Schwartz Did Economics the Right Way

On Thursday, Anna Schwartz, one of the most important economists of the 20th century, died at the age of 96.

Schwartz, who remained busy into her nineties, was best known for co-authoring “A Monetary History of the United States” with her famed colleague Milton Friedman.

David Shankbone

Anna J. Schwartz, the economist who co-wrote “A Monetary History of the United States” with Milton Friedman, in 2007.


Lars Christensen: Goodbye to a great monetary historian


Paul Krugman: Friedman and Schwartz were wrong

It is difficult to overstate the importance of Schwartz’s contribution to the economics profession. David Romer — a macroeconomist at the University of California, Berkeley, and a member of the Business Cycle Dating Committee of the National Bureau of Economic Research — once remarked in a lecture that economists hold a range of views on “A Monetary History” and that his own view was somewhere in the middle of this range. He considered it the most important piece of work of the last 75 years.

The key insight of Friedman and Schwartz’s work was that short-run fluctuations in the economy — booms and busts — are the result of changes in the money supply. In particular, Friedman and Schwartz argued that the Great Depression was the result of a collapsing money supply, which fell by one-third during the contraction from 1929 to 1933. For this they blamed the Federal Reserve, which was responsible for maintaining a stable money supply but, when faced with deteriorating economic conditions, either looked the other way or took actions that worsened the downturn.

In retrospect, the importance of the money supply seems obvious. The connection between the money supply and inflation, for example, is taken for granted today. And hundreds of years ago, the philosopher David Hume wrote extensively on the connection between money and prices, reasoning that an expansion of the money supply could raise employment. Friedman and Schwartz were hardly breaking any new ground.

However, at the time Schwartz partnered with Friedman, this view was not widely accepted. In fact, the view they outlined in “A Monetary History” was so at odds with the conventional view of the profession that it became its own separate school of thought: the monetarist school.

Led by Friedman and Schwartz, the monetarists blamed the Fed for the Great Depression and, later, for the high inflation of the late 1970s and early 1980s. They advocated the k-percent rule — which called for the Fed to set a constant rate of growth for the money supply — as a way to avoid wild and costly swings in the economy.

Although the k-percent rule ultimately proved unworkable, Friedman, Schwartz, and their fellow monetarists were nevertheless successful in challenging many of the conventional views of the profession. Their most important insights have since been incorporated into mainstream New Keynesian economics, and the spirit of the now-defunct k-percent rule arguably lives on in the form of nominal GDP targeting.

But as remarkable as these intellectual contributions are, the most impressive thing about “A Monetary History” is the way Friedman and Schwartz tackled the so-called identification problem in economics.

The identification problem is a question of cause and effect. Given that two economic variables are correlated, which one causes the other? Friedman and Schwartz, through exhaustive historical research, assembled a mass of data demonstrating a close correlation between various measures of the money supply and economic output.

However, the nature of the relationship between the two — and whether one caused the other — was far from clear. Arguably the most obvious interpretation of the correlation was that the collapsing economy led to a falling money stock, as a smaller number of economic transactions in a shrinking economy would mean less demand for the medium of exchange. Economists would say that the size of the money supply was “endogenous” to — an outgrowth of — the state of the economy.

To settle the issue of causation, Friedman and Schwartz set out to find “exogenous” shocks to the money supply — instances in which the money supply changed for reasons unrelated to the state of the economy. If output responded to such events in the expected way — expanding or contracting with the money supply — then a causal relationship from money to output could be established.

Friedman and Schwartz identified four such instances during the Great Depression.

“By locating such episodes,” said an admiring Ben Bernanke on Friedman’s 90th birthday, “[and] then observing what subsequently occurred in the economy, Friedman and Schwartz laboriously built the case that the causality can be interpreted as running (mostly) from money to output and prices, so that the Great Depression can reasonably be described as having been caused by monetary forces.”

This “laborious” study of cause and effect is crucial in any rigorous economic analysis. With so many variables moving in complicated and interrelated ways, deducing how one event leads to another means untangling a messy web of causation. The so-called “natural experiments” that Friedman and Schwartz identified were crucial in untangling the causes of the Depression.

Sadly, the difficulty and subtlety of this task is almost entirely unappreciated in today’s economic discourse. Most perniciously, hard-money advocates on the right have criticized the Fed’s policy of low interests as “easy money” — forgetting one of the key insights of “A Monetary History”: interest rates are a poor indicator of the stance of monetary policy, since they respond strongly to the state of the economy.

Schwartz herself succumbed to such fallacies late in life, opposing Bernanke’s reappointment as Fed chairman partly on the basis of the interest-rate fallacy that her work had debunked.

Nevertheless, as the less-recognized of the “Friedman and Schwartz” duo, Anna Schwartz is easily one of the most underrated economists in recent history. Let’s hope her death, sad though it may be, offers one final opportunity to grant her the full recognition her illustrious career — and life — deserves.

Alexander Hudson is co-founder and Editor-in-Chief of Partisans. He was previously a Fulbright Scholar to the United Kingdom, based at the University of Oxford. He is currently a Ph.D. candidate in chemistry at the University of California, Berkeley.