The monetary/fiscal policy debate,McCallum (1985) otherwise known as the Ando–Modigliani/Friedman–Meiselman debateEisner (1988) (or AM/FM debate from the main instigators' initials, and for this reason sometimes jokingly called the "radio stations debate"See AM Broadcasting and FM BroadcastingGramlich (2004)), was the exchange of viewpoints about the comparative efficiency of monetary policies and fiscal policies that originated with a workFriedman/Meiselman (1963) co-authored by Milton Friedman and David I. Meiselman and first published in 1963, as part of studies submitted to the Commission on Money and Credit.
Surveys of American Economic Association (AEA) members since the 1970s have shown that professional economists generally agree with the statement: "Fiscal policy has a significant stimulative impact on a less than fully employed economy." Conversely, while a 2000 survey of AEA members found that while 72 percent generally agreed with the statement that "Management of the business cycle should be left to the Federal Reserve; activist fiscal policy should be avoided", surveys from 2011 and 2021 found 56 percent and 67 percent disagreed respectively.
Origin In the early 1960s, contributing to the studies invited by the Commission on Money and Credit, Milton Friedman and David Meiselman published a study whereby, they found that "[e]xcept for the early years of the Great Depression, money is more closely related to consumption than is autonomous expenditures,"The term "autonomous expenditures" denotes the components of an economy's aggregate expenditure that are not affected by that same economy's real level of income. E.g. government spending, basic living expenses, and private investing. See Friedman/Meiselman (1963) claiming moreover that "[t]he results [of the tests] are strikingly one-sided". They used the following reduced form, least squares regression equation to compare the effectiveness of monetary and fiscal policies; in effect, to compare Keynesian and monetarist theories:
(1)
where C is induced private consumption, α is a constant, V represents money velocity, M is approximately M2, K represents an expenditure-multiplier, A is autonomous expenditures, and t represents time. Friedman and Meiselman found that, whether using annual data from 1897 to 1958 or quarterly data from 1946 to 1958, and whether using only real, contemporaneous data, or experimenting with various time lags, private consumption was not statistically significantly affected by discretionary fiscal policy, but was by monetary policy. They stated that their monetary variables were "highly correlated" with consumption, whereas fiscal policy variables were not.
Debate The Friedman/Meiselman 1963 paper was addressed with numerous articles, where counter-arguments were made: The model was erroneously specified because important and statistically relevant variables were omitted; the data used were not actually coincident with the theory behind them; there was no correction for the "thermostat effect"The "thermostat effect" denotes the occasion when discretionary fiscal policy is used because spending and output are down, just as a thermostat senses the house temperature and raises the heat so that the temperature is maintained at the desired level. See Bias (2014) so that even if fiscal policy is effective it will seem to have a neutral or even negative relationship with spending rather than the positive effect it is theorized to have; and that the results were time-specific.
Hester claims bias In 1964, Donald D. Hester criticizedHester (1964) the F/M paper for "bias" against a "Keynesian" outcome. For that purpose, Hester argued that government deficits are endogenously determined, and not exogenously, and thus no single-equation approach could properly capture government spending and deficits, while the same principle applies for short-run private investment. Also, Hester emphasized that the actual data should have been empirically tested in first-differential form so as to extricate the trends of both explanatory variables, and thus demonstrate only the endogenously generated economic growth. Hester stated that, when he tried "improved" data and empirical methods, “the autonomous expenditure theory outperformed the quantity theory [of money],” i.e. Keynesian economics win over monetarist economics.
Friedman/Meiselman respond In a paper published in 1964,Friedman/Meiselman (1964) Friedman and Meiselman conceded that Hester’s suggestion of using first differences was correct and that it is a better method for their single-equation approach. But they insisted that their interpretations of income and autonomous expenditures are relevant, rejecting Hester’s misgivings. They claimed that Hester’s use of correlation coefficients with his newly defined autonomous expenditures constituted an "unsound argument,"and summarized as follows: We remain of the opinion that there is a striking division among students of economic affairs about the role of money in determining the course of economic events. One view is that the quantity of money matters little; the other, that it is a key factor in understanding, and even more, controlling economic change. Our paper tried to present some evidence relevant to deciding between these views. The kind of evidence we gave is not the only kind that is relevant and may not be the most important or significant. And, of course, much other evidence is available from other work by us and by many others. This other evidence needs to be added to and brought to bear on the main issue that divides economists into two groups. Hester does not quarrel with the relevance of our evidence but with the particular form of the income-expenditure theory we use. [Hester's] criticism of our procedure rests primarily on a misunderstanding of the theoretical basis of our approach. He offers neither theoretical argument nor empirical evidence in support of his alternative formulation. Hence his criticism is largely beside the point. That is unfortunate. We badly need work on these problems that will clarify the issues involved. We can ill afford to waste the energy, interest, and ability that Hester displays in his paper on frivolous quibbling.
