Episode 64. George Tavlas on the History of Monetarism

"Capitalism and Freedom in the 21st Century" Hoover Podcast Episode Transcript

Jon Hartley and George Tavlas discuss George’s career as an economist, including as a central banker at the Bank of Greece, the history of monetarism (including George’s new book The Monetarists), Milton Friedman, and the evolution of central banking over the past decades, including its decline since the 1980s, and its renewed post-pandemic interest.

Listen to or watch the full Capitalism and Freedom in the 21st Century Podcast episode with George, which is hosted at the Hoover Institution Economic Policy Working Group.

Jon Hartley: This is the Capitalism and Freedom of the 21st Century Podcast, an official podcast of the Hoover Institution Economic Policy Working Group, where we talk about economics, markets, and public policy. I’m Jon Hartley, your host. Today, my guest is George Tavlas, an alternate governor of the Bank of Greece for the European Central Bank since 2008. He’s also a Distinguished Visiting Fellow at the Hoover Institution at Sanford University. And he was previously the Director General of the Bank of Greece from 2010 to 2013, and a member of the General Council in the Monetary Policy Council of the Bank of Greece from 2013 to 2020. He was also an advisor to the governors when the country entered the Eurozone, and was involved in the management and resolution of the Greek Debt Crisis. Welcome, George.

George Tavlas: Thank you so much, Jon. It’s a pleasure to be here, and I thank you for the invitation.

Jon Hartley: I want to start by getting into your early life. Where did you grow up, and how did you first get interested in economics?

