Sebastiano Nerozzi. History of Political Economy. Volume 41, Issue 3. Fall 2009.

The origins and nature of the so-called Chicago monetary tradition have been widely and hotly debated over the last fifty years. This debate has provided a further opportunity for economists and historians to appreciate the importance and, at the same time, the complexity of any attempt to trace the origins and the evolution of ideas or schools of thought, especially in such a ticklish and crowded field as monetary theory.

Profiting from the vast literature assembled in the last few years, this essay aims to assess Jacob Viner’s role within the Chicago monetary tradition by examining published, as well as unpublished, evidence concerning his positions with regard to monetary issues during the 1930s.

Different authors hold quite different views on Viner’s role at the onset of the Chicago monetary tradition: according to Milton Friedman ([1974] 2003), Frank Steindl (1995), and George Tavlas ([1997] 2003), Viner can be listed among the fathers of the tradition; yet Eugene Rotwein (1983) questions Viner’s partnership in any school of thought and tends rather to limit the similarities between Viner and Friedman, while Don Patinkin ([1969] 2003) traces a broader line of demarcation between an “early” Chicago school, with Viner and Knight among its undisputed leaders, and that of the postwar period.

In section 1, we recall the main lines of this debate and examine the theoretical propositions and policy prescriptions that, according to Tavlas, represent the peculiar core of the Chicago view in the early 1930s. In the following three sections, we examine Viner’s position relating to the different points highlighted by Tavlas; we devote our attention respectively to Viner’s view of the Great Depression and the role played in it by the banking system (section 2); his views and proposals concerning compensatory monetary policy between 1931 and 1936 (section 3); and the evolution of his monetary framework during the 1930s and the growing preference he gave to fiscal policy (section 4). We profit from this analysis in order to state Viner’s position within the context of the early Chicago school (section 5).

1. The Debate over the Origins and Nature of the Chicago Monetary Tradition

More than fifty years ago, introducing a collection of his students’ essays, Milton Friedman ([1956] 2003) expounded the main lines of his monetary framework, in which the quantity theory of money was restated in the form of a theory of the demand for money, and its velocity was regarded as a stable function of a quite limited set of variables. The stability of the money demand function provided a new theoretical basis in order to reaffirm the validity of the causal relation between variations in the quantity of money and those in the general price level, which had been questioned by the Keynesian theory; the quantity theory of money was thus restored as a relevant framework to understand and also predict business conditions, in the short as well as in the long run: the old monetary orthodoxy, cast away by the Keynesian revolution, was now ready to regain its legitimate kingship.

Never imagining that such a long-standing querelle would arise, in his 1956 essay Friedman disclaimed any originality and sited his model within an “oral tradition,” to which influence he and his colleagues had been exposed at Chicago since the early 1930s. The forefathers of this tradition were Henry Simons and Lloyd Mints, with Frank Knight and Jacob Viner at “one remove.” What Friedman ([1956] 2003, 33) claimed to have captured with his model was the “flavor” of the “oral tradition” stemming from their teachings.

Actually, no immediate reaction followed Friedman’s recollections: it took thirteen years before another excellent former Chicago student, Don Patinkin, came to address Friedman’s claims. It was 1969 and Friedman’s “long march” to prove that “money does matter” had conquered a significant part of the profession. The forces of counterrevolution were now gathering against the Keynesian revolution: the new quantity theory of money, as restated by Friedman, patently contested Keynesian theory and policies. Issues of intellectual history merged with economic issues that were at the time urgent, and the debate over the origins of the Chicago monetary tradition arose and gained momentum (Leeson 2003, 1:5–6).

According to Patinkin ([1969] 2003, 101–2), Friedman’s monetary theory was not a restatement of the old quantity theory, but rather a refined version of the Keynesian portfolio approach, first expounded by Keynes in the Treatise on Money and laid down in much clearer terms in the General Theory by means of the liquidity preference. Moreover, Friedman’s account of the origins of his model was misleading: demand for money, interest rates, and expected inflation did not enter the monetary framework of early Chicagoans, and their quantity theory was based on the assumption of autonomous movements in the velocity of money, which made the causal relation between M and P quite unreliable. Friedman’s monetary theory was much more Keynesian than Chicagoan: his lack of accuracy in accounting for the Chicago monetary tradition implicitly weakened his claim to be at the forefront of an anti-Keynesian counterrevolution (Patinkin [1974] 2003, 126; Leeson [2000] 2003, 250, 257).

Other scholars went even further and questioned the uniqueness and originality of the quantity theory held at Chicago in the early thirties: Lauchlin Currie, James Angell, Lionel Edie, Clark Warburton, and other monetary economists of the 1930s and 1940s were called on stage. These scholars rather than the Chicagoans came to be regarded as the legitimate forerunners of Chicago’s postwar achievements in monetary analysis, history, and policy. Friedman and Anna Schwartz’s monetary interpretation of the Great Depression; their advocacy of monetary expansion through fiscal policy or open market operations; their radical proposals for banking reform and regulation; and their preference for “rules over discretion” in the management of the money supply had several precedents in the monetary literature of non-Chicagoans (Humphrey [1971] 2003, [1973] 2003; Patinkin [1973] 2003).

