Table of Contents
Title Page
Copyright Page
Black’s Business Cycle Theory
The Crash, Then and Now
Appendix: Origin of Chapters of Black (1987)
Chapter 1 - Banking and Interest Rates in a World Without Money
A World Without Money
Evolution of the Means of Payment
Evolution of Central Bank Control
Monopoly Banking
The Myth of Aggregate Demand
The Quantity Theory of Money
The Liquidity Preference Theory
Chapter 2 - Active and Passive Monetary Policy in a Neoclassical Model
Growth Models
Active and Passive Monetary Policy
Passive Monetary Policy and the Price Level
Banking and Inside Money
Policy Implications
Chapter 3 - Rational Economic Behavior and the Balance of Payments
International General Equilibrium Without Money
The Balance of Trade
General Equilibrium with Money
Floating Exchange Rates
Fixed Exchange Rates Through Taxation
Fixed Exchange Rates Through Intervention
Taxation and Intervention Combined
Intervention with Zero Reserves
Summary and Conclusions
Chapter 4 - Uniqueness of the Price Level in Monetary Growth Models with ...
The Basic Model
Adaptive Monetary Policy
Future Rates of Inflation and Money Demand
Adaptive Expectations
Chapter 5 - Purchasing Power Parity in an Equilibrium Model
Chapter 6 - Ups and Downs in Human Capital and Business
Capital and Labor
The Sources of Uncertainty
The Great Depression
Chapter 7 - How Passive Monetary Policy Might Work
Free Exchange of Reserves and Securities
Free Borrowing of Reserves
The Right Targets
Indirect Methods
Free Exchange of Reserves and Deposits
Chapter 8 - What a Non-Monetarist Thinks
What the Government Can’t Do
What the Government Can Do
What Does Move the Money Stock?
Some Reasons for Thinking This Way
The Currency Trap
Chapter 9 - Global Monetarism in a World of National Currencies
A Simple Model
Home Countries and Target Countries
International Reserves
Chapter 10 - The ABCs of Business Cycles
What are Business Cycles?
What Causes Business Cycles?
What Caused the Great Depression?
Can We Stop the Business Cycle?
Can We Stimulate Growth?
Can We Predict Business Cycle Movements?
Chapter 11 - A Gold Standard with Double Feedback and Near Zero Reserves
Chapter 12 - The Trouble with Econometric Models
Supply and Demand
Glossary: The Language of Econometrics
Chapter 13 - General Equilibrium and Business Cycles
A Multisector Model
A Durable Goods Model
Choice among Technologies
Other Matters
Chapter 14 - Noise


Fischer Black (1938-1995) is best known for his fundamental contributions to finance, most famously the Black-Scholes option pricing formula that bears his name. He also aspired to contribute to macroeconomics. Indeed, he viewed his contributions to macroeconomics as more important than his contributions to finance, because they were potentially more consequential for general social welfare.This book records the development of his thinking in that field from 1968, when he wrote the first draft of the paper that he includes as the first chapter, to 1986, when he revised his presidential address to the American Finance Association to produce the paper that he includes as the last chapter. In between, the papers are organized chronologically, rather than thematically, more or less in the order in which Black brought them to fruition (see the Appendix at the end of the Foreword). He added some few notes, but otherwise there were no retrospective additions or omissions.
In Black’s own professional life, the temporal span of this book took him from his first job at the management consultancy firm Arthur D. Little, Inc., to what would be his last job at the investment banking firm Goldman, Sachs & Co. In between, he spent 13 years in academia, first at the University of Chicago’s Graduate School of Business (1971-1975), then at MIT’s Sloan School of Management (1975-1984). This professional trajectory suggests that we can read the present book as the record of a nonacademic outsider’s attempt to insert a new idea into the insiders’ debate then raging between the Keynesians (at MIT) and the monetarists (at Chicago).
The outsider’s idea is present in the very first chapter. Fischer Black invites us to imagine a world without money and to think about how such a world might work, then holds up that picture against both the existing financial system and against existing economic theories about how that system works. For Black, this comparison suggests that there are powerful forces at work tending to move us away from the existing system in the direction of a world without money. That tendency, once we recognize it, can be expected to produce a similar tendency in the world of ideas, a tendency to move beyond our existing understanding—based on the quantity theory of money (embraced by monetarists) and its revision into the liquidity preference theory of money (embraced by Keynesians)—in the direction of something new.