George Tavlas: I was born in Worcester, Massachusetts, to Greek immigrant parents. My father left Greece and his village in Greece and his formal education when he was 12 years old, and he came to the United States at the end of the First World War. He worked his way up and became a successful business person. He owns several retail stores and rental properties. He learned to read and write in English and read the Wall Street Journal every day. Like many immigrants, he had a simple dream. He wanted to see his children have the education that he never was able to have. And so, when I was 13, he enrolled me into one of the top prep schools in New England. It was located in… it is located in my hometown. It’s called Worcester Academy. But then, tragedy struck. Several weeks before I started my first classes, my dad died unexpectedly of a heart attack. After that, I didn’t take classes, I didn’t take school seriously. And so… My grades at Worcester Academy were terrible. I had to repeat my fir- my junior year. And then I did something that… Perhaps was the first in the history of the school, which is pretty hard to do, because the school was founded in the 1830s. I fielded my junior year a second time around. In fact, my grades the second time around were worse than the first time. Well, that’s summer. after the second junior year, a letter arrived at my home, addressed to my mother. It was from the headmaster of the school, and he advised her that the school board had determined that I wasn’t college material. She should look elsewhere for me to enroll. My mother never saw the letter. I intercepted it, and immediately went to see the headmaster, and I asked him for another chance. He gave it to me. He allowed me to enter my senior year with the provision That my grades have to show immediate immediate improvement. Well, that changed things around. For the first time, a fire was lit under me. I realized that I had to study. My grades went up. I applied to 5 colleges, was admitted into all of them. My family stared me to Babson College. It’s a business college, because it had expected or assumed that I was going to go into the family business. That’s with a letter addressed to my mother. Some years later, when I… on the day that I received my PhD degree. I showed my mother that letter for the first time. At the same time that I showed her my PhD diploma. After I, graduated from Worcester Academy, I attended Babson College, Which is… as I mentioned, a business school in Massachusetts. At Babson in my first year, I took… an economic principles course with Bill Casey. Bill had just graduated from Boston College. We’ve become lifelong friends. The course lit a fire. I knew from the… almost from the first that I wanted to pursue economics for a career. I like the quantification and the logic of economics. the faculty at Babson encouraging me to do my graduate work at New York University. At NYU, three courses were especially important for my future research. Monetary economics, taught by Bill Silber. Bill and I had become lifelong friends. History of Economic Thought and Econometrics. My dissertation combined the first two areas, monetary economics and the history of thought. Upon completing my PhD dissertation in 1977, I was offered a position as a macroeconometric modeler at a newly formed economic analysis team at the State Department. The team was created by Richard Cooper. Cooper, who had been teaching at Yale and subsequently was to teach at Harvard, had become Under Secretary of State in the Potter administration. Richard Cooper was a very famous, very famous international economist who just passed away a few years ago. He was an excellent economist and an excellent writer. Well, the main motivation for the economic analysis team under, under Cooper was to create a group at the State Department that could support the State Department’s positions at interagency meetings. So while I was at State, I learned how to Build and simulate macroeconometric models. While at State, I received an offer from the OECD in Paris to help them build their multi-country macro model. I accepted the offer, and… I took a leave of absence from the State Department in 1980. That turned out to be a good decision professionally. And a great decision, personally. Because while… living in Paris, I was able to visit Greece frequently, because my mother had resettled there, and on one of those visits, I met my future wife, Sophia. After I returned to the State Department, George Schultz had become Secretary of State. Alan Wallace had become his Undersecretary. Wallace had been his former colleague at Chicago. Martin Bailey, who had taught macro at Chicago in the 1970s and 1960s. In 1970s, he was a assistant secretary at the U.S. Treasury, had become the chief economist. Martin was a theoretician. He was a brilliant theoretician. He needed someone to do the estimation to test his ideas, and I was the person to do it. We worked very closely together. We wrote several… published several papers, continued to receive citations. I learned a lot from that… from Martin. In 1985, I received an offer to join the IMF. And I accepted it. At the IMF, I was assigned to do research, among other things, on the international monetary system. One of the things I was especially involved with on… was looking at the advantages and disadvantages of a country having an international currency, such as the U.S. dollar. A very topical issue today in light of the tariffs. However, as I rose through the ranks at the IMF and was promoted to managerial positions, I had less and less time to do research, which I especially enjoyed. And so, having spent several years Visiting the Bank of Greece in the late 1990s, I accepted an offer from the bank to become a director. at the bank, where I was able to continue to do research, while at the same time continue to do policy-relevant work in such areas as the Euro-sovereign debt crisis and, of course, monetary policy. Among the responsibilities that I’ve had at the bank, in 2002, The then governor appointed me as his… then accompanying person, but it’s essentially the same as his alternate on the governing council of the ECB. Now, the way this works, each governor at the ECB is allowed to bring one person with them into the meetings to be able to consult with. The alternate takes the place of the governor, should the governor not be able to attend the meetings. Since… That appointment, successive governors at the Bank of Greece have reappointed me as their alternate on the governing council. So, having served on the governing council as an alternate since 2002, Continuously, I’m the longest serving member of the Governing Council. During the past 10 to 12 years, I’ve had the privilege to be visiting such institutions as Chicago on several occasions. Drexel, Duke, and of course… the Hoover Institution at the invitation of John Taylor. These academic associations have been instrumental in helping me revisit the fierce debates over Milton Freeman’s monetarism in the 1970s when I was a graduate student. They became like a thread of my research over the years, and it’s the reason that I was able to write the book, The Monetarists.

Jon Hartley: That’s terrific. I want to talk about The Monetarists in a moment. I also just want to talk about, a little bit about your career. I mean, you’re there at the dawn of the euro. You’ve seen the… you know, the European debt crisis in the early 2010s play out? What do you think we’ve learned in the past 25 years, since the advent of the euro, about the nature of monetary unions without a fiscal union. And what do you think, the euro will look like in the future. I mean, do you see there being more fiscal integration in the future? Obviously, there’s a lot that’s changing right now in Europe in 2025, with increased military spending and, and… more debt being issued, for example, by Germany to partly fund this, but I’m just curious, having been there at the beginning. having seen some of its… and been part of managing some of its greatest challenges, notably, you know, Greece, the Sovereign debt crisis in the early 2010s, and it’s, you know, been put in a better trajectory. I mean, at the time, there were a lot of questions around whether Greece would leave the euro, or other countries would leave the Euro. That hasn’t happened yet, but there are many critics, I guess, who say that a monetary union without a fiscal union is, isn’t sustainable in the long run, and that encourages, free riding on the part of some countries. I’m just curious what… What you’ve learned and what you think economists have learned about the nature of this monetary union.

