I can’t possibly present to you all the evidence that I have
referred to, so I want to turn to a slide show now and give you
a little flavour of the evidence. I understand that there is an
old Yiddish proverb that one picture is worth a thousand equations.
And that is what these pictures are for.
The first four slides come from a study of monetary trends that
Anna Schwartz and I have been making. These four charts are for
a period of almost a century, from about 1880 to 1970, for two countries,
the United States and the United Kingdom. They are intended to illuminate
longer period movements and so we have used as our basic unit of
observation a business cycle phase, that is, either an expansion
or a contraction. The individual observation plotted in Chart
1 is the average value during a half cycle, that is during the
period from a business cycle trough to a business cycle peak, or
from a peak to a trough. The purpose is to eliminate the cyclical
movement and concentrate on the longer term movement.
In each part of the chart (the top is for the U.S., the bottom for
the U.K.), there is plotted the level of nominal income (it is called
“nominal” because it is in dollars or in pounds sterling,
and not corrected for price changes) and the quantity of money,
also in dollars or in pounds sterling.1 These are levels and because
of the strong upward trend it is hard to see what is happening over
shorter periods. However, it is clear that there is a very close
relationship between the two, that the two move much in the same
In order to eliminate the very long period trend, the next chart
(Chart 2) shows
exactly the same data but in the form of rates of change computed
from the earlier levels.2 For both the United States and the United
Kingdom, there is a remarkable degree of agreement between the rate
of change of nominal income and the rate of change of money over
a century. The only really big discrepancy occurs for both the United
States and the United Kingdom in World War II. You will note that
in World War II the money stock rises more rapidly than income in
the period of the war itself, and then it goes below it in the post-war
period. What you had in both cases was that velocity fell sharply
during the war and then rose back after the war. In the United States,
the pre-war relation is restored by about 1960; in Great Britain,
where the wartime disturbance was much greater, the pre-war relation
was not yet restored in the period shown in that chart.
I find that particular deviation fascinating and very instructive
because precisely the opposite happened in both countries in World
War I: velocity rose during the war, that is, nominal income rose
more rapidly than money, and after the war velocity fell. We shall
come back to this in a later chart
The natural next question to ask is how the change in money which
was reflected in the change in nominal income was reflected separately
in prices and output?
Chart 3 parallels
Chart 2 except that
the rates of change this time are in the quantity of money per unit
of output and in prices. That is, if money was growing at 10 per
cent per year and output at 3 per cent per year, then money per
unit of output would be growing at 7 per cent per year and that
is the amount of monetary growth that would be related to prices,
which is the other variable in the chart. Again, as you can see,
for both countries for nearly a century, there is an extremely close
relation between the rate of change of money per unit of output
and the rate of change of prices.
The next chart shows velocity in the United States and the United
Kingdom. This chart was the biggest surprise to me in the work we
have done in this area, and has caused us to turn our study in a
very different direction than I initially thought it was going to
go. If you look at the levels of velocity, the striking thing is
that here you have two different countries—the United States
on the one hand and the United Kingdom on the other—yet, except
for the initial discrepancy in the early period which I’ll
come back to in a moment, the velocities are almost identical; they
are practically the same series, one on top of the other. If I showed
you one of those series by itself, I would challenge anybody, even
if he knew the monetary history of the two countries very well,
to know if it was for the United Kingdom or the United States.
The initial discrepancy reflects the much more rapid fall in velocity
in the United States than in the United Kingdom until 1905. I believe
that this more rapid fall is attributable to the increasing financial
sophistication of the United States in that period. We have observed
this phenomenon for many countries. In the early stages of economic
development, people want to increase the amount of money they hold
relative to their income; they want to have a larger stock of money.
And this means that in early stages of development, for every 1
per cent increase in real income, you generally have about a 2 per
cent increase in the real quantity of money people want to hold.