In this first chapter, Black’s methodological focus is not yet on equilibrium, not even financial market equilibrium. We can see the influence of Treynor’s capital asset pricing model (CAPM) in the argument that “a principal reason for introducing borrowing and lending is for the transfer of risk” (p. 12), but the price of risk plays no role and the focus is instead on the rate of interest. Even more, Black’s world without money is largely a world of banking institutions, not of financial markets. He imagines a world in which essentially all fixed-income securities, government and corporate bonds alike, are replaced by bank lending and funded by bank deposits of one kind or another. It is recognizably the CAPM world of equity and short-term debt, but the debt part involves “indirect finance” not “direct finance” (to use the phraseology of Gurley and Shaw in their 1960 Money in a Theory of Finance).
Black says that “equilibrium was the concept that attracted me to finance and economics” (p. xxi). In the first chapter, we can see what he means. Conceptualizing banks as financial intermediaries that hold loans to business and government as assets, and deposits from households as liabilities, Black was led naturally to conceptualize the larger economy as a set of interlocking balance sheets. One person’s asset is another person’s liability. Balance-sheet thinking of this sort is a kind of natural general equilibrium (or macroeconomic) thinking. Add to this thinking the simple idea of profit-seeking and competition between intermediaries, and you have the abstract equilibrium concept with which Fischer Black started his intellectual journey. For him, equilibrium is not at all a position of rest, much less the endpoint of a process of dynamic adjustment. It is, as he says, only a position in which “there are no opportunities to make abnormal profits.”
One consequence of his balance-sheet starting point was an instinctual antipathy for the quantity theory of money, in both its domestic and international incarnations (Milton Friedman and Harry Johnson, respectively). “Those who believe in the quantity theory are forced to argue in terms of a world with commodity money or a world where the government hands out massive amounts of currency or bonds, and then transfer their conclusions to an entirely different kind of world” (p. 20). Currency, in Black’s world, is not paper gold (outside money), but rather a bank deposit (inside money), not the exogenous imposition of government policy, but rather the endogenous outcome of private profit maximization. As such, the law of reflux applies—the supply of money adjusts to the demand for money. “When a bank creates a deposit larger than the individual wants to hold, he can always use it to pay off some of his loan” (p. 16). “If a bank issues money to make a loan to one person, and that money is more than the public wants to hold at equilibrium interest rates, then it will simply be used to pay off another loan, at the same bank or at another bank” (p. 38). In this way, any incipient excess supply of money has no chance to affect the price level (or the rate of interest), since it is immediately cancelled.
Because of his antipathy toward the quantity theory, Black recognized that monetarists would resist his ideas, but he seems to have thought that Keynesians would be more sympathetic. Thus, we see him positioning his ideas in explicit opposition to Friedman and Johnson, but as an extension of the work of Keynesian economists such as Vickrey, Tobin, Gurley and Shaw, and Patinkin (pp. 2-4). Indeed, it was to the Keynesians that he first offered these ideas, on March 12, 1970, in Franco Modigliani’s Monetary Theory Seminar at MIT. His first formal academic presentation was a success, but Modigliani was not convinced.
As leader of the research team that had recently produced the monetary sector of the Federal Reserve’s econometric model of the United States, Franco Modigliani was a central figure of Keynesian monetary economics. By contrast to Milton Friedman, he urged an activist countercyclical monetary policy, but his opposition to Friedman’s monetarism did not extend to the quantity theory of money more generally. Rather, following in the footsteps of the so-called American Keynes, Irving Fisher, Modigliani accepted the quantity theory of money as a theory of the long run, and understood short-run business fluctuations as disequilibrium deviations from the long-run equilibrium path.
From this perspective, we can understand Black’s second chapter as an attempt to engage economists like Modigliani on their own turf. Instead of trying to tempt the reader with his own vision of a world without money, in this second paper he is trying to demonstrate that the reader’s own vision of a world with money simply does not make logical sense. He does this by taking the Solow growth model as a widely accepted model of long-run equilibrium, and then showing how attempts to bring money into the picture as an active force controlled by policymakers lead inevitably to logical contradiction. (Chapter 4 plays a similar game with a paper of Sargent and Wallace.) The only way these models make sense, he argues, is if policymakers passively supply whatever quantity of money is demanded by households (thus reproducing in the public money supply exactly the behavior that Black expects from private banks in his world without money). Apparently, Black viewed this second paper as foundational for everything else in his subsequent engagement with the academic economists, as evidenced by his frequent references to it (p. 60, 61, 79, 151, 165, 187).Why?