George Tavlas: Well, I don’t think that economists have learned a great deal about the need of a fiscal union. They knew that before the euro system started. They thought that the monetary union could survive in the absence of a fiscal union, because they thought that the markets would… Would impose discipline on countries that were spending extravagantly. But it didn’t happen that way. Between 2005 and 2009, Greek government debt doubled from about 100… external debt from about $150 billion to $300 billion. And yet, for much of that time, Greek interest rates were very low. The markets thought that if Greece got into trouble, the euro area would be able to increase. It wouldn’t have let a crisis happen. And so, while the Greek debt was… building, doubling, as I mentioned, in the 5 years 2005 to 2009. Especially during the early years, 2005 and 2006, Greek interest rates were not very much different from German interest rates. So, one lesson that we’ve learned from the Euro is that countries have to maintain their fiscal hosts in order. We’ve also learned that we need to have a stronger fiscal mechanism inherently in Europe, in case countries do get in trouble, where that mechanism can support the countries, perhaps impose policies on the countries to take, should a crisis erupt. Now, when the crisis erupted in Greece in late 2009, … the, the Euro system had to rely on the IMF and the European Union, and it was a little bit… Unorthodox, because having been at the IMF, when the country got into trouble, and the IMF visited the country to see what policies would be needed. The IMF would sit on one side of the table. And the finance ministry and the central banks from the other country would sit on the other side. When a Greek crisis erupted, we had… the Bank of Greece and the Finance Ministry on one side. On the other side, we have the IMF, We have the European Commission, and we had the Central Bank of the Euro area. the ECB. So, in a way, there was an advert… there was a clash between our central bank, which was really the ECB, and the policies that were being formulated to deal with the Greek crisis. In retrospect, the crisis that were taken in Greece were… Very, very contractionary. And it was very difficult for Greece to emerge from the crisis. We needed support. … from the rest of the union, but we didn’t get the support. And so what happened? The markets… of course, perceive this. And they perceive that there’s some other countries on the line that could possibly erupt into crises such as Portugal, … Ireland, and even Spain, which required a program for its baking system. So, one lesson that we learned is that We need to have an internal mechanism within the euro area so we don’t need to rely on the IMF should a crisis erupt. Another thing that we learned was, and… Now, as I mentioned, at the beginning of the euro area, people understood that… We weren’t a complete fiscal union, and that was going to create a problem. But one thing we didn’t anticipate, nobody essentially anticipated, maybe one or two people in, … peripheral journals, because I came across one… one person who argued this in the early 1990s, but nobody paid attention to him. We learned that we needed a banking union. We need… we learned that… If Greek beings got in trouble, the Marxists weren’t going to believe that the Greek government a small country is going to be able to take care of the banks. Now, we had a situation in the U.S, I think it was in 2023, as Silicon Valley Bank got in trouble. You remember that? And, one or two other banks followed suit, and those banks were going under. And it started looking like it could become a full-scale crisis. And so the stock market, financial markets, began to tank. And then one day, within days of the crisis having erupted, Secretary of State, Secretary of Treasury Janet Yellen said. All depositors will be covered in full the next day, or… Around the same time. Jerome Powell said the same thing. Was it Jerome Powell who was… yeah, Jerome Powell said the same thing. We will bail out everybody. End of crisis. We did… we don’t have that in the Eurozone. If the Greek government said in 2012-13, We’ll take care of the Greek beings. Crisis over. Where were they going to get the resources? They didn’t have it. So, we also need a banking union. We also need a capital markets union to further integrate countries, you know, across countries. So there… there are certain priorities or prerequisites for a well-functioning monetary union that we started to build. We’re in the process of building, but we’re not all the way there yet. We’ve learned lessons, we’re applying it, but it’s a slow lesson to come to a complete monetary union. And that’s one reason why, despite the fact that the dollar has been under siege as an international currency over the last year. there’s really no rival to come up and take the dollar’s place. It’s Chinese yuan, the financial markets are very opaque. Investors don’t want to go with the Chinese want. The euro area, We have tried to make the Euro an international currency, but we still lack the mechanisms I just underlined to make the euro such a valid international currency. We’re away, away. some way away from doing that. We’re working on it, it’s moving in that direction. But things are slow. My governor, by the way, had a, … a guest column in The Economist about 2 months ago, Yannis Stournaras, which has pointed out all those issues in a very nice way.

