Fourteen graduate students took the prelim exam for the field of money, banking and monetary policy during the summer quarter at the University of Chicago in 1956. These examination questions were found in Milton Friedman’s papers at the Hoover Institution Archives along with the points awarded for each question along with the final grade recommendation by Friedman and the examination committee.
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MONEY, BANKING AND MONETARY POLICY
Preliminary Examination
Summer Quarter, 1956
Write your number and not your name on your examination paper.
Answer all questions. Time: 4 hours. [120 points total]
- (a) What is the Keynesian “investment multiplier” in its simplest form? How can it be computed from the consumption function? [5 points]
(b) Keynes assumed that the consumption function is expressed in wage units and that the average propensity to consume is greater than the marginal propensity. He further assumed as a first approximation that an increase in income is fully reflected in real income with prices stable up to “full employment” and in prices with real income stable, thereafter. What, if any, is the effect of the shift from below full employment to full employment on the numerical value of the “multiplier”? Explain in terms of the properties assigned to the consumption function by Keynes. [15 points]
- (a) Compare very briefly the essential parts of the a “fiscal operation” and a “monetary operation,” as they are usually described in the literature, and the way in which they affect prices and employment. Then discuss what the following statement might mean. Is it a meaningful comparison? If not, why not? If so, in what way? “Fiscal policy is more effective than monetary policy.” [10 points]
(b) Suppose the Treasury engaged in a fiscal operation by running a budget deficit and paid for it by selling bonds to the public. Suppose further the Federal Reserve simultaneously engaged in a monetary operation by selling the public an amount of bonds equal to the deficit. What is likely to be the net effect of these two operations on prices in the short run? In the long run? Explain. What questions of fact did you need to consider in arriving at your answer? [10 points]
- “What, by the way of comparison, is likely to be the monetary mechanism of a price-wage spiral? When wages are increased, the immediate finance may be provided either by drawing on firms’ balances which would otherwise have been idle in the short period in question, or by increased borrowing from the banks.” – A. J. Brown
Discuss, paying special attention to the relation implied between an increase in wages and the willingness of firms to hold smaller cash balances or engage in larger borrowing.
(a) Discuss both the case of a wage increase in a particular sector and for “all” labor. [5 points]
(b) Do the two cases differ?
(c) Does “wages” as used in the second sentence of the quotation refer to “wage rates” or “wage payments”? Does it matter? [5 points]
(d) If so, why? If not, why not? [5 points] - (a) Sketch the development of the quantity theory of money. [7 points]
(b) Compared the Cambridge and the Fisherine versions of this theory. [6 points]
(c) What are the differences and similarities in the formulation of the demand for money between the Cambridge version of the quantity theory and the liquidity-preference function used by Keynes in his General Theory? What are the assumptions underlying these two formulations? What seems to you the most useful formulation of the demand for money? [7 points]
- “Inasmuch as the total quantity of purchasing media is expected to increase more or less in parallel with the production of gold and goods, the importance of a given amount of inflationary purchasing media will depend on its relation to the non-inflationary purchasing media in use… The commercial banks are able to [create inflationary purchasing media by acquiring investments in securities and noncommercial loans greater in dollar value than the total of their time deposits and capital], because the banks can create the purchasing media (demand deposits) with which they buy such assets. The inflationary purchasing media thus created are initially in the form of credits (bookkeeping additions) to the accounts of depositors…As these inflationary purchasing media are spent by the original recipients, the funds flow into the channels of trade and are indistinguishable from other demand deposits and currency that represent gold and goods being offered in the Nation’s markets. Thus great additions to the purchasing media used to buy goods can occur without corresponding increases in the goods available in the market; hence the upward pressure on prices and related developments of an inflationary boom.” – American Institute for Economic Research, Current Economic Trends, (June, 1955), p. 7.(a) What is meant by “inflationary purchasing media” in this quotation? [7 points]
(b) How does their creation allegedly produce “an inflationary boom?” [6 points]
(c) Evaluate the reasoning implied in the last sentence [7 points].