As a student of the mathematical logician W. V. O. Quine, Black considered the demonstration of logical error to be sufficient for rejection of a theory. This Quine influence is also likely the source of Black’s otherwise puzzling argument that “the quantity of money can have no effect on output, employment, or prices, because the quantity of money does not exist” (p. 10). See also his puzzling idea that logical contradiction qualifies as “evidence that a government cannot control its country’s money stock” (p. 60). “A plausible theory is one that does not imply consistent, easy to exploit profit opportunities” (p. 142). Equilibrium modeling is, for Black, fundamentally a test of the logical consistency of the posited axioms. Inconsistency means that some axiom must be replaced; Black’s suggestion is to replace the axiom of active monetary policy with the axiom of passive monetary policy.
The Keynesians, not being followers of Quine, were no more convinced by the second paper than they were by the first. They understood quite well that their theories were disequilibrium theories, in the sense that they were theories of an economy away from full equilibrium, although possibly adjusting slowly in the direction of equilibrium. Indeed, their whole rationale for government policy intervention was to help the economy to move more quickly toward equilibrium. Whatever “consistent, easy to exploit profit opportunities” might seem to exist in the theories, the observable fact of business fluctuations must mean that people do not in fact exploit them, which means that there is a role for government policy. The whole purpose of economic theory, and of the elaborate econometric modeling built on top of that theory, is to provide a scientific guide for policy intervention.
The economists’ point of view is not obviously nonsensical. One historical origin of this view is Irving Fisher, who saw business fluctuations as deviations from equilibrium caused typically by monetary disturbances, the “dance of the dollar” (Fisher 1923). Arguing in quantity theory terms, Irving Fisher urged government control of the money supply as a way of controlling business fluctuations. Modern Keynesians (such as Modigliani) understood themselves as merely going one better than Irving Fisher, by using control of government spending as an additional policy instrument, and one possibly better suited for addressing fluctuations that are not monetary in origin. Modern monetarists (such as Friedman) disagreed with Keynesians not about the disequilibrium character of fluctuations, but rather only about the efficacy of activist countercyclical policy (both monetary and fiscal) as a remedy. The debate between the monetarists and the Keynesians was, from this point of view, an intramural debate following agreed ground rules.
Black disagreed with the economists’ ground rules, but nonetheless he tried hard to follow them in order to enter the debate, at least at first. Economists seemed all to agree that, in the long run, the economy could be described as being in equilibrium. Taking advantage of this, Black thought he might be able to bracket the whole fraught issue of disequilibrium by presenting his monetary theory as a theory of the long run, and by demonstrating how the quantity theory of money made no sense even in that context. That is what he is trying to do in Chapter 2 (as well as Chapters 4 and 9).1 For this project, however, he found himself almost entirely alone, since essentially all economists, Keynesians and monetarists alike, were monetarists when it came to the long run. Black says, “There’s only one other person I know of who takes a position almost as strong as mine” (p. 99).2
Black did not mind being alone. Notably, his business-cycle theory says that economic fluctuations are caused when large numbers of people make the same error because they base their reasoning on the same erroneous information. “If that information is wrong, it will be wrong in the same direction for everyone. (Except that a few people may have ignored the information or may have assumed that it was wrong.)” (p. 89). Black thought of himself as one of those few people. The dismal economic performance of the 1970s, performance that inspired the neologism stagflation to describe the combination of economic stagnation with simultaneous inflation, was the material consequence of correlated error. In the world of ideas, the consequence was crisis in economic orthodoxy.The New Classical and then Real Business Cycle project to reconstruct macroeconomics on an equilibrium basis was very much in line with Black’s own predilections. Having resolved the matter of monetary theory to his own satisfaction, even if no one else’s, he moved on to the more important matter of building a nonmonetary equilibrium theory of business fluctuation.

