Hendry told Ericsson that:
The graph in Friedman and Schwartz … made UK velocity look constant over their century of data. I initially questioned your plot of UK velocity–using Friedman and Schwartz’s own annual data–because your graph showed considerable nonconstancy in velocity. We discovered that the discrepancy between the two graphs arose mainly because Friedman and Schwartz plotted velocity allowing for a range of 1 to 10, whereas UK velocity itself only varied between 1 and 2.4.Hendry went on:
Testing Friedman and Schwartz’s equations revealed a considerable lack of congruence. Friedman and Schwartz phase-averaged their annual data in an attempt to remove the business cycle, but phase averaging still left highly autocorrelated, non-stationary processes.As Hendry puts it in the interview:
Margaret Thatcher – the Prime Minister – had instituted a regime of monetary control, as she believed that money caused inflation, precisely the view put forward by Friedman and Schwartz. From this perspective, a credible monetary tightening would rapidly reduce inflation because expectations were rational. In fact, inflation fell slowly, whereas unemployment leapt to levels not seen since the 1930s. The Treasury and Civil Service Committee on Monetary Policy (which I had advised in … had found no evidence that monetary expansion was the cause of the post-oil-crisis inflation. If anything, inflation caused money, whereas money was almost an epiphenomenon. The structure of the British banking system made the Bank of England a “lender of the first resort,” and so the Bank could only control the quantity of money by varying interest rates.In the book by J.D. Hammond (1996) Theory and Measurement: Causality Issues in Milton Friedman ‘Monetary History, published by Cambridge University Press (page 199) you see the letter that Hendry wrote to Friedman on July 13, 1984. In part it said:
… if your assertion is true that newspapers have produced ‘a spate of libellous and slanderous’ articles ‘impugning Anna Schwartz’s and … [your] … honesty and integrity’ then you must have ready recourse to a legal solution.Friedman never sued!
As Hendry notes in the interview:
One of the criticisms of Friedman and Schwartz was that is was “unacceptable for Friedman and Schwartz to use their data-based dummy variable for 1921—1955 and still claim parameter constancy of their money-demand equation. Rather, that dummy variable actually implied nonconstancy because the regression results were substantively different in its absence. That nonconstancy undermined Friedman and Schwartz’s policy conclusions.Friedman and Schwartz (FS) have claimed (page 624) that their UK money demand model was constant (that is, stable in its estimated parameters):
… more sophisticated analysis … reveals the existence of a stable demand function for money covering the whole of the period we examine.
As HE showed – it was certainly a fudge in the FSs models. They wrote that FSs models were not constant once the evidence was properly considered and that the:
… inferences which Friedman and Schwartz draw from their regression would be invalid … [due to biases]They also report a range of problems with the FS models.
In conclusion they say:
Taking this evidence together … [the FS preferred model] … is not an adequate characterization of the data and is not consistent with the hypothesis of a constant money-demand equation … none of the relevant hypotheses could have been tested by Friedman and Schwartz … without their having obtained a rejection …Excerpts from here http://bilbo.economicoutlook.net/blog/?p=20281
For those unfamiliar with the notion of money velocity, here's Asher Edelman (aka Gordon Gekko) explaining it in under a minute.