The uniqueness and originality of the monetary theory held by the early Chicago school were reaffirmed by George Tavlas. Developing Patinkin’s account, Tavlas was able to highlight and specify the essential features of the Chicago monetary tradition. According to Tavlas ([1997] 2003, 177), many Chicago economists held the following propositions: (1) in the MV = PT framework, economic fluctuations were caused by autonomous movements of V; (2) variations in V were cumulative in nature, because of changes in price expectations and business confidence; (3) the effects of cumulative changes in V were exacerbated by the perverse behavior of the banking system; (4) budget deficits during a depression should be reversed into a surplus during an expansion; (5) antidepression policy required a countercyclical expansion in M; (6) such an expansion in M could best be achieved by generating budget deficits, which were a mechanism for conducting monetary policy. Even though other scholars from a different intellectual milieu shared some of these analyses and proposals, since the early 1930s only the Chicago economics department had demonstrated, in Tavlas’ estimation, a broad and constant adherence to these views. Chicago’s primacy and originality over policy and monetary theory during the 1930s were thus restated.

After a relapse of more than a decade, the debate was revived by Tavlas’ claims. David Laidler, supported by Roger Sandilands, highlighted the strong connections between the views and proposals coming from Chicago and the ones stemming from Harvard’s economics department, especially from the writings of Allyn A. Young and Lauchlin Currie during the 1920s and early 1930s (Sandilands 1990; Laidler [1993] 2003, 1999; Laidler and Sandilands [2002] 2003); both of them were deeply influenced by Ralph G. Hawtrey’s studies on money, banking, and the business cycle. Moreover, their wide statistical inquiries into the behavior of the banking system in the United States (Young 1928; Currie 1931, 1933a, 1933b, 1934a) anticipated in many ways Friedman and Schwartz’s (1963) own interpretation of the Great Depression. In this respect Harvard seemed to be ahead of Chicago, where Knight and Simons opposed the use of quantitative methods in economics.

Laidler’s and Sandilands’s remarks about a strong Harvard influence on the origins of the Chicago tradition were harshly contested by Tavlas in an intense exchange of arguments and rebuttals that endured until a few years ago (Laidler [1998] 2003a, [1998] 2003b; Tavlas [1998] 2003a, [1998] 2003b; Laidler [1999] 2003; Tavlas [1999] 2003; Laidler and Sandilands [2002] 2003).

In this context, Jacob Viner’s position seems to be particularly relevant. While most young economists in the United States at the time embraced the Keynesian gospel, Milton Friedman did not, and he identified Viner as one of the scholars whose proposals and analysis kept him from doing so. While most of the American profession maintained that the depression would cure itself, Viner had been an early and outspoken advocate of anticyclical budget deficits, providing since 1931 a straightforward case for public intervention in the monetary, as well as in the fiscal, fi eld. His framework was not the income-expenditure approach, but a “more relevant and sensible version of the quantity theory of money,” which he applied to the explanation of the business cycle and the definition of cures that were quite similar to the ones later suggested by Keynes and the Keynesians (Friedman [1974] 2003). Second, according to Friedman, Viner’s analysis of the failure of the Treasury and the Fed to prevent and stop the depression anticipated many details of his and Anna Schwartz’s criticisms.

What in the field of interpretation and policy, did Keynes have to offer those of us who learned economics at a Chicago that was filled with these views? Can anyone who knows my work read Viner’s comments and not see the direct links between them and Anna Schwartz’s and my Monetary History (1963) or between them and the empirical Studies on the Quantity Theory of Money (1956)? Indeed … I have myself been amazed to discover how precisely it [Viner (1932) 1951] foreshadows the main thesis of our Monetary History for the depression period. (Friedman [1974] 2003, 156)

These remarks would suffice to place Viner very high in the pantheon of the early Chicago school and in the origins of its monetary tradition as well. Yet this close link between Viner and the Chicagoans of his time, as well as between Viner and the postwar Chicagoans, has been denied by such interpreters as Rotwein and Patinkin and seems to call for some further reflection.

Third, Viner’s position seems to be crucial for his close academic and scientific ties to that “Harvard tradition” that Laidler and Sandilands ([2002] 2003) regard as so important at the onset of the Chicago tradition itself. Viner had been trained at Harvard from 1914 to 1919 under Frank Taussig’s supervision. His PhD dissertation was a detailed examination of the mechanism of monetary adjustment in the balance of payments under the international gold standard (Viner 1924). Many of Viner’s monetary views had their roots in his Harvard years, and later he maintained contacts with his former department, lecturing at Harvard almost every year. In November 1932, during one of these lectures, he met Lauchlin Currie, who was at the time assistant to his friend John H. Williams, also a former student of Taussig’s. Viner invited Currie to publish two articles on monetary and banking issues in the Journal of Political Economy (Currie 1933b, 1934a); in 1934 Viner was engaged by the secretary of the treasury, Henry Morgenthau Jr., as his special assistant and invited Currie to join him in the Treasury’s “Freshman Brain Trust”: the group of young and brilliant economists gathered by Viner was counted on to provide a wide set of preliminary studies and proposals in the monetary and fiscal field. Aside from Currie, other top-notch students came from Harvard: Albert G. Hart, Alan Sweezy, and Harry D. White. Martin Krost, one of Currie’s students, was brought in shortly thereafter (Nerozzi 2007).

