Milton Friedman and moneyness

Steve Williamson recently posted a joke of sorts:

What's the difference between a New Keynesian, an Old Monetarist, and a New Monetarist? A New Keynesian thinks no assets matter, an Old Monetarist thinks that some of the assets matter, and a New Monetarist thinks all of the assets matter.

While I wouldn't try it around the dinner table, what Steve seems to be referring to here is the question of money. New Keynesians don't have money in their models, Old Monetarists have some narrow aggregate of assets that qualify as M, and New Monetarists like Steve think everything is money-like.*

This is a interesting way to describe their differences, but is it right? In this post I'll argue that these divisions aren't so cut and dry. Surprisingly enough, Milton Friedman, an old-fashioned monetarist, was an occasional exponent of the idea that all assets are to some degree money-like. I like to call this the moneyness view. Typically when people think of money they take an either/or approach in which a few select goods fall into the money category while everything else falls into the non-money category. If we think in terms of moneyness, then money is a characteristic that all goods and assets possess to some degree or another.

One of my favorite examples of the idea of moneyness can be found in William Barnett's Divisia monetary aggregates. Popular monetary aggregates like M1 and M2 are constructed by a simple summation of the various assets that economists have seen fit to place in the bin labeled 'money'. Barnett's approach, on the other hand, is to quantify each asset's contribution to the Divisia monetary aggregate according to the marginal value that markets and investors place on that asset's moneyness, more specifically the value of the monetary services that it throws off. The more marketable an asset is on the margin, the greater its contribution to the Divisia aggregate.

Barnett isolates the monetary services provided by an asset by first removing the marginal value that investors place on that asset's non-monetary services, where non-monetary services might include pecuniary returns, investment yields and consumption yields. The residual that remains after removing these non-monetary components equates to the market's valuation of that given asset's monetary services. Since classical aggregates like M1 glob all assets together without first stripping away their various non-monetary service flows, they effectively combine monetary phenomena with non-monetary phenomena—a clumsy approach, especially when it is the former that we're interested in.

An interesting incident highlighting the differences between these two approaches occurred on September 26, 1983, when Milton Friedman, observing the terrific rise in M2 that year, published an article in Newsweek warning of impending inflation. Barnett simultaneously published an article in Forbes in which he downplayed the threat, largely because his Divisia monetary aggregates did not show the same rise as M2. The cause of this discrepancy was the recent authorization of money market deposit accounts (MMDAs) and NOW accounts in the US. These new "monies" had been piped directly into Friedman's preferred M2, causing the index to show a discrete jump. Barnett's Divisia had incorporated them only after adjusting for their liquidity. Since neither NOW accounts nor MMDAs were terribly liquid at the time—they did not throw off significant monetary services—their addition to Divisia hardly made a difference. As we know now, events would prove Friedman wrong since the large rise in M2 did not cause a new outbreak of inflation.**

However, Friedman was not above taking a moneyness approach to monetary phenomenon. As Barnett points out in his book Getting it Wrong, Friedman himself requested that Barnett's initial Divisia paper, written in 1980, include a reference to a passage in Friedman & Schwartz's famous Monetary History of the United States. In this passage, Friedman & Schwartz discuss the idea of taking a Divisia-style approach to constructing monetary aggregates:

One alternative that we did not consider nonetheless seems to us a promising line of approach. It involves regarding assets as joint products with different degrees of "moneyness" and defining the quantity of money as the weighted sum of the aggregate value of all assets, the weights varying with the degree of "moneyness".

F&S go on to say that this approach

consists of regarding each asset as a joint product having different degrees of "moneyness," and defining the quantity of money as the weighted sum of the aggregate value of all assets, the weights for individual assets varying from zero to unity with a weight of unity assigned to that asset or assets regarded as having the largest quantity of "moneyness" per dollar of aggregate value.

There you have it. The moneyness view didn't emerge suddenly out of the brains of New Monetarists. William Barnett was thinking about this stuff a long time ago, and even an Old Monetarist like Friedman had the idea running in the back of his mind. And if you go back even further than Friedman, you can find the idea in Keynes & Hayek, Mises, and as far back as Henry Thornton, who wrote in the early 1800s. The moneyness idea has a long history.

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* Steve on moneyness: "all assets are to some extent useful in exchange, or as collateral. "Moneyness" is a matter of degree, and it is silly to draw a line between some assets that we call money and others which are not-money."

...and on old monetarists: "Central to Old Monetarism - the Quantity Theory of Money - is the idea that we can define some subset of assets to be "money". Money, according to an Old Monetarist, is the stuff that is used as a medium of exchange, and could include public liabilities (currency and bank reserves) as well as private ones (transactions deposits at financial institutions)."

** See Barnett, Which Road Leads to Stable Money Demand?