Black’s Business Cycle Theory

In the present book, the development of Black’s business-cycle theory can be followed in Chapters 6, 10, and 13. However, the underlying idea, that business cycles might be understood as an equilibrium, emerges much earlier in Black’s own thinking. More or less from the beginning, he seems to have had the idea to extend Treynor’s CAPM by conceiving of the assets in the model not as financial assets but as real assets, which moreover arise endogenously because someone chooses to make a real investment. Black’s first sketch of a general equilibrium CAPM, published in 1972 as “Equilibrium in the Creation of Investment Goods Under Uncertainty,” was essentially complete already in September 1969 as Financial Note No. 8. There is a continuous thread that runs from this initial paper to “The ABCs of Business Cycles” (Chapter 10) and “General Equilibrium and Business Cycles” (Chapter 13), and indeed even beyond to his final book Exploring General Equilibrium (1995).
The standard financial CAPM starts from the idea that there is an exogenously given supply of various different securities, and proceeds to work out a theory of market-clearing security prices given the risk preferences of wealth holders (Treynor 1962, Sharpe 1964, Lintner 1965). In equilibrium, everyone holds the market portfolio and adjusts risk exposure by borrowing or lending at the riskfree rate. In equilibrium, the expected return on any given risky asset depends on its riskiness, which is measured by the covariance of its return with the market as a whole. More risk means higher expected return, but not necessarily higher actual return since returns fluctuate around their expected value.
Fischer Black saw in this simple CAPM the seed of a possible model of economic growth and fluctuation. Business fluctuation could be thought of as nothing more than the fluctuating return on our economy’s underlying real stock of capital. If our capital investments are risky, then we can expect greater fluctuation, but the reward will be a higher expected return (and higher economic growth to the extent that the higher return is reinvested). If we don’t like the fluctuations, the solution is not government intervention using monetary and fiscal policy, but rather a downward adjustment of the risk (and the associated expected return) embodied in our capital stock.
The CAPM analogy doesn’t work all that well—it requires that we have instantaneous production and a single consumption good—but at least it is an equilibrium model, so we can safely start there and work on building in more reality. That is what Black is doing in the business-cycle chapters in this book. Ultimately, his business-cycle theory relies centrally on the presence of a large number of economic sectors, each producing a distinct good using specialized inputs that must be put in place some time before the good itself is produced.This time-lag feature of production forces everyone to forecast the future state of demand in detail, and errors are inevitable because the world is changing. When errors are few, we have a boom; when errors are many and correlated, we have a recession. Recessions are thus a matter of mismatch between the structure of production and the structure of demand, and the way out of recession is adjustment of the structure of production.That means moving people and resources from one sector to another, which takes time and involves some period of unemployment.
This way of thinking seems to capture many, but not all, of the features of the fluctuations we observe. To make the model more realistic, Black adds successively the idea that some goods are durable, and the idea that production is a team effort; what he does not add is any market failure or monetary disturbance. The general equilibrium model, properly understood, is consistent with almost everything we see; that is the central organizing principle of Black’s entire opus.
In this respect, one way of understanding Black’s work is as an attempt to extend the work of Irving Fisher to the case of uncertainty. Like Irving Fisher in his 1907 The Rate of Interest, Black built his first general equilibrium model as the simultaneous solution to the household’s problem of “Individual Investment and Consumption under Uncertainty” (Black 1969), and the firm’s problem of “Corporate Investment Decisions” (Treynor and Black 1967). Also like Irving Fisher, Fischer Black went on to build a theory of money and business cycles on these general equilibrium foundations.
Even more, Black seems to have taken his underlying vision of the economy from Fisher. In Fisher’s treatise on accounting, The Nature of Capital and Income (1906), he presents a picture of the economy as a stock of wealth moving through time, throwing off a flow of services as its goes. In his formulation all wealth is capital, not just machines and buildings, but also land and even human beings. Indeed, for Fisher, human beings are the most important form of capital because the most versatile. Thus, at the highest level of abstraction, there is no distinction between the traditional categories of labor, capital, and land. All produce a stream of income (services) so all are capital, and their income discounted back to the present is their capital value. Similarly, at the highest level of abstraction, there is no distinction between the traditional categories of wages, profit, and rent. All are incomes thrown off by capital, hence all are forms of the more general category of interest, which is the rate at which income flows from wealth.
All this is in Black from the very beginning and throughout his career. The significant state variable in all his macroeconomic work is the value of wealth, understood to include both physical and human capital. Further, human capital is quantitatively the more important (as Chapter 6), although measurement problems often prevent us from seeing this clearly in economic data. As in Fisher, Black’s emphasis is on the market value of wealth calculated as the expected present value of future income flows, rather than on the quantity of wealth calculated as the historical accumulation of saving minus depreciation.This allows Black to treat knowledge and technology as forms of capital, since their expected effects are included when we measure capital at market value.