Jon Hartley: Perfect. So, I want to get, into your book, The Monetarists, which you published in 2023 with the University of Chicago Press. And this book essentially argues that on the topic of monetarism, which I think is, you know, broadly speaking, the doctrine that, Inflation is always and everywhere a monetary phenomenon, and that, you know, MV equals PQ, that’s, you know, the quantity, the theory of exchange, or the, quantity theory of money, that, that’s sort of front and center for, for monetary policy, that monetary policy aggregates matter. You know, some people, some monetarists might argue (and were certainly arguing in the 1980s) that monetary aggregates were, a tool, a monetary policy tool that should be used. I think economists have shifted a bit away from that, obviously embracing interest rates. But this was an idea that was largely promoted by Milton Friedman and Anna Schwartz in, I think, the public mind. You know, there was a big book that they released, A Monetary History of the United States, a very famous book, that tries to make the case that the contraction of the money supply caused the Great Depression. And this was published in the 1960s, and a very popular book, and arguably one of Friedman’s most influential books. Now, your book, The Monetarists sort of gets into this, the intellectual history of monetarism, and argues that there was a tradition of monetarism before Milton Friedman and Anna Schwartz, largely at the University of Chicago. And I’m just curious, how did you get into, you know, the debates about Chicago monetarism, and could you explain to us, you know, who some of these earlier Chicago monetarists were, and how they might have influenced Friedman later?

George Tavlas: Well, how did I get into the debate?

Jon Hartley: Yeah, I’m just curious, how did getting into this intellectual history, begin for you, and how did you sort of discover, that the story of Chicago monetarism, begins well before Milton Friedman.

George Tavlas: Well, when I was doing my dissertation in the middle of 1970s. There was a heated controversy underway between Milton Friedman on one side and just about everybody else on the other side. Friedman had been a graduate student and a research assistant at the University of Chicago in the first half of the 1930s. And, when monetarism began to have traction in the late 1950s and early 1960s, he had argued that his monetarist views derived from an important, what he called, oral quantity theory tradition at Chicago. That tradition, he argued, differed from Other versions, what he called rigid versions of the quantity theory, utilized at other institutions, because unlike those other versions, he argued that the Chicago version was policy-relevant. And this policy relevance, he argued, was able to, leave the Chicago quantity theorists less vulnerable to the Keynesian Revolution than quantity theorists at other institutions. He singled out some of his mentors as having developed the Chicago quantity theory. I’ll mention four of them, Henry Simons, Lloyd Mintz, Frank Knight, and Jacob Viner. Now, with the rise of monetarism as a counter-revolutionary force, In the late 1960s, Friedman’s claim of a Chicago monetary tradition came under fire. The first to take game at Friedman was Don Patinkin, who had undertaken his graduate studies and undergraduate studies at Chicago in the 1930s and 1940s. In 1969, writing in the inaugural issue of the Journal of Money, Credit, and Banking. Patinkin presented evidence, doctrinal evidence, from the writings and teachings of his teachers at Chicago, showing that Friedman’s theoretical framework had nothing to do with what had been written about or taught at Chicago. In the late 19… in the 1920s or 1930s. Because Patinken showed that the earliest Chicagoans used Irving Fisher’s, as you mentioned, velocity-based equation of exchange. Money times velocity equals prices times transactions. Whereas Friedman used a money demand approach to his monetary analysis. So, the issue arised that since the two theories were so different, how could they be related? Enter into the picture Harry Johnson, who was Freedman Chicago colleague, not necessarily….

Jon Hartley: International economist.

