kept clearlyin perspective.52 It is in this connection that the ex-tensive work by Friedman and Schwartz serves as asignificant contribution to macroeconomics relative tothat of econometric studies based on only 15 or 20years of data.u However, studies with a long histori-cal perspective tend to be ignored by policymakerswho are preoccupied with solving short-run problemsof economic stabilization.54 Apparent lack of im-

52For an example of perspective on the relation betweenmoney and prices covering the period from 500 B.C. tothe early 1930s, see Anna J. Schwartz, “Secular PriceChange in Historical Perspective,” Journal of Money, Creditand Banking (February 1.973), pp. 243-69.

53Milton Friedman and Anna Jacobson Schwartz, A MonetaryHistory of the United States: 1867-1960 (Princeton: Prince-ton University Press, 1963).

54Note the following statement by Fritz Machlup in EmilClaasen and Pascal Salin, eds., Stabilization Policies in Inter-dependent Economics (Proceedings of a conference held atthe University of Paris-Daaphiae, March 1972), p. 34:

mediate relevance does not negate the operation of]onger-run principles.

The second part of this paper identified those fac-tors which appear relevant to the present controversyon the relative impact of mouetary and fiscal actions.Several side issues were shown not to be directly rele-vant to the issues at hand. A gap has developed be-tween monetarists and fiscalists that has tended toimpede rather than advance the level of understand-ing relating to the role of monetary and fiscal actions.

It was concluded that methodological issues havebeen confused with the hypotheses. Specifically, ques-tions of “reduced forms vs. structure” have sidetrackedthe discussion as well as introduced confusion as tojust what a hypothesis is. Tracing the source of con-fusion to one side or the other is difficult and notparticularly useful. It is probably to be expected thatthe advance of knowledge is almost always accom-panied by confusion as the conventional wisdomcomes under attack.~~

In an attempt to clarify the issues, the final sectionof the paper discussed a portion of an alternativeframework for macroeconomic analysis. This frame-work has been developed by Professors Brnnner andMeltzer, and stands in contrast to the traditionalIS-LM model. A market for existing real capital isexplicitly incorporated in the Brurtner-Meltzer modeland the stabilization implications of monetary andfiscal actions are shown to be substantially broaderthan those of the IS-LM model.

“While we are on the distinction between the short run andthe long, I may he allowed to comment on the famousdictum by Keynes to the effect that we always live in theshort ma, and in the long run we’ll all be dead. My counter-dictum is that the short run is awfully short and before Ionwe’ll all be tertibly sick. Tlas does not mean that we shoalforget about the short ma, but it does mean that seriouseconomics should deal chiefly with the long-mn come-quences of our public policy actions.”

~5This statement is not attributable to Harry Johnson, but thereader is referred to Hasty G. Johnson, “The Keyne-sian Revolution and the Monetarist Counter-Revolution,”American Economic Review, Papers and Proceedings (May1971), pp. 1-14,

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