Fischer Black extended Irving Fisher to the case of uncertainty, but in so doing he arrived at some rather different conclusions. It was on precisely those points of divergence that he met resistance, since most economists remained attached to Irving Fisher’s original conclusions. First, money. In his 1911 The Purchasing Power of Money, Irving Fisher revived the quantity theory of money, in part to provide the theory of the price level that was missing from his version of general equilibrium. Economics followed this lead, but Fischer Black did not, on the grounds that the quantity theory was inconsistent with equilibrium as he understood it.
Second, business cycles. Irving Fisher analyzed business cycles as disequilibrium phenomena caused by monetary instability (1911, Chapter 4). In his theory, nominal interest rates adjust only slowly to changes in the rate of inflation and the resulting changes in the real rate of interest cause real disequilibrium fluctuations. Monetary stabilization that brings price level stabilization can therefore help to stabilize business cycles. Again, economics followed this lead, but Fischer Black did not. By adding in uncertainty, he could explain fluctuations in economic activity using the same equilibrium approach that financial economists were already using to explain fluctuations in asset prices.
This departure from the crowd meant that Black’s work was mostly not publishable in academic journals at the time it was written. Only Chapters 2 and 4 managed to find their way in; all the rest were publishable only in practitioner’s journals, or by private circulation. Even, or perhaps especially, Chapter 13, “General Equilibrium and Business Cycles,” in which Black puts forth his business cycle theory, was rejected outright by the American Economic Review, and so found its first public audience only in the present book. And, truth told, the present book itself was probably publishable only because of Black’s standing as president of the American Finance Association. Such is the fate of outsiders, no matter how long they spend inside.
Probably, Black himself had high hopes for the book. Although his business-cycle theory had been unpublishable in 1982, the publication of papers by Kydland and Prescott (1982) and Long and Plosser (1983) showed that at least some academic journals were willing to entertain the idea of a nonmonetary equilibrium business-cycle theory. (Both papers are cited in Chapter 13 as unpublished memoranda.) Black thus had good reason to think that his own work might be appreciated as a forerunner of the Real Business Cycle approach,3 maybe even as an indication of where that literature would eventually have to go. Black’s care to express his ideas in regular language, rather than formal mathematical models, might also have won for him a larger audience than the papers that found more favor with the academic journals.
It didn’t happen. The Real Business Cycle approach did flourish, but in directions that Black found ultimately disappointing—too much mathematical and statistical technique for their own sake, and not enough engagement with the important facts in the material world. Nevertheless, he did not give up, and his second book Exploring General Equilibrium (1995) is an attempt to engage with the burgeoning academic literature. Readers will want to consult that book in order to find out what happened next.

The Crash, Then and Now

One test of a theory is whether it helps to explain what is happening in the world around us. From this point of view, which is very much Black’s own point of view, the original publication date of this book was singularly inauspicious. On October 19, 1987, the U.S. stock market experienced its largest ever percentage loss. This would have been the news ringing in people’s heads as they considered whether to engage with a book titled Business Cycles and Equilibrium. For anyone whose conception of equilibrium involved stability, the apparent volatility of the market appeared as prima facie evidence against any equilibrium theory. For Black himself, however, the 1987 crash was merely a recalcitrant data point that challenged him to think hard, and so he did in “An Equilibrium Model of the Crash” (1988).
Black’s story about the 1987 crash was that taste for risk increased as the stock market rose—in part because of portfolio insurance?—but investors did not fully appreciate the consequences of that taste change, so their beliefs about the world came to embody more and more error as prices rose higher and higher. The crash came when investors realized their error and corrected their beliefs, thus correcting also the price overshoot. Technical and psychological factors—Black says “We might call this element ‘liquidity’”—came into play also as the crash itself produced trading bottlenecks and fear that drove prices even lower, temporarily.