While the relationships between Viner, Chicago, and Harvard will be the focus of our last section, in the next two sections we will examine the relevance of Viner’s monetary analysis and policy proposals during the 1930s.

2. The Quantity Theory of Money and Viner’s Analysis of the Great Depression

Viner’s analysis of the Great Depression is not a novel subject for historians. Viner was one of the first American economists to advocate strong government intervention in order to stop the depression. In August 1931 he explained at Williamstown what the problem with the American economy was: aggregate demand had been dramatically shrinking in the last few years; prices had fallen below production costs, wiping out profit margins and causing losses. Production and employment had been drastically reduced.

At a first approximation the fall in aggregate demand was due to a reduction of the money stock of the country. The quantity of money was a simple focus for understanding what was going on. As Viner (1931, 185) put it,

The price level tends to fall with respect to the level in other countries, according to [this] formula:
P = GV +NV + DV
           TV [sic]

Where P is the price level, G the monetary stock of gold, N the amount of paper money in circulation, D the bank deposits, T the physical volume of transactions, and V the velocity of circulation.

What were the reasons for the decline in the money stock and aggregate demand? The depression was spreading around the world and no country appeared to be in a safe position. Balances of payments were disrupted almost everywhere, and after the sterling devaluation of September 1931, many countries were struggling against capital outflows and loss of international reserves. One after the other, they abandoned the gold standard and adopted policies of quantitative restrictions, exchange controls, and flexible exchange rates.

At the Harris Foundation Conference in January 1932, Viner provided an ample and thorough analysis of the crisis. Monetary factors had by no means exclusive responsibility, but they certainly played a major role both on a national and international scale.

The gold standard was committed for trial. Jacob Viner, who had long been a major student of its functioning and had tirelessly battled against the detractors of the Hume mechanism, on this occasion defended only mildly the gold exchange standard and warned against any policy that could carry the United States out of it. If the postwar gold exchange standard could be charged for its inability to produce international equilibrium and price stability, the reason was not in its institutional differences with the prewar gold standard. Contrary to what was generally believed, even the “classical” gold standard did not provide, in itself, price stability and automatic adjustment of balance of payments. According to Viner the old gold standard was in fact a “managed” standard, with central banks, above all the Bank of England, actively engaged with a host of monetary measures in order to avoid excessive loss or accumulation of reserves and meet foreign gold claims without impairing internal credit conditions (Viner [1932] 1951, 126–29). The main differences between the two regimes were more in “degree rather than in kind” (127): the failure of the latter to attain international monetary stability after the war was due to such factors as the lack of cooperation between central banks, the low responsiveness of balance of payments to changes in prices (mostly due to wage rigidities and high tariffs), the growing instability of the political environment, the heavy load of international indebtedness caused by the war and by the unwise peace settlements, and the destabilizing nature of a huge amount of international capital flows (132–33). All these factors played their part in producing a sharp contraction of international trade and investments: the resort to growing trade barriers and bilateral agreements, the banking crisis and suspensions of debt repayments, and the fall in the prices of internationally traded commodities (due to the attempt of debtor countries to boost their exports) severely affected monetary and economic conditions all over the world (131–33).

Yet this host of international factors did not provide a complete explanation for what had happened in the United States, where gold reserves were abundant and industrial production had grown steadily during the 1920s. Viner ([1932] 1951, 130–31; 1933b, 129–31) did not hesitate to put most of the blame for the crisis upon the improvident policy enacted by the Fed.

The Chicago economist pointed out the Fed’s inability to formulate a consistent policy aimed at stabilizing business conditions at home and abroad.

Except under Governor Strong, the Federal Reserve Board has avoided having a definite policy; it has acted in a purely opportunist manner … Abroad central bankers and economists are unanimous in the view that the Federal Reserve System has missed important opportunities. (Viner 1931, 189)

[The] Federal Reserve Board has revealed to the outsider no greater capacity to formulate a consistent policy, unless a program of drift, punctuated at intervals by homeopathic doses of belated inflation or deflation and rationalized by declaration of impotence, can be accepted as the proper constituents of central bank policy. (Viner [1932] 1951, 134)

It was not only a problem of personal capacities. As later pointed out by Friedman and Schwartz, Viner stated that its weak and decentralized institutional structure prevented the Fed from acting effectively as a central bank, especially on an international scale.