That is so for the United States until about 1905; exactly the same
thing holds for Japan in the past 20 years; I suspect that the same
thing holds for Israel, if you can eliminate the effect of accelerating
inflation, which has tended to work in the other direction.
The bottom part of Chart
4 gives rates of change and so abstracts from the very long-term
trend. That too is remarkable.
Very often in economics, good statistical relationships are spurious.
For example, if we correlate consumption with income, we are bound
to get a good relation because consumption is 70 or 80 per cent
or 90 per cent of income, so that we are in large measure correlating
a series with itself. In the present case, no spurious statistical
element whatsoever is present—and this applies also to the
earlier graphs. The income series in each country is statistically
independent of the money series, and certainly the series for the
U.S. and the U.K. are statistically independent. Yet, for almost
90 years, velocity in the two countries moves together
What does that mean? It means that whatever forces have been producing
the changes in velocity have been forces that have been common to
the United States and the United Kingdom. In this respect, we have
been doing some more studies which show that what happens to the
quantity of money in the United States has an effect on the United
Kingdom in ways other than through affecting the U.K. quantity of
money, and vice versa. There really was one world.
I would like to see such comparisons for other countries, but as
yet we haven’t made them. However, some have been made for
Canada and the United States and they show almost exactly the same
thing. If you want to know what happens to Canadian income, you
do better to know what happens to the U.S. money stock than to know
what happens to the Canadian money stock.
However, my present point is somewhat different. I think you will
agree with me that this set of four charts, if it does nothing else,
makes it clear that money and income are not independent magnitudes
that can go their own ways, that what happens to the quantity of
money is closely related to what happens to income and vice versa
These studies, as I say, are for two countries for a period of
nearly a century. Chart
5 also deals with longer period relations but it deals with
relations among countries. What you have here are 40 countries.
Each dot plots the rate of change in prices over a 17-year period
versus the rate of change in the quantity of money per unit of output
over the same period. There are 40 dots for 40 countries. The diagonal
line across the chart is the line on which 12 per cent change in
prices is associated with a 12 per cent change in the quantity of
money per unit of output, and so on. You can see that the points
are very closely scattered along such a diagonal line. At the top
of the chart are the countries that have had about a 30 per cent
per year increase in the quantity of money per unit of output, and
they have had about a 30 per cent per year change in prices. At
the bottom are the countries that have had a small rate of change
in money and a small rate of change in prices. Again, there is no
escaping the conclusion that is illustrated by that chart—that
inflation is primarily a monetary phenomenon and reflects what happens
to the quantity of money per unit of output.
The next set of charts shifts from this very long-term view to
a much shorter term view. Here we look at the opposite side of the
picture—the amount of noise in the relationships. So far,
the relationships I have been showing you have been very tight,
because they have averaged out the irregularities from day to day,
quarter to quarter. Chart
6 is for the United States for quarter-to-quarter changes over
the past 17 years. The rate of change in gross national product
from quarter-to-quarter is plotted against the rate of change of
money (currency plus all commercial bank deposits) two quarters
earlier, to allow for the characteristic tendency of GNP to lag
money. For example, one of these points shows that GNP grew by 11⁄2
per cent from one quarter to the next quarter while the quantity
of money declined at the rate of 11⁄2 per cent two quarters
There is broadly a positive relationship. However, from quarter-to-quarter
there is an enormous amount of noise, an enormous amount of irregularity,
which shows up very sharply in Chart
6. I believe that it is extremely important to recognize the
limitations as well as the closeness of the relation between money
and income. There is a very loose relation between changes in money
and income over very short periods, a very close relation over longer
periods of time.
In order to eliminate some of that noise, the next chart averages
over four quarters. It plots the change from one quarter to a quarter
a year later. For example, instead of plotting the rate of change
in GNP from the first three months of 1971 to the second three months,
it plots the rate of change from the first three months of 1970
to the first three months of 1971. As you can see, averaging over
four quarters brings the scatter a lot closer together but it still
leaves a very considerable amount of noise.