Black’s conception of equilibrium in 1988 was apparently much more capacious than it was in 1968, when he started out. Perhaps the most startling addition to his intellectual arsenal is the willingness to consider “liquidity” as an independent cause of price. This addition was long in coming, but Chapter 14, “Noise,” clearly demonstrates that it was in his mind well before the crash. In that chapter, the concept of liquidity is fundamentally microeconomic, and arises from the need to introduce “noise traders” to explain why there is any trade at all. “The whole structure of financial markets depends on relatively liquid markets in the shares of individual firms” (p. 172). In his analysis of the 1987 crash, however, he extended the concept to the market as a whole. Still he resisted what for many economists would be the next logical step, namely to argue that there is a role for central bank intervention to ensure market liquidity so that markets do not overshoot on the way down. “This led to a decline in the equilibrium level of the market that was greater than the decline a model would have figured—unless it accounted for the psychological factor” (1988, p. 274).
What about the crisis that is under way at this very moment? Clearly, Black’s vision of a world without money has largely come true, but his prescience was even greater than that. In an unpublished memo, titled “Fundamentals of Liquidity” (June 1970), Black imagined additional dimensions of a future possible financial world:
Thus a long term corporate bond could actually be sold to three separate persons. One would supply the money for the bond; one would bear the interest rate risk; and one would bear the risk of default. The last two would not have to put up any capital for the bonds, although they might have to post some sort of collateral.
The instruments Black is suggesting are what we know today as interest rate derivatives and credit derivatives and, more specifically, interest rate swaps and credit default swaps. A central dimension of Black’s contribution at Goldman, Sachs & Co. was his development of models for pricing interest rate derivatives, but he died before the credit default swap became a standard instrument. Perhaps as much as $60 trillion in notional CDS exposure had been written by the peak of the boom that has now been collapsing ever since August 2007. What would Black have said about that?
It is possible to imagine an account of the present crisis analogous to Black’s account of the 1987 crash. For the present case, the changing taste for risk might most plausibly be located in the market for credit risk—in part because of credit default swaps?—but investors did not fully appreciate the consequences of that taste change, so their beliefs about the world came to embody more and more error as credit spreads grew tighter and tighter. As in 1987, eventually beliefs caught up to reality and the consequence was a price correction. As in 1987, liquidity factors kicked in to push prices even farther. As in 1987, domestic price movements stimulated similar price movements worldwide.
Because the present crisis involves debt markets rather than equity markets, there is an additional dimension that Black would likely have pointed out. In his very first paper, he notes the possible importance of guarantees on personal notes (pp. 12-13); these guarantees are credit default swaps. However, he also imagines that the providers of those guarantees will supervise the borrower, and that the government might require providers of guarantees to hold capital to ensure payment. In the case of American International Group (AIG), neither of these things happened, and the capital that has ensured payment to AIG counterparties has come from the government after the fact.
The present crisis has also affected currency markets, including a breakdown of private forward exchange markets.4 Here as elsewhere, liquidity effects have very clearly been present, and central banks have taken it to be their job to use their own balance sheets to make up for the vanishing liquidity in markets generally. Notoriously, the Fed’s balance sheet has already more than doubled in size. Was that the right thing to do? We cannot know for sure what Fischer Black would have said, but it would be consistent with his 1988 position to argue that central banks should have allowed the market to price the extreme scarcity of liquidity, rather than stepping in to impose an artificially low price.
Finally, the financial crisis is clearly spilling over into the economy as a whole. All major economies are in recession at the same time, and talk at the recent G20 meeting was all about using fiscal stimulus to substitute for falling aggregate demand. Black’s view, of course, would be that the recession, global as it is, is an index of the extent of mismatch between the structure of production and the structure of demand. The only way out is to reorganize production by moving resources in order to bring the structure of production more into line. That is something that must happen in each country individually, but also at the global level, so it seems likely to take some time. The danger is that fiscal stimulus delays adjustment and so prolongs the recession.
That is not, however, to say that the government should do nothing. Most important, Black would have called our attention to the possibility of a currency trap, which was his explanation of the Great Depression (p. 89-90, 105, 124-25, 162). Nominal interest rates are now practically zero, but prices are falling, and that means that real interest rates are still positive. The zero lower bound on nominal interest rates is a problem, and not one easily solved by quantitative easing because (according to Black) the money supply has very little to do with the price level.
Facing such a dilemma, I wonder whether Black might have reconsidered his antipathy for measures that expand government provision of liquidity to take the place of vanishing private provision. That is not to suggest that he would have approved of the attempts by the Fed to impose an artificially low price for liquidity. Rather, the problem with the Fed’s efforts so far is the excessively single-minded focus on liquidity in money markets, rather than in credit markets where the problem originated and where trade has more or less completely broken down.