Our central banking organization is overcomplex, too decentralized, and too much subject to regional pressure to act quickly and decisively in the international sphere. Moreover … while the New York Federal Bank has made more effort than any other central bank institution to develop a program and a technique of credit control with a view to stabilization, it has at critical moments found itself at cross-purposes with, and inhibited from action by, a Federal Reserve Board with an attitude towards its functions resembling with almost miraculous closeness that of the Bank of England during its worst period. (Viner [1932] 1951, 134)

During the 1920s the Fed managed to sterilize much of the gold inflows, preventing the price level from increasing and the interest rates from falling according to the “rules of the game.” By insulating their economy from price increases, the United States impaired the mechanism of international adjustment and put growing pressure on the balance of payments of other countries that experienced massive reserve losses and deflation. Due to the high interest rates and to the high demand for credit generated by the stock market expansion, capital flows continued to accrue to the American commercial banks, boosting further speculation (Viner [1932] 1951, 131). When in 1927–29 the Fed tried to curb speculation by restricting credit availability, its action deprived “legitimate” business of credit facilities and reduced the money in bank and cash circulation, provoking a general downturn in economic activity. It was the onset of the depression.

Many Englishmen feel that the attempt of the Federal Reserve Board from 1927 to 1929 to check the growth of bank credit which was supporting security speculation in the United States was an unfavorable factor for England. It was impossible to distinguish between credit expansion for legitimate business purposes and expansion for speculation. The large demand for both types raised the money rate in the United States, and this drew money from England to this country and checked American foreign investments. (Viner 1931, 187–88)

The Fed’s awkward policy was also due to the prevailing theoretical framework by which it designed its policies. Viner particularly blamed the persistent influence of the so-called commercial loan theory on the Fed and its ominous consequences in the managing of the banking system.

The school which holds that if commercial banks limited their portfolios to short-term commercial paper, credit booms and crises could not occur and the volume of bank credit would always be proportioned to the “needs of business” … is nursing ancient fallacies. In a banking system whose portfolio consisted only of “sound” short-term commercial paper there still would be ample scope for drastic cyclical fluctuation: in the velocity of use of bank deposits; in the monetary volume of commercial discounts resulting from fluctuations in the price level and in the number of hands through which commodities passed before reaching the consumer; in the ratio of commercial transactions financed by recourse to the banks to the total volume of commercial transactions; and in the total physical volume of business. (Viner 1936b, 117)

In the early 1930s, Viner’s criticisms of the Fed actions and of the commercial loan theory of banking anticipated the main lines of later reconstructions made by Friedman and Schwartz (1963). Viner did not enjoy the ample gathering of statistical data that grounded the work of the latter. Yet he had at his disposal, at least since 1931, Carl Snyder’s statistical works on money and credit conditions in the United States8 and, later, those of Lauchlin Currie (1933a, 1934a, 1934b).

Speaking in February 1933 Viner (1933a, 21–22) stated clearly, probably on the basis of Currie’s data, the following:

It is often said that the federal government and the Federal reserve system have practiced inflation during this depression and that no beneficial effects resulted from it … On the contrary, the government and Federal reserve bank operations have not nearly sufficed to countervail the contraction of credit on the part of the member banks and nonmember banks. There has been no net inflation of bank credit since the end of 1929. There has been instead a fairly continuous and unprecedented great contraction of credit during the entire period.

Anyway it was clear to him that a host of factors, national as well as international, but all essentially grounded on errors of monetary, financial, and commercial policy, had provoked a dramatic and sudden decline in aggregate demand.

Whatever the reasons for the fall in the stock of means of payment, there would have been no ground for a steep fall in production and employment, if the economy was flexible enough to adjust its costs and prices at a level consistent with equilibrium. Yet wage stickiness and widespread monopoly positions, encouraged by tariff protection and other government policies, had deprived the economy of any possibility of a quick and spontaneous recovery. The classical mechanism envisioned by Ricardo and Say as a rationale against general overproduction did not smoothly work anymore and a way out should be looked for.

I think the most serviceable definition of a depression from the point of view of the possibility of control is a state of affairs in which a large portion of the productive factors of a country are remaining idle, because it does not pay business men to employ them or because business men think it does not pay them. You can only change this situation by deliberate action, by re-establishing an actual or prospective profit margin, either by helping to lower costs or by raising prices. (Viner 1933b, 120–21)

Only a resurrection of profit margins could foster an upsurge in employment and production. This could be attained either by means of a balanced deflation of costs or by a deliberate inflation of prices. While, according to Viner, the former was more desirable but likely to be slow and painful, the latter could be carried out more easily by the government, especially as long as its operations were coordinated with other advanced countries. In the following years he devoted his efforts to supporting and even designing a host of policy measures able to accomplish an upsurge in prices.

3. Viner’s Policy Proposals from the Great Depression to the New Deal

Writing to his friend Bertil Ohlin in January 1932, Viner complained about his recent record as a professional writer and formulated a schedule that proved to be overly optimistic:

The depression here has involved me in all sorts of committee work and memoranda writing, as well as in more lecturing than I care to do. I’m beginning now to write a book on international trade theory and I hope to have it finished before next Christmas.

While his Studies in the Theory of International Trade had to wait until 1937 to get ready for publication, his involvement in policy proposals and advising was to grow steadily in the following years and became, at least from 1933 to 1935, his main employment as an economist (Nerozzi 2007). This deep involvement in active policy advocacy is testified by a good deal of published speeches, by the joint messages and reports he signed or helped write, and by letters and memoranda he composed while he was working as economic adviser for the Treasury. Without entering into details of his activity, we wish to describe the main policy proposals he put forward (and those that he opposed) during the Great Depression and the early New Deal.