Ando and Modigliani: both policies affect outcome Albert Ando and Franco Modigliani, in a paper published in 1965,Ando/Modigliani (1965) disputed the findings presented in the 1963 Friedman/Meiselman work. Ando and Modigliani claimed that [The Friedman/Meiselman 1963 work] has shortcomings in procedures that if repaired change the result, but, moreover, the single-equation approach coupled with the equally single, independent variable approach and the corresponding correlations cannot shed light on macro-policy. They argued that the consumption functionFriedman, in 1957, had written on the subject of the consumption function a book (Friedman (1957)) that he later stated he considered his "most important professional contribution". See Taylor (2001) was not correctly specified within the F/M use of autonomous expenditures and claimed that the variable that Friedman and Meiselman had derived was actually saving and not autonomous expenditures. They also observed that the data used in the 1963 paper would need to be modified by including corporate retained earnings, transfer payments made by the government to foreigners, and “wage accruals over disbursement.”
Ando and Modigliani objected to the use of an ordinary, least squares equation because of the induced influence on the independent variable by the dependent variableMeaning that the independent variable is not really independent and offered their own model, which ostensibly removed the independent part from the induced part.
Ando and Modigliani criticized the Friedman/Meiselman paper for omitting to determine exogenous and endogenous components to monetary policy in the same manner as economists do with fiscal policy. Instead, Ando and Modigliani, rather than using a standard money-supply variable, introduced M*, which is meant to represent what the money stock would be if high powered money were "fully utilized", thus introducing a "high-usage variable."This is somewhat akin to a high-employment fiscal variable. See Bias (2014) The purpose was to show that money is not exogenously determined: people can choose to hold money in different amounts and levels of liquidity as situations warrant, while lenders don't need to lend out all of their excess reserves if they so desire - which constitutes a standard Keynesian concept. Moreover, Ando and Modigliani found that the error variance in predicting output"NNP" in the paper, i.e. Net National Product was "much higher" when using money than any of the fiscal variables and labeled the F & M respective results "spurious."
They concluded that Friedman and Meiselman’s results were biased in favor of monetary policy, and that, if both policy variables were to be given a balanced approach, the end result would be that both policies would have real and statistically significant effects on the economy. Indeed, in the opening statement of their paper, they state that the "number of basic shortcomings in [the Friedman/Meiselman] procedure...make the results of their elaborate battery of tests essentially worthless." Economists Michael DePrano and Thomas Mayer publishedDePrano/Mayer (1965) a critique of the F & M paper that was generally in line with the criticisms leveled by A & M.
FM respond to AM In 1965, Friedman and Mieselman respondedFriedman/Meiselman (1965) to the criticism leveled at their 1963 paper, particularly by Ando and Modigliani. They claimed that although one could indeed object to their autonomous-expenditure variable, any of the alternatives that had been put forward by others were equally objectionable. Additionally, Friedman and Meiselman defended their use of their consumption function and explained why it is, in their view, the right method to use. And they pointed out that, unlike them, Ando and Modigliani used nominal data rather than real data and, therefore, the empirical results put forward by A & M could not be correctly comparable to their own.
Friedman and Mieselman agreed in theory with A & M that the term M* is a valid means to determine the exogenous versus the endogenous nature of the policy variable but still disagreed with the actual A & M methodology to determine M*. As to the consumption variance, they maintained that "of the total variance of consumption for the 25 years, 88 per cent is accounted for by the differences between the means for the two subperiods."
Finally, they claimed complete lack of bias in their research and the empirical processes and claimed that even if they had built a model that seemed to favor monetary policy over fiscal policy, that was because the theory comes out that way. They concluded as follows: None of the calculations made by our critics for supposedly the same purpose is correct because they omit some components of income for the income-expenditure calculations, set the two theories different tasks, or use lengthy periods combining two different sub-periods. We have made some of the correct calculations for one of the alternative concepts of autonomous expenditures (Ando and Modigliani’s). Though less clear-cut, the results are in the same direction as those from our original calculations. Hence, we are left with no reason to change our earlier conclusion that “so far as these data go [and, we may now add, those adduced by Ando and Modigliani, DePrano and Mayer, and Hester]Text inside brackets in the original the widespread belief that the investment multiplier is stabler than the monetary velocity is an invalid generalization from the experience of three or four years. It holds for neither later nor earlier years”.
The St. Louis equation