One thing is for sure. Fischer Black would not have been surprised that standard monetary and fiscal policy measures have so far had so little impact on the crisis. “Monetary and exchange rate policies accomplish almost nothing, and fiscal policies are unimportant in causing or changing business cycles” (p. xxviii).Then, as now, economic crisis is also crisis for economic theory, and that is potentially a good thing. Crisis by crisis, knowledge advances.

Appendix: Origin of Chapters of Black (1987)

1. “Banking and Interest Rates in a World without Money: The Effects of Uncontrolled Banking.” Financial Note No. 7 (Sept 5, 1968), revision published as Black (1970).
2. “Active and Passive Monetary Policy in a Neoclassical Model.” Financial Note No. 17 (December 1, 1970), revision published as Black (1972).
3. “Rational Economic Behavior and the Balance of Payments.” Financial Note No. 26 (1972), unpublished.
4. “Uniqueness of the Price Level in Monetary Growth Models with Rational Expectations.” Financial Note No. 27 (1972), revision published as Black (1974).
5. “Purchasing Power Parity in an Equilibrium Model.” Unpublished mimeo (April 1974).
6. “Ups and Downs in Human Capital and Business.” Fischer Black on Markets No. 4 (March 29, 1976).
7. “How Passive Monetary Policy Might Work.”Fischer Black on Markets No. 7 (May 10, 1976).
8. “What a Non-Monetarist Thinks.” Fischer Black on Markets No. 8 (May 24, 1976).
9. “Global Monetarism in a World of National Currencies.” Unpublished mimeo (September 1976), published as Black (1978).
10. “The ABCs of Business Cycles.” Published as Black (1981).
11. “A Gold Standard with Double Feedback and Near Zero Reserves.”
Unpublished mimeo (December 1981).
12. “The Trouble with Econometric Models.” Mimeo (April 1974), revision published as Black (1982).
13. “General Equilibrium and Business Cycles.” Mimeo (April 1978), revised as NBER WP No. 950 (August 1982).
14. “Noise.” Speech (December 30, 1985), revision published as Black (1986).


1 Chapter 9 is about the international version of the quantity theory. Fischer presents his own alternative theory of international money in Chapters 3 and 5. Initially, he is a supporter of flexible exchange rates, because he imagines that forward markets will provide sufficient hedging facility for international trade. Experience with flexible exchange rates, however, seems to have made him more sympathetic toward a fixed exchange rate system, as Chapter 11.
2 I asked him once who that person was, and he told me that probably he had been thinking of Arthur Laffer.
3 Jeremy Siegel, reviewing the book for the Journal of Finance (June 1988), said exactly that.
4 Baba, N., F. Packer, and T. Nagano 2008: The spillover of money market turbulence to FX swap and cross-currency swap markets, BIS Quarterly Review, March, pp. 73-86.


Black, Fischer 1969: Individual investment and consumption under uncertainty. Financial Note No. 6. Revised version published as pp. 207-225 in Portfolio Insurance, A Guide to Dynamic Hedging, edited by Donald L. Luskin. New York: John Wiley and Sons, 1988.
Black, Fischer 1969: Equilibrium in the creation of investment goods under uncertainty. Financial Note No. 8. Revised version published as pp. 249-265 in Studies in the Theory of Capital Markets, edited by Michael C. Jensen. New York: Praeger, 1972.
Black, Fischer 1970: Banking and interest rates in a world without money: The Effects of Uncontrolled Banking. Journal of Bank Research 1 (Autumn): 8-20.
Black, Fischer 1972: Active and passive monetary policy in a neoclassical model. Journal of Finance 27 (September): 801-814.
Black, Fischer 1974: Uniqueness of the price level in monetary growth models with rational expectations. Journal of Economic Theory 7 (January): 53-65.
Black, Fischer 1978: Global monetarism in a world of national currencies. Columbia Journal of World Business 51 (Spring): 27-32.
Black, Fischer 1981: The ABCs of business cycles. Financial Analysts Journal 37 (No. 6, November/December): 75-80.
Black, Fischer 1982: The trouble with econometric models. Financial Analysts Journal 38 (No. 2, March/April): 29-37.
Black, Fischer 1986: Noise. Journal of Finance 41 (No. 3, July): 529-543.
