Forget about big hair, Ray-Bans, and Donkey Kong. Don't even think about Live-Aid, Thriller, and E.T. Above all else, the 1980s were the gravy days of the money supply aggregates.
Beginning in late 1979, the Fed built its policy approach around the aggregates—primarily M1 but occasionally M2, and policymakers also monitored M3 while experimenting with M1B and, later, MZM. But those were just the “official” figures. Economists and pundits debated the Fed's preferred measures while concocting their own home-brewed variations.
Notably, the Fed allowed interest rates to fluctuate as much as necessary to achieve its money growth targets. Fluctuate they did—rates soared and dipped wildly as a direct result of the Fed's policy. The world, meanwhile, watched the action as attentively as a Yorkie watches breakfast, studying every wiggle in every M. Missing one wiggle could have meant the difference between exploiting the volatility that the Fed unleashed or being sunk by that same volatility.
And to make sense of it all, the world looked to the most famous economist of his day, Milton Friedman. By converting a large swath of his profession to his strict brand of Monetarism, Friedman more than anyone else had triggered the monetary frenzy.
But then, almost as quickly as the frenzy blew in, it blew right back out. With none of the Ms living up to their billings as economic indicators, the Monetarists drifted from view. Not in five minutes but in five years, give or take a couple, their period of fame was over. Friedman's reputation as an economics savant fell particularly hard—his highly publicized forecasts proved inaccurate in each year from 1983 to 1986. And the Fed once again redesigned its approach, first deemphasizing and eventually dropping its money growth targets.
But maybe the Monetarists came closer to explaining the economy than their critics allowed?
Maybe the best indicator—I'll call it “MDuh”—was somehow hidden in plain sight?
Those are the arguments I'll make in this article, and I'll back each one with up-to-date data. I'll propose a way of thinking that's considered common sense in some circles even as it's blasphemous within the mainstream core of the economics profession. And I'll explain why MDuh was the true lesson of Friedman's research.
Before we get to MDuh, though, there are two things you should know about Friedman and his co-researcher Anna Schwartz (if you didn't already know them). First, they relied on data, not theory, when they shaped their version of Monetarism. They found a strong historical correlation between money growth and economic activity, and they also found that money growth predicts activity. They published those results in a groundbreaking 1963 book, A Monetary History of the United States, 1867–1960.