As we noted above, the main cure against the depression was, according to Viner, a policy of deliberate inflation designed to promote an upsurge of prices over costs and restart investment and production. Since the summer of 1931, Viner had clearly supported a bold campaign of open market purchases designed to enhance banks’ liquid reserves and induce them to extend their credit facilities. The method preferred by Viner (1931, 189) was

to begin market operations on a considerable scale, buying up securities and thus increasing the amount of cash in the banking system by a corresponding amount. The effect of this would be to increase the cash reserve ratios of member banks and thus drive them to find uses through new loans for their funds.

In modern terms we could say that Viner was supporting an increase in the monetary base in order to expand the money supply. There was not at the time a clear theoretical distinction between money and credit, and Viner, although aware of their difference, used to underline important interconnections between them. Thanks to the banking multiplier, an expansion of bank reserves would have brought about a more than proportional increase in the quantity of loans, which in turn would have become, for the most part, demand deposits added to the national stock of means of payments.

Member banks never keep idle funds. They can’t afford to. If the Federal Reserve Banks were to buy a billion dollars of commercial paper and bonds, these billion dollars would flow as cash reserves into the member banks, and these banks would be forced to find some employment for them. They would force them to look more favorably upon applications for credit and [give them] the liberty to take risks from which they now shrink.

Yet Viner was aware that an effective expansion of bank credit could be hindered by the existing standard of eligible paper for banking rediscount and reserve accounting. According to Viner, the concept of “eligible paper” as collateral for bank loans was to be replaced with the broader one of “sound assets,” comprehending a wide range of assets and even government bonds. As long as government bonds were regarded as “eligible paper,” the increase in government indebtedness would have been a powerful support to the expansion of bank credit. Even the credit operations undertaken by the government by means of the Reconstruction Finance Corporation could boost inflation and provide sound assets in which the banks could invest their liquidity.

These measures were strongly pressed on the public and on the Hoover administration by the famous telegram signed by twenty-four of the economists participating in the Harris Foundation Conference of January 1932, at which Viner played an important role.

In 1931–32 Viner was still convinced that a monetary expansion by means of open market operations could be achieved without impairing the adherence of the United States to the gold standard. That is the first reason why he opposed any measure designed to enhance directly the circulating medium by money creation. A deliberate greenback issue among the public would have been a straightforward application of the quantity theory. Yet Viner opposed it, since he believed that it would have immediately provoked massive capital outflows and gold losses.

The scheme, therefore, should be either one of credit expansion through governmental assistance and stimulations plus maintenance of the Gold Standard, or greenback and departure from the Gold Standard. I believe it would be much more possible to get action on the former plan than on the latter, and in any case I believe the former plan is more desirable … I believe that, from the point of view of tactics, there is a great deal to be said for choosing mild ways of formulating strong programs. If action is to be obtained at all, it must be with the consent, either cheerful or not, of important financial and industrial interests.

International cooperation in the financial, monetary, and commercial fields, exchange stability (if not fixity under the gold standard), and “balanced deflation” could be considered the permanent factors of his antidepression policies. Monetary policy should be the engine with which to actively boost recovery.

In the summer of 1932 the Fed began a program of open market operations, injecting liquidity into the system and lowering interest rates. The amount of assets purchased by the Fed was not large enough and failed to get the banks out of debt:18 banks used the newly acquired liquidity to strengthen their balance sheets and reduce indebtedness toward the Federal Reserve, but did not expand credit to the economic system. Prices, employment, and production continued to fall and reached their bottom. At the same time massive capital outflows and cash withdrawals started up and new chains of failures shocked the banking system. In March 1933, Roosevelt took office and declared a week of bank closures together with a host of other emergency measures, among which was the temporary suspension of gold payments. Viner’s hopes had been disappointed: the open market purchases had produced no significant effects and the United States was now off the gold standard.

Yet, once off the gold standard, one of the main arguments against outright measures of monetary expansion had been eliminated and the United States could follow other countries in taking advantage of the acquired freedom (Viner 1933a). Many monetary schemes were designed to produce an upsurge of prices: devaluation in the gold content of the dollar, depreciation in the foreign exchange market, monetization of the public debt, bonus to World War I veterans, coinage of silver, unemployment relief, and so on. Yet Viner refused to subscribe to any of these schemes and finally, when at the Treasury, actively opposed their adoption on the part of the government: he favored instead a stabilization of exchange rates and fiscal expansion as measures to foster recovery (Nerozzi 2007).