- “There cannot, in short, be intrinsically a more insignificant thing, in the economy of society, then money; except in the character of a contrivance for sparing time and labor. It is machine for doing quickly and commodiously, what would be done without it; and like many other kinds of machinery, it exerts a distinct and independent influence of its own when it gets out of order.” – John Stuart Mill, Principles of Political Economy, Ashley addition, p. 488.
(a) Formulate your conception of money that is in order [5 points],
(b) sketch the monetary experience of one or more countries [5 points],
(c) indicate clearly when you think money was “out of order,” [5 points] and
(d) explain the results [5 points].
From Friedman’s handwritten table we find the following distribution of points by question as well as the final grade awarded for the preliminary examination (failure, MA candidacy, PhD candidacy). The committee final grades awarded are designated in boldface. Friedman judged four exams to be borderline cases.
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1. | 2. | 3. | 4. | 5. | 6. | Total | Final Grade | |||||||||
| ID no. | (a) | (b) | (a) | (b) | (a) | (b) | (c) | (a) | (b) | (c) | (a) | (b) | (c) | (d) |
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||
|
1 |
4 | 0 | 7 | 4 | 5 | 2 | 4 | 7 | 6 | 4 | 6 | 4 | 3 | 2 | 1 | 59 | PhD |
| 2 | 5 | 8 | 4 | 3 | 7 | 4 | 3 | 5 | 1 | 3 | 1 | 3 | 3 | 5 | 1 | 56 |
PhD |
|
3 |
4 | 12 | 5 | 6 | 6 | 2 | 5 | 5 | 5 | 3 | 3 | 5 | 4 | 3 | 1 | 69 | PhD |
| 5 | 5 | 0 | 7 | 6 | 13 | 3 | 4 | 7 | 0 | 4 | 3 | 4 | 3 | 3 | 1 | 63 |
PhD |
|
6 |
4 | 3 | 4 | 5 | 3 | 3 | 3 | 2 | 0 | 2 | 0 | 3 | 4 | 2 | 2 | 40 | MA/F |
| 7 | 5 | 8 | 7 | 4 | 10 | 3 | 6 | 6 | 3 | 1 | 4 | 3 | 5 | 5 | 3 | 71 |
PhD |
|
8 |
3 | 0 | 3 | 0 | 7 | 2 | 1 | 3 | 2 | 0 | 0 | 3 | 5 | 2 | 0 | 31 | F |
| 10 | 4 | 2 | 5 | 4 | 8 | 3 | 3 | 6 | 5 | 3 | 5 | 3 | 2 | 2 | 1 | 56 |
PhD |
|
11 |
5 | 5 | 5 | 2 | 0 | 0 | 3 | 5 | 0 | 0 | 0 | — | — | — | — | 25 | F |
| 12 | 5 | 7 | 4 | 6 | 3 | 2 | 3 | 3 | 0 | 3 | 1 | 2 | 1 | 2 | 0 | 42 |
MA/F |
|
13 |
4 | 3 | 6 | 6 | 5 | 4 | 3 | 4 | 1 | 1 | 1 | 3 | 3 | 2 | 0 | 46 | MA |
| 14 | 5 | 4 | 5 | 4 | 2 | 3 | 3 | 4 | 0 | 3 | 1 | 1 | 3 | 1 | 0 | 39 |
MA/F |
|
15 |
4 | 5 | 3 | 2 | 5 | 2 | 1 | 3 | 5 | 2 | 4 | 3 | 5 | 4 | 2 | 50 | MA/PhD |
| 16 | 5 | 6 | 9 | 4 | 10 | 4 | 4 | 6 | 5 | 3 | 4 | 4 | 5 | 3 | 0 | 72 |
PhD |
Source: Hoover Institution Archives. Papers of Milton Friedman. Box 76, Folder 10.
Image Source: University of Chicago Photographic Archive, apf1-06231, Special Collections Research Center, University of Chicago Library