George Tavlas: Chicago colleague, not necessarily his Chicago friend. who usually… occasion of the 1970 Richard T. Ely Lecture in front of the American Economic Association. To argue that… Well, he made the argument that if… in order to create a successful counter-revolution to the Keynesian Revolution, Friedman had to establish some plausible linkage with pre-Keynesian Orthodox, with what came before the Keynesian Revolution. Friedman’s solution, in Johnson’s words, was to, and this is pretty brutal, to invent a Chicago monetary tradition. In Johnson’s words, Friedman had engaged in scholarly chicanery. In the debate with Patinkin on this issue in the Journal Political Economy in 1972, Friedman admitted that his monetary theory had been influenced by Keynesian theory. But he also continued to insist that his overall monetary economics was what he continued to argue was a direct outgrowth of a unique Chicago quantity theory tradition. He was incensed with both Patinkin and Johnson. He thought that Patinkin had mischaracterized the Chicago monetary tradition, and by doing so, had damaged his Friedman’s professional reputation. In private correspondence, he accused Johnson of having committed libel. And so, while I was a graduate student, I had followed the debate closely, and I decided to write my dissertation on the origins, the doctrinal historical origins of monetarism. I wrote 5 essays. Four had been accepted in journals. The fifth one. dealt directly with the Friedman-Patinkin Exchange and the Journal of Political Economy. I wrote a paper in which I showed that there was Chicago economists in the late 20s, early 30s, who were in favor of policy rules, like Friedman. And not only that, they advocated a Friedman rule before Friedman did. They advocated that the money supply should grow by 3-5% annually. I submitted that paper to the Journal of Political Economy. The editor wrote back that he sent a paper, in his words, to a learned scholar. The learned scholar wrote a lengthy rejection letter. Now. At that time in the 1970s, one of the most popular graduate textbooks was Patinkin’s 1965 Money, Interest, and Prices. I had studied it. read it many times and studied it very hard, and I knew Patinkin’s writing style. I had no doubt that Patinkin was the guy who rejected my paper. So I then submitted the paper to the Journal of Money, Credit, and Banking. The editor wrote back that he sent the paper to an associate editor. The associate editor liked the paper, but he thought that the only two people that were really qualify to judge her were Don Patinkin and Milton Friedman. The editor wrote to me that he… asked Patinkin and Friedman to referee the paper. Patinkin wrote back. That he already refereed and rejected the paper, confirming my suspicion. But Friedman had not responded. The editor said, I leave it up to you. to see if you can get Friedman to respond to your paper. I wrote to Friedman and told him what the circumstances were. He wrote a lengthy letter to the editor. of the JMCB telling him that the paper should be accepted. It was. It was published in 1977. And there began a lengthy correspondence between me and Friedman that lasted until a couple of months before Friedman passed away. That’s how I got involved in the debate about the Chicago Monetary Tradition.

Jon Hartley: That’s fascinating, you know, all these, characters were involved, and, famously, a lot of these iconoclast economists would clash with each other, and I guess it’s… one thing that I guess some don’t realize is that, you know, I guess the Chicago school isn’t necessarily, like, a monolithic, school of economics, and also, you know, it’s very fascinating that, you’re pointing out this, this fact that, you know, the idea for, like, a K% money growth rule, sort of preceded Friedman. I think, you know, the equation of exchange, you know, MV equals PQ goes back to I think David Hume, maybe even earlier. So, you know, I think at some level, there’s sort of different… even different schools of monetarism, in the sense that, like, you know, today there… there’s maybe some people who argue that, I think increasingly following the early 2020s inflation, that… which also saw the money supply, or measures of the money supply, like M2, grow pretty, rapidly during that same time that, we should look back to monetary aggregates, which previously had fallen out of favor. I guess my question,

George Tavlas: Can I… just let me say one thing, Jon. Monetarism is just not money. Money was the vehicle that Friedman thought was important for judging monetary policy. But the lasting contribution of monetarism was to Bring back or highlight the importance of monetary policy itself. In the 1940s, 50s, 60s, even the first half of the 70s, monetary policy was considered a secondary tool. It took a backseat to fiscal policy. What Friedman and monetarism did, didn’t bring back money. That was their way of saying that money was… that monetary policy was important. But what really mattered was monetary policy, whether with money or with interest rates, that monetary policy was one of the most important tools in the macroeconomy. In the 1940s, 50s, and 60s, it was downgraded. It had secondary status. So the monetarist revolution, when some people say, whoa, where’s money? Doesn’t matter. What matters is, look where monetary policy is. It’s right there on top. It’s the… it’s the primary tool for managing the macro economy. When monetary… when… the Federal Reserve or the European Central Bank make a decision on interest rates. Everybody’s following. Everybody reacts. And depending upon the decisions, the reactions could be benign, or they can be They can be very volatile, but monetary policy is right there at the top of the policy list, of the policy Options that we have in the economy. And that is due to monetarism.

Jon Hartley: Absolutely, and… it’s worth noting that, you know, thinking back to the 1970s, I think there was an idea that, you know. Inflation, some people argued that, you know, price controls were the right answer, to fighting inflation. You know, this was, I think, apparent in the Nixon administration.