At the same time banks’ behavior was the object of widespread criticism: their responsiveness to Fed operations designed to enhance credit availability had proven very weak. The autonomous variations in the “banking multiplier,” which connected banking reserves and credit supply, made open market operations an ineffective measure to control the quantity of money. Several reform proposals were advanced along the lines of a sharp division between credit and money creation, the requirement of a 100% reserve against demand deposits and bank notes, and the establishment of a statutory fixed rule in the creation of money in order to maintain price stability. In 1933 a detailed plan of this type was elaborated by Henry Simons and supported by a group of Chicago economists (Simons et al. [1933] 1994): it precipitated a heated debate in the political arena and was later developed by Irving Fisher, gaining international standing as the “Fisher Plan” (Phillips 1995; Allen 1993). Yet Viner was neither involved in the elaboration of the “Chicago Plan” nor willing to sign it. Once at the Treasury, he asked Lauchlin Currie to develop the main lines of a 100% reserve plan, but never proposed it as a realistic solution to the problems of the banking system (Currie [1934] 1968). He finally supported the banking bill elaborated by Currie under Governor Eccles, which strengthened and rationalized the Fed’s powers along more conservative lines, without reducing the freedom of commercial banks, divorcing credit from money, or fixing any monetary rule (Viner 1936a)

Viner’s policy activity in 1933–36 may cast a shadow on his record as a quantity theorist. How can we explain his opposition to measures of monetary expansion and banking reform that were sponsored by his Chicago colleagues? It has been argued that his opposition to the 100% plan was grounded on political considerations;19 personal bias against Henry Simons may also have played a role.

Whatever the reasons, after the failure of open market operations in 1932, Viner came to support fiscal policy as the effective way to recovery. According to Davis (1971, 39–46) and Steindl (1995, 83–85), Viner regarded budget deficits as an alternative means to expand the money supply. This might remove any doubt about his adherence to the Chicago monetary tradition. Yet some insight into the evolution of his monetary framework may be useful in addressing this question.

4. Viner’s Monetary Rationale for Fiscal Policy

During the depression Viner showed some uneasiness about the most appropriate measures to fight the depression and appeared to change frequently his opinions, especially after the disappointing outcome of the 1932 open market operations. The main problem he was trying to address was the role of psychological factors in determining the results of any policy.

According to Viner, business confidence was the most important factor in restarting the economic system: as long as firms did not expect any increase in the prices of their final goods, or were threatened by exchange rate instability, heavy taxation, or any other government measure designed to restrict their freedom and prospective gains, they would not have increased investments, production, and employment. Any policy measure undertaken to produce an upsurge in prices or relieve unemployment would have been ineffective or even damaging as long as the public, the financial markets, and firms perceived it as a danger to their future business prospects.

In monetary terms this lack of confidence brought about a lowering of the velocity of money, that is, hoarding. Like most of his Chicago colleagues, Viner regarded money velocity as by far the most sensitive, volatile, and unpredictable factor in the functioning of the monetary system. The first enemy of recovery was not the scarcity of money, but the low level of its velocity. Aggregate demand depended upon

the rate at which potential purchasing power flows into the hands of income receivers and … the rate at which income receivers make use of their available purchasing power.

Yet Viner did not look satisfied with the quantity theory, at least in its most rudimental version. Since 1931 he had been refining his ideas concerning the flow of purchasing power into the economic system and focused on the dynamic factors and the cumulative processes that underlay the disequilibrium between costs and prices.

The central characteristic of a depression is a more rapid rate of decline in the use of spendable funds than in commodity prices. The decline … is directly due to two factors: a contraction in the amount of spendable funds in existence, and the immobilization or non use of such funds as still exist, which manifests itself objectively in a decline in their velocity of circulation. The primary cause for this contraction and immobilization of funds is to be found in the normal response of business men to a declining excess, and still more to a deficit, of prices as compared to costs. (Viner 1933a, 7)

Viner expounded this framework for the first time in his discussion of the effects of international money inflows on aggregate demand. The relevant factor was not velocity itself but the “final purchases velocity of money,” that is, the rate of use of money and demand deposits in the purchases of commodities and services (Viner 1937, 367). Money could be used to buy and sell houses, stocks, or other assets without exerting any influence on prices, production, and employment.

His approach departed somewhat from the quantity theory and got closer to the income-expenditure approach. In defining the final purchases velocity of money, Viner was eager to examine the link between money and aggregate demand and distanced his final purchases velocity from other definitions of velocity that he regarded less useful in this respect. Contemporary monetary debate was providing a host of different concepts of velocity, and that of Viner was neither the oldest nor the most influential. Since the early 1920s William Foster and Waddill Catchings had made use of the circuit velocity of money (Patinkin [1973] 2003, 332)26 as the rationale for a proper public intervention designed to accelerate the flow of purchasing power and maintain price and employment stability. Similar views were held by Young and Currie: according to them, aggregate demand depended upon variations in the amount of purchasing power, as well as the income or circuit velocity of money, which was related to new money put in circulation by the banks or the government.