Black, Fischer 1988: An equilibrium model of the crash. pp. 269-275 in NBER Macroeconomic Annual, edited by Stanley Fischer. Cambridge, MA: MIT Press.
Black, Fischer 1995: Exploring General Equilibrium. Cambridge, MA: MIT Press.
Fisher, Irving 1906: The Nature of Capital and Income. New York : Macmillan.
Fisher, Irving 1907: The Rate of Interest, Its Nature, Determination and Relation to Economic Phenomena. New York : Macmillan.
Fisher, Irving 1911: The Purchasing Power of Money. New York : Macmillan.
Fisher, Irving 1923: The business cycle largely a ‘dance of the dollar’. American Statistical Association Quarterly 18 No. 144 (December): 1024-26.
Kydland, Finn E. and Prescott, Edward 1982: Time to build and aggregate fluctuations. Econometrica 50 No. 6 (November): 1345-1370.
Lintner, John 1965: The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economics and Statistics 47 No. 1 (February): 13-37.
Long, John B., Jr., and Plosser, Charles I. 1983: Real business cycles. Journal of Political Economy 91 No. 1 (February): 39-69.
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Since the late 1960s I have been working on theories that depend on the idea that economic and financial markets are in continual equilibrium. Equilibrium means there are no opportunities to make abnormal profits; more generally, it means that there are no easy ways for people to shift positions in a way that makes everyone better off.
Equilibrium was the concept that attracted me to finance and economics. I have never had a course in either subject. While working at Arthur D. Little in 1966, I met Jack Treynor, who began telling me about an equilibrium theory he was working on called the capital asset pricing model. I was hooked.
I began doing research in finance, and later in economics. I started doing consulting in finance. I was especially interested in applying the idea of continual equilibrium to all kinds of markets. I found it stimulating to combine consulting and research: most of the key concepts in my work were developed at this time, before I went to the University of Chicago to start my academic career.
The capital asset pricing model was first applied to stocks, but I wanted to apply it to other securities, like options and bonds. In trying to apply it to options, Myron Scholes and I found an option pricing formula. In trying to apply it to bonds, I developed the notion that monetary policy is and must be passive in an economy with well-developed financial markets.
This research on monetary policy and banking led to my first published paper, which begins this volume. I continued looking for a model that would allow markets to be in continual equilibrium while leaving a way for the government to control the money stock, but I was never able to find one. I decided that monetary policy can influence neither output nor prices.
At first I felt that the government could not influence interest rates through open market operations, but I changed that view over time. I became convinced that it takes time for people to respond to certain events even when markets are in continual equilibrium.This allows the government to force the federal funds rate above or below its natural level while the government is intervening actively in debt markets, but only if it forces other interest rates in the opposite direction. I still believe that the government has no control over “the” interest rate through monetary policy.
This work on monetary theory led me into research on business cycles. If monetary policy does not influence the economy, what does? I decided that business cycles are a natural result of uncertainty in a general equilibrium model. I see no need to assume sticky prices or easily corrected ignorance or government-influenced aggregate demand to explain business cycles.
At first I put some emphasis on rational expectations in my theories. Later I decided I didn’t need that assumption. My key assumption now is simply that markets are in continual equilibrium. Some people may be confused, and others may have odd-looking objectives, but so long as prices and quantities are free to move, we are in a general equilibrium world.
While I don’t believe the government can do much with open market operations, I do think it has some influence on the economy through taxes and regulations. Changes in taxes and regulations may even play a small role in business cycles.Taxes can also be used to affect the balance of trade with other countries, though I don’t think the balance of trade affects our welfare in any particular way.
Though I think monetary policy is ineffective in a country with well-developed financial markets, I believe that when the government in a country with more primitive markets prints money and spends it, the inflation rate will rise. Hyperinflation will be a common result.
I’m not sure we should say that it’s monetary policy that causes the hyperinflation. A government that prints money and spends it is usually creating massive deficits at the same time. Perhaps we should say that fiscal policy causes the hyperinflation. In any case, a government that prints massive amounts of money to spend will usually cause both hyperinflation and a general breakdown in financial markets.
My research on monetary theory and business cycles led to work on the balance of payments and the world business cycle. I was unable to find any interesting definition of the balance of payments other than the net flow of gold out of a country, and even that has no obvious impact on the country’s welfare.