George Tavlas: And that was Arthur Burns. That was Arthur Burns, who, when he was appointed chair of the Federal Reserve, Friedman was ecstatic because he thought that Burns was somebody who understood monetary policy. But no, Burns relied, as you said, on price and wage controls. He let monetary policy run loose, and we had two episodes, one in the mid-1970s, and one in the mid-1970s, where inflation reached double-digit levels, and it was Paul Volcker. Who came on the scene. And he understood. As well as anybody else, the importance of endogenous expectations. He understood that markets had to have belief in that the Federal Reserve is doing the right thing. Volcker’s approach was to apply cold turkey. Raise interest rates to close to 20%, let the economy go into recession. It had to prove something. It had to prove that the Federal Reserve was what we now call hard-nosed credibility. The Fed gained credibility under Volcker, and it maintained credibility under the success of Fed shares, like Alan Greenspan, and… Bernanke and Yellen, they all understood that credibility is very, very important. And when we had the rise of inflation. In the early 220s, both the ECB and the… and the Fed. may have been a little slow to react, especially the Fed, but the Fed had credibility. Price expectations never took off because the markets had believed that the Fed would take the necessary action to bring inflation back down, and it did. And that’s all the legacy of the… what happened in the late 1970s, early 80s from Volcker.

Jon Hartley: You know, I also tend to think that there’s two schools of monetarism. And, yeah, I think there’s various sub-schools of monetarism, in the sense that there’s… I’d say, a group of, maybe, passive monitors, think Milton Friedman K% Rule that argues you know, the Fed should just be run like a computer, just grow the money supplied by 2% every year. We don’t need FOMC meetings, or we don’t need monetary policy council or committee meetings, and that the central bank’s sole job should be just to maintain price stability, and do so with a constant money percent growth rule. And that’s it. And I would say there’s maybe another school of people who argue that, you know, yes, MV equals PQ matters, but, you know, per Friedman’s observation, you know, monetary policy is not neutral in the short run, and that it can impact real economic variables. And that the Fed or central banks should intervene. During periods of recession, Should provide monetary accommodation, to improve, real economic variables, during recessionary times. And should also contract the money supply when the economy’s, you know, so-called overheating, and you get big spurts of inflation. I’m curious how… you’ve seen that play out, I guess, in your, … in your research of the monetarists, of how people think… how different monetarists have thought that money should be used in monetary policy.

George Tavlas: Well, I think Friedman wouldn’t always say that a monetary role should be used all the time. When we were in the Great Depression, he would… he would not have, … advocated a monetary rule. He thought that this was the time to employ activist monetary policy, expansionary monetary policy. What he does argue, however, is that by following a rule, we’re less likely to have episodes as we did during the Great Depression. The central banks sometimes do make mistakes. Sometimes they are under political pressures. We see that today, don’t we? That they follow… that they make policy mistakes because of the political pressures and for other reasons. And in order to keep the economy on a more even keel. you follow a policy rule. I think the same thing applies to a Taylor Rule. The Taylor Rule is an activist rule, because it involves the economy responding. To developments in the economy, whereas Friedman’s Rule does not. Friedman’s Rule is always 3-5% monetary growth. But, … The advantage of a monetary role is that it prevents policy mistakes from occurring. It prevents political interference with monetary policy. The debate continues. it’s hard to take a position on one side or the other, especially since I’m a central banker, and I don’t want to, … You know, I don’t want to prejudge this issue as a central banker.