Even though a clear definition of the final purchases velocity found its way to the press only in 1937, archival evidence dates it back to 1931, when Viner was trying to explain to some of his correspondents the conditions under which an expansion of the money supply could boost recovery. The major issue was how to measure the extent to which the newly created or the existing funds were used to purchase goods and services. In this concern Viner clearly distinguished that

the difference between current use of purchasing power in any unit of time and increment to available purchasing power during the same unit of time would roughly correspond, I believe, to what Keynes calls savings, but I would rather call additions to (or subtractions from) idle purchasing power … The fluctuations in amounts of available purchasing power should be roughly indicated by such series as bank and saving deposits, total pay-roll figures and production data, converted, of course, to index bases. The trend of use of purchasing power, on the other hand, would be roughly indicated by data as department store, chain store and other retail sales within the district and by debits to individual accounts in banks, although the latter would include what I would call “transfer items” resulting from the purchase and sale of securities and real estate, and not involving directly or indirectly purchase of currently produced goods and services.

The use of this terminology can be traced to Viner’s speeches concerning the opportunity of a bold program of public works and expenditures in order to revive the national economy. Since 1931 Viner had pointed out that fiscal policy was an effective means to smooth out business fluctuations.

The government may give employment to idle capital and labor by borrowing money for wise government expenditures. In so far as the capital and labor would otherwise be idle, from a national as distinguished from a Treasury accounting, the value of the basic raw materials consumed is almost the sole cost to be charged against them … The public works or other useful government services so financed during a period of economic depression are from the national economic point of view almost costless and their stimulating influence on business psychology and on the rest of the national economy may bring about even an additional business activity on the part of the private individuals. (Viner 1931, 183)

Yet, while in 1931 Viner saw open market operations as the most effective and safest measure to stimulate demand, in 1933, after the failure of credit expansion and the departure from the gold standard, Viner thought that government expansion had to gain a prominent role. Once at the Treasury, Viner actively pressed for the realization of statistical studies concerning the impact of overall public expenditures and receipts on the national income. Yet Currie was the man who, once at the Treasury in the summer of 1934 and with the help of Martin Krost, another Harvard student, began to collect statistical series on the impact of the different categories of revenues and expenditures on the circular flow of purchasing power. The quantitative series collected by Currie and Krost were later to underpin Currie’s analysis of the 1937 recession and his recommendations for a bold program of public expenditures in 1938 (Sandilands 2004, 179).

In 1938 Viner opposed the Roosevelt administration’s program of fiscal expansion. In his 1953 recollections (see Viner [1953] 2008), he claimed to have played an important role in that concern, providing Secretary Morgenthau with a set of critical arguments that were unfruitfully presented to the president. The problem, according to Viner, was not deficit spending itself: he criticized instead the ill-designed and improvised character of the spending. He was convinced that such expenditures would have an overly negative influence on private investments, especially as long as they were not coupled with other measures able to foster business confidence and reduce the conflict between business and the government, which New Deal policies had enhanced.

Morgenthau with a set of critical arguments that were unfruitfully presented to the president. The problem, according to Viner, was not deficit spending itself: he criticized instead the ill-designed and improvised character of the spending. He was convinced that such expenditures would have an overly negative influence on private investments, especially as long as they were not coupled with other measures able to foster business confidence and reduce the conflict between business and the government, which New Deal policies had enhanced.

The most promising method, I think, is that of governmental expenditures financed by borrowing from the banking system, with the hope that what the banks lend is newly created credit or credit which otherwise would have remained idle and not funds that would otherwise have been used by private business. There will not be recovery through the method of inflation unless there is an expansion in the use of means of payment. That expansion will not take place except through the mediation of banks in granting new loans or making new investments, or of individuals in making more rapid use of their existing funds in purchases for consumption or investment …

The government itself cannot achieve inflation … The [American] government can give a stimulus, encourage it, can take a moderate share in it, but the major part must be done by the general public, and it will take the form, as already pointed out, of a speeding up in the rate at which business men use such cash resources as they still have, and the rate at which they ask and induce banks to create new funds for them. Until the business men are using funds more rapidly for materials, payrolls, construction, and so on, concrete recovery will not be definitely on the way. When this rapid use of funds does come, recovery will be definitely under way. (Viner 1933b, 133–34)

Viner’s main idea was that the country did not need any addition to the quantity of money, but first of all needed to boost the use of available money in the purchases of consumption or investment goods. Government expenditures were not only the best means to put money in circulation, bypassing the banking system; government expenditures put money directly at work, accelerating what Viner defined as the final purchases velocity of money. The endogenous money supply would have provided the credit and money facilities needed to support the recovery insofar as private business boosted its own expenses.

Conversely, an injection of money in the banks’ vaults or in the hands of individuals could be ineffective and dangerous at the same time. While, in the short term, banks and people were likely to add the new money to their hoarding (especially if the money was put in the hands of entrepreneurs or members of the high and middle classes), in the longer term a revival in business psychology could generate a new acceleration of velocity and, given the increased quantity of money, it would have been very difficult to keep inflation under control. Deficit financing by means of bank credit instead of money creation was a safer way to generate inflation, since, for the most part, it mobilized the existing idle funds rather than augmenting their quantity.

In modern terms we could say that government expenditures were not to Viner a means of increasing M in MV = PY, but instead of augmenting G in Y = G + I + C, with the accompanying induced effect on M and V. Even though he regarded the main economic effects of government expenditures as depending on business psychology rather than on mechanical devices of any sort, Viner was well aware of the multiplying effect of government expenditures on private incomes: the resumption of expenditures for consumption and investments on the individuals’ part was the ultimate goal of his antidepression fiscal policies.

