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The Real Bills Doctrine and the Persistence of Monetarism

The Real Bills Doctrine (RBD) suggests that the central bank passively provides liquidity to the system.* The name of the doctrine results from the notion that banks only discount real bills, associated with the functioning of the economy, in particular for international trade that was essential in the 18th century when the doctrine was developed. In terms of central banking policy, the RBD fundamentally meant that there was no need to lean against the wind, and money supply should adjust to the needs of trade. It is generally presumed that in the 1930s a more activist position – leaning against the wind – was developed.

In particular, Allan Meltzer in his A History of the Federal Reserve seems to believe that the RBD was the main cause of the Depression and that its abandonment was essential for the recovery from the Great Depression, since, in his view, the increase in money supply was the crucial element in the recovery, rather than the New Deal policies. Meltzer (2003, p. 282 and p. 357) says: "the main reason for the failure of monetary policy in the depression was the reliance on an inappropriate set of beliefs about speculative excesses and real bills," and "passage of the 1932 legislation recognized that the real bills doctrine did not provide the flexibility (elasticity) to expand the note issue or prevent the crisis from deepening." In other words, the RBD led to too much contraction, and the Glass-Steagall Act signaled its abandonment.

This view, both of the causes of and the recovery from the Depression and about central banking practices, has been generally accepted and is canonical among economists and policy makers, Old Monetarists like Meltzer, or New Keynesians like Christina Romer, by the way. Friedman and Schwartz's A Monetary History of the United States is the locus classicus of the monetarist view of the Great Depression. Richard Timberlake suggests (here) that the RBD, not the Gold Standard was behind the Great Contraction. Barry Eichengreen is the main defender of the view that the Gold Standard (see here), not the RBD, was behind high rates of interest and contractionary monetary policy, a view not very different from that of Keynes in the early 1930s.

I point this out, since in this view money is essentially exogenous, contrary to the RBD, but also in contrast to the conventional New Keynesian model, which assumes some version of an interest rate rule (i.e. Taylor's Rule). I've already referred to this strange persistence of Monetarist ideas when it comes to economic history (here). I guess that is why Meltzer thinks that inflation is around the corner. By the way, I suggested somewhere else that is not clear that the Fed actually abandoned the RBD in the 1930s, and that a more Keynesian approach to monetary policy does not (in fact it shouldn't) require the abandonment of an endogenous money view.

* The RBD suggests that money is created according to the needs of trade. Hence, money cannot be issued in excess, and is endogenously created by banks. Adam Smith was an early proponent of the Real Bills Doctrine. The RBD is, in a sense, an early version of endogenous money and of some aspects of MMT.


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