Jon Hartley: I want to ask you about the current state of monetarism, and how… how it kind of fell out of favor. That is how monetarism, in part, has fallen out of favor at central banks and in monetary economics and in academia. So, you know, how I think of, I guess, the sort of rough history of these things is you had the sort of old Keynesians, and then around the same time in the 1970s, you sort of had both… in the 60s and 70s, you had both monetarists emerging, like Milton Friedman, and those that were highlighting MV equals PQ, which is, I think, very popular, in the public, in the public in general, and PQ is, I think, a pretty easy thing to communicate. And then, you know, for a brief period of time, the Federal Reserve, was targeting monetary policy aggregates in the 1980s. Then it sort of realized that money demand wasn’t quite predictable, and it kind of abandoned that, and then it moved toward targeting interest rates. Sort of in parallel, what was going on at the same time. In the 70s, you had the rise of the rational expectations revolution that influenced macroeconomists, you know, thinking, you know. Prescott, Sargent, and many others, who were very influential. And the challenge there, though, was that, you know, policy, monetary policy didn’t really matter, so you also had folks you know, the new Keynesians kind of emerged around that time as well. Folks like John Taylor, Guillermo Calvo, and later Mike Woodford, and, Rich Clarida, and many others, Jordi Gali, who argued that, well, if you have some sort of frictions, whether it’s, you know, sticky prices or sticky wages or or, seeking information, that, that you could… monetary policy could produce, real economic effects. You would get, monetary non-neutrality. And not only that, but you also have interest rates, as being sort of the key, monetary policy instrument in that type of modeling. And so, in the early 90s, there was, I think, this You know, pretty quick shift, along with when inflation targeting was introduced, to sort of put, interest rates as, as, sort of the key policy instrument of, of interest. no longer money, no longer, you know, thinking about the money supply. And then we, you know, then central bankers got very focused on, on targeting inflation, 2% in particular, largely, 2% inflation targets, and use interest rates to achieve that, and not necessarily target some sort of monetary aggregate growth. And I think we’ve kind of been in that regime for… the past, say, 35 years or so, where, you know, economists who are writing macroeconomic models write down these three equation DSGE models. You know, changing the DSGE models, and, yeah, essentially, you know, there’s, there’s a Taylor rule in there, a monetary policy rule, there’s a Phillips curve, there’s an IS equation, or, you know, think of as, like, an aggregate demand, kind of like an equation, investment savings curve. And… And that’s it. Money is nowhere to be found. So, I’m just curious, there’s some people who point to monetary aggregates as being sort of a useful indicator, maybe a predictor of inflation. And many people on Wall Street, I think, still use money and talk about monetarism all the time, but largely, when I hear about monetarism today, it’s not in academic seminars. or from central banks, it’s largely from Wall Street or, a few monetary, economists and a few monetarists, who are still out there. I’m curious, you know, what happened in your mind, and is money making in any way?

George Tavlas: I, think you got it pretty, pretty right when you, made the analysis about monetary aggregates were unstable in the 1980s and 1990s, and so central banks stop putting an emphasis on growth of monetary aggregates. When the ECB started in 1999, its main pillar for monetary policy was M3 growth. But that lasted for about 4 or 5 or 6 years, and it became evident that focusing on monetary growth for monetary policy was not the right way to go, that the aggregates were unstable and could not be relied on, and so, just like the other central banks, the ECB started focusing on interest rates, I think this is just taking into account reality. Now, in the year 2020, when, just before inflation started taking off, M3 in the U.S. jumped by, I think it was 35% in one year. We had a very… very large, perhaps not as large, rise in M2 in the Eurozone, and sure enough, a year or two later, we had big surges of inflation. Now, you can argue whether those surges were due to the to the monetary growth itself, to the financing of fiscal deficits, especially in the U.S, or to the supply-side shocks that came from COVID and the Russian invasion of the Ukraine. But in any case, it provided some… A bit of a rebound for the view that Money, as under monetarism matters, but it was just a… It was not a long-lasting… it didn’t make a long-lasting impression on monetary policy makers, but what is important is what I came… what I referred to earlier, is that, alright, we get inflation up, as we did in 2022-2023. How do we bring it down? We bring it down by wage price controls? Nobody ever talks about wage price controls anymore. We know they’re a failure. In the 1970s, we brought them down by high interest rates. Monetary policy. If you didn’t know the debates in the 1950s and 1960s, you would have never had suspected that monetary policy would become the chief instrument for dealing with shocks on the inflation front. So, again, a lasting contribution for Milton Friedman was the emphasis that he put, and other monetarists, that they put on… on, monetary policy, per se, whether pursued through by having the main instrument, the money supply, or the main instrument, the interest rate. And don’t forget, when we had quantitative easing. in the Eurozone in 2014-2015, that was essentially increasing the money supply to try and get the interest rate up, because We reached the lower bound of interest rates. We even had negative interest rates in the Eurozone, but they weren’t being effective in bringing inflation up, so we relied on quantitative easing, which meant buying… large purchases of bonds and increasing the money supply. So, I would not go… So far to say that monetarism as a emphasis on money is something that is no longer… being discussed. It has been used, it has shown to be valid in the year 20… years 2020 and 21, in terms of bringing inflation up, and monetary policy itself has been the main tool for bringing inflation under control.