5. Conclusions

Our analysis of Viner’s monetary theory and policy proposals allows us to state more clearly his position in the so-called Chicago monetary tradition. As long as Tavlas’ remarks are taken as valid, Viner’s views fi t well with at least the first four points he highlights as typical of “Chicagoans.”

First of all, we have seen that Viner used the quantity theory of money as a general framework to describe the variations in the price level and regarded velocity as the most unstable factor in the equation of exchanges. Yet, Viner’s record as a quantity theorist needs some qualification: as the depression worsened (at a time when theoretical developments were under way) the Chicago economist came to focus on the flow of purchasing power rather than on its stock. Moreover, he regarded not simply transaction velocity, but the final purchases velocity of money as the relevant factor in determining aggregate demand and hence prices, output, and employment.

As for the second point, business confidence and price expectations, we have seen that Viner was aware of the importance of psychological factors in generating and enhancing booms and depressions: price expectations (and rigid costs) determined decisions of firms in terms of investments, inventories, output, and employment.

Third, Viner laid down a thorough and detailed analysis, supported by statistical data, of the effects exerted by the discretional use of reserves on the part of commercial banks: at least since the summer of 1932 their piling up of cash reserves and idle funds had been at the center of Viner’s concerns for the deflationary forces that were under way. The perverse behavior of the banking multiplier and the procyclical changes in the reserve-deposit ratio on the part of the banks, as well as deposit-cash ratios on the part of the public, had a strong bearing on the crisis.

As for the fourth point, anticyclical budget balancing, Viner’s position does not need to be further qualified, since he is widely credited with having been one of the first to expose the rationale for such a policy, laying down a specific Chicago tradition on this point.

Thus we can get to the last and most problematic points, the efficacy of monetary expansion in counteracting any fall in the velocity of money and fiscal policy as an alternative means to expand the money supply.

Documentary evidence, both published and unpublished, shows that Viner firmly opposed any monetary measure other than credit expansion under government auspices: the main reason for this attitude was that he regarded the quantity of money (demand deposits and circulating medium) as a flexible magnitude determined by business confidence and banking behavior. Any outright expansion in the stock of money might be more than counteracted by the contraction in the use of spendable funds on the part of firms, banks, and individuals. In other terms, Viner envisioned a sort of infinitely elastic demand for money that might impair any effort to raise prices and production by means of an expansion in the means of payments.

Fiscal policy was by no means exempt from these shortcomings: even government expenditures may be counteracted by a fall in private expenditures, especially as long as budget deficits worsened business confidence with the prospects of higher taxation and more limited financial facilities. Yet government expenditures enjoyed an important advantage: by using money in the purchases of goods and services they primed the final purchases velocity of money, exerting their benefits directly on aggregate demand, prices, and production.

Yet, aside from Tavlas’ treatment, other points deserve to be highlighted in Viner’s analyses and policy proposals. They, in fact, represent quite relevant differences if compared with the views held by distinguished members of the so-called early Chicago school. To the 100% reserve plan Viner preferred the milder reform enacted by the 1935 Banking Act, designed by Currie under Eccles; contrary to Fisher’s and Simons’ proposals, he opposed the imposition of any fixed monetary or price rule on Fed actions and preferred a discretional management according to a set of objectives that were wider than price stability.

Our description of Viner’s analysis and policy proposals allows us to highlight another point. As noted above, Viner’s first steps as a public servant revealed his preferences toward economists coming from the Harvard economics department. The only Chicago affiliate called to join the Treasury in 1934 was Albert G. Hart, who, actually, was also a Harvard graduate. An analysis of Viner’s actions and ideas can show that this “crowding in” of Harvard economists cannot be regarded as a mere coincidence. A comparison between Viner’s views and those held by Currie reveals important similarities.

First of all, both of them harshly criticized the Fed for its failure to understand business and monetary conditions before the depression, for its responsibility in the shrinking of the monetary market at a critical time, and for its weak and misguided antidepression policies thereafter. Viner and Currie provided these views independently of one another, at least until their first meeting in November 1932, or perhaps with some indirect influence exerted by the “Harvard memorandum” at the Harris Foundation Conference in January 1932.

Second, both Viner and Currie had long been trained to test “economic theory” with empirical verification and they relied extensively on statistical data for their monetary analysis and policy proposals. Not the same could be said for the Chicago Department of Economics, where Knight, Mints, and Simons maintained a strong bias against quantitative economics.

Third, they both came to disregard monetary policy as the proper means of fighting the depression and to prefer government expenditures as a pump priming on business conditions.

Finally, they both made use of a quite similar concept of money velocity, which focused on the flow of purchasing power in boosting aggregate demand for final commodities and services, and applied this peculiar monetary framework (rather than the quantity theory itself) as a rationale for fiscal policy.

As long as Friedman was right in claiming Viner’s merits on his own monetary training, he implicitly, though probably unconsciously, deserved this tribute to more than one school of monetary thought.