The next chart shows that even that residual noise is very deceptive,
that there is in one way less to it than one might gather from Chart
7 alone. The line in this chart labelled “actual”
shows the rate of change of personal income in the United States
averaged over a six-month period to reduce random perturbations.
The dashed line labelled “predicted” shows the rate
of change in personal income predicted from the movement of money
nine months earlier. Put differently, that predicted series is the
movement of money itself nine months earlier adjusted in scale to
correspond to personal income on the basis of a correlation computed
for a 17-year period.
Now I have labelled some of those points: 1, 2, 3, 4--because those
are points that are explained by exceptional circumstances. Point
No. 1 reflects a retroactive pay increase which was all included
in one month; point No. 2, the GM strike; point No. 3, the threat
of a steel strike, and point No. 4, which is most interesting in
another connection that I am tempted to dwell on at length but shall
only pass over here, reflects the effect of the price freeze of
August 15 which chilled a nicely developing expansion for some months
by introducing great uncertainty into the economy.
As you can see, the predicted values go on longer than the actual
values because there is another nine months for prediction. As you
can see, the series is coming back up to the predicted path after
the shock introduced by the wage and price freeze.
If you eliminate those exceptional events, I think you will agree
that the chart shows extraordinarily good predictions for a very
simple-minded relationship. There is nothing in the chart except
the movement of money nine months earlier and the movement of personal
Chart 9 shows both
the strength and weakness of this relation-ship. It is identical
with Chart 8 except
that it covers the preceding 15 years, 1953 to 1968. Again I won’t
discuss the exceptional numbered points. I want to stress something
very different. From about 1958 on, the relationship is just as
close as in Chart 8.
On the other hand, for the first five years, the relationship is
much looser. The pattern of the two series is the same but the actual
personal income series fluctuates much more widely than the predicted
I have no good explanation for this divergence. I conjecture that
it has something to do with the system settling down after the shock
of the Korean War. But in any event, including both periods gives
an indication of both the strength and the limitations of this relationship.
The next chart shows the same relationship separately for output
and for prices. The upper panel shows the relationship of money
to industrial production six months later. One of the things that
we found and that I shall discuss below, is that a change in the
quantity of money has an effect on output much earlier than it does
on prices. While I used a nine-month lead for nominal income, a
six-month lead is best for output alone. The panel shows a very
close relation although a slight difference in level. For prices
for the United States for this period, it turned out that a 23 month
lead of money over prices gives the best results. As you can see,
that relation is not nearly as close over short periods as the relation
for output and the delay is much longer.
I didn’t want to give a lecture in Israel without having
at least a few numbers for Israel, so Anna Schwartz managed to scrounge
up some numbers for me in New York on Israel. The next and final
chart shows the same kind of a relationship for the last few years
in Israel. The solid series, based on rough estimates of your current
GNP on a quarterly basis, shows the actual rate of change from quarter
to quarter (the U.S. charts use monthly data for a six-month period).
The dashed line shows the rate of change of GNP predicted from the
change in high-powered money two quarters earlier. I am not sure
what the best monetary aggregate is for Israel. When I studied the
Israeli situation in 1962, I decided that currency was most reliable
because your authorities were changing the meaning of deposits so
rapidly that the deposit series had very little economic significance.
I suspect that may still be the case. In any case, that is why we
used high-powered money. The sharp decline and then rise in the
rate of growth of GNP corresponds to the Six Day War. Note that
that first period is rather like the early years in Chart
9 for the U.S.—the general pattern is the same for the
actual and predicted, but the fluctuations in actual income are
much wider. The second period is like the later period for the U.S.
data—the two series are much closer. Towards the end of the
period, the actual GNP is starting to diverge from the predicted.
I suspect that this reflects what is happening to your rate of inflation.
Such a divergence is precisely what accelerating inflation could
be expected to produce.
At any rate, the relationships I have described are not relationships
that prevail exclusively for the United States. They are relevant
to Israel as well as to other countries.
That is the end of the slide show.