Jon Hartley: Well, it’s, ….

George Tavlas: And one other thing, if I may, one of the, … tenets of monetarism, or one of… yeah, I would call it a tenet of freedom as monetarism, was the importance of flexible exchange rates. When Friedman first wrote his article on the desirability of flexible exchange rates in 1953. He predicted the demise of the Bretton Woods adjustable peg system. He said it couldn’t last. He said we would move to a system of flexible exchange rates. Sooner or later, we would get there. It was the only system that would… that would be viable and sustainable. He was right. In 1973, the world moved to a system of flexible exchange rates. That became part of monetarism. And so, … You know, when we say monetarism, it’s just not money, it’s other things as well. It’s rules versus discretion. It doesn’t have to be a 3-5% monetary rule. You know, we now think that a Taylor Rule works better, but it’s rules versus discretion. So there are a number of aspects to monetarism that have survived to this day, even though the emphasis on The quantity of money is not… The main element that has survived.

Jon Hartley: Absolutely. It’s, … It’s interesting, too, you know, you think about… and we’re talking about largely advanced economies, and times where I think inflation’s been fairly stable, I think, you know, even if setting aside the early 2020s, you know, inflation jumping to nearly 10%,

George Tavlas: Over 10% in Europe.

Jon Hartley: over 10% in Europe, but in the US, just under 10%. But, you know, I think about, you know, all these episodes of hyperinflation, and … thinking to, you know, Zimbabwe, thinking to Venezuela, and thinking to all these episodes where you know, there’s been massive amounts of inflation. You can see, you know, there’s, obviously in all these cases, there’s a massive surge in the money supply. And, you know, there’s… Tom Sargent’s very famous paper, “The Ends of Four Big Inflations”. And it is… that in particular looks at all the interwar, European countries. Germany, you know, Weimar, Germany, Austria, Hungary, that had these, massive inflations, you know, they were trying to essentially inflate away their, their, their war-related debts, in… it’s interesting how, just in all these cases, money is there, and it’s, it’s expanding enormously. And so, you know, all these regressions, that I like, to show of. you know, monetary policy growth versus inflation. When you plot all these… all this cross-country data, you see a pretty clear relationship that you know, when you have massive inflations, there’s always a money story there. Now, when we get into, you know, low inflation environments, like in advanced economies. you know, it’s less clear that there’s, you know, such a direct relationship between money and prices at lower levels of inflation, but at big, you know, with big hyperinflations, money is always growing enormously. So I think, you know, Friedman’s maxim that, you know, inflation is always and everywhere a monetary phenomenon. bears a lot of truth, I think, you know, especially with larger inflations, especially with looking at the cross-country and historical evidence. So I think, I think there’s a very good, I think monetarism, itself for this idea that money is behind inflation certainly, I think holds up, well, especially when we look at, larger inflations. George, I really….

George Tavlas: It also holds up at 5-10% inflation rates, too. There have been studies done that show that the money is a predominant cause of inflations in the levels between, as I mentioned, 5% and 10%. It’s only at low low frequencies of inflation, 1%, 2%, 3%, that money is not an important variable these days. But at the medium frequencies and the very high frequencies that you mentioned, it’s always a predominant cause of inflation.

Jon Hartley: Absolutely.

George Tavlas: So, one reason why, perhaps less emphasis has been placed on money over the past 25, 30 years. It’s because we’ve had low inflation rates, but as we know, we had a high inflation rate in 2022, 2023, and we also know that that was preceded by very high rates of money growth, both in the U.S. and the Eurozone.

Jon Hartley: Well, it’s been a fascinating conversation, George. I really want to thank you for coming on, and for all your excellent scholarly work on monetarism and monetary economics, as well as all your public service. It’s a real honor to have you on.

George Tavlas: It’s been a pleasure and an honor, and I thank you so much for having invited me.

Jon Hartley: This is the Capitalism and Freedom of the 21st Century podcast, an official podcast of the Hoover Institution Economic Policy Working Group, where we talk about economics, markets, and public policy. I’m John Harley, your host. Thanks so much for joining us.