Interviewer: Instructional Dynamics Incorporated, welcomes you to this weekly series of commentaries on the current economic scene. Reporting to you will be one of the nation's leading economists, professor Milton Friedman of the University of Chicago. Dr. Friedman before we begin the formal part of the discussion, I'd like to refer you to a item in the New York Times this morning which describes your debate with professor Walter Heller, in New York University yesterday. I was wondering if we could begin by having you explain what was that all about. 

Milton: Well, I'd be glad to that was quite a nice debate, we had a good audience, an overflow, a group accommodated in closed circuit TV. It's an annual event, NYU has a, so called Salomon lectures. and as I was saying, and Mr Salomon who, although he spells his name S-A-L, I was making a, kind of a joke about the fact that NYU decided this year to follow King Solomon's advice and divide the baby into two parts. And have two talks instead of one, namely Walter Heller talking on the question of whether his monetary policy being oversold, and myself, talking on the question is fiscal policy being oversold. Needless to say, Walter Heller's position was that on the one hand, monetary policy is being oversold in the sense that the, I and people who follow the general view I do, have stressed the enormous importance of changes in the quantity of money as oppose to fiscal changes. And in Walter Heller's view we've carried that to far. In his view my position, and the position of others like me, that we should have a steady rated growth in the money supply, seems to him like locking the steering wheel of a car driving along a road. You know, whenever people resort to metaphors it always seems to me there's something wrong with their arguments. But at any rate, that was his position and he defended it, and presented it very well, and stressed of course, from his point of view what he regarded as the enormous roll which the tax cut of 1964 had played in promoting the rapid expansion in the economy subsequently. From my turn, I expressed the view, that both monetary policy and fiscal policy were in fact being oversold, and that I answered yes to both questions. What I argued was that what's being oversold is fine tuning, is the idea that it is possible for the few people in Washington to turn a button here, and turn a button there a little, and through delicate adjustments in taxes and in monetary policy effect the course of the economy in such a way as to keep a perfectly even keel. It has always seem to me that there's an old saying that the best is sometimes the enemy of the good. That you try to achieve perfection and then in the end you don't do as well as if you hadn't tried so hard. And it seems to me that's the case here. If you try to achieve an absolutely perfect course what you're going to do is to introduce large uncertainties into the economy which will cause it to divert from that course. I've expressed these views over a long period and it seems to me the evidence of the fine tuning of the last 10 years brings it rather close to home and supports that view. But going down to more specific points, in my opinion, while both are being oversold, fiscal policy has been oversold in a different sense into a far greater degree then monetary policy. The problem is that, what Walter Heller, and other people like him say is that, oh of course money matters but money isn't all that matters. And they accuse us, that is people like myself, and our group, the so called Chicago school, are monetarist, as he was referring to us. They accuse us of saying that money is all that matters. Now, I argued that, that was a strong man that, that isn't the position we've said, that it makes no sense to talk about, is money all that matters unless you ask for what. If you're going talk about the happiness in marriage, well, money in the sense of income may matter but it isn't all that matters. And turning more directly to the economy, if you're going to talk about the long run growth of the economy, of why it is that the US has a tremendously productive society, why we all, why we are relatively affluent. I think that has very little to do with the quantity of money. That is determined by our resources, the kind of economic system we have, that we have a free enterprise system it's determined by the fact that we have an abled effective energetic people, lots of capital and so on. Those are the factors that are really important. On the other hand, from the point of view on inflation, of price rise and price flow, from the point of view of what happens in the short period to the nominal quantity, nominal income, income expressed in dollars, not real income. Well their money, while it isn't all that matters, is in my opinion unquestionably the dominant factor, the quantity of money is the dominant factor in determining those changes. In my opinion, fiscal policy on the other hand while it's important for somethings, again matters for what? It matters greatly in terms of what fraction of the nations resources are going to be devoted to governmental rather then to private uses. It matters greatly in determining what fractions of your income you're gonna have to turn over to the government. But in my opinion, it has no significant influence, on whether we have inflation or deflation, whether nominal income raises or falls, except as it influences monetary policy. And indeed, the great difficulty in this whole argument is to try to keep separate, the influence of fiscal policy from the influence of monetary policy. You can do it, both intellectually and statistically, by separating out what happens to government deficits and surpluses on the one side. And what happens on the other, to the quantity of money. It's perfectly possible for the government to have a big deficit, but to finance it by borrowing it from the public at large rather than by printing more money, in that case the quantity of money will not be affected. Now the difficulty with the 1964 tax cut for example, is that while the cut was cut, and the fiscalist would argue that, that was the source of the expansion, it so happens that the quantity of money was increased very rapidly, particularly rapidly during the hold of that period, and therefore, the monetarist can claim that what produced the expansion was the raising quantity of money. The hard question is how do you separate these out, how do you hold the one constant and get the separate influence. Now, it so happen, that there's been a lot of empirical work which has been directed towards separating them out. And most of my own talk was devoted to summarizing some of the empirical evidence that has been produced on this question. I made a study about 15 or 16 years ago, comparing the Civil War, the first World of War, and the second World of War, from the point of view, of whether the price behavior in those wars, could be explained more nearly by the monetary forces, monetary changes between them, or by fiscal changes. And it turned out that the monetary changes gave you a very simply picture the fiscal changes didn't. I published, and other people have published a considerably number of studies in the interim, giving the same results for other periods. Most recently and I once special to mention this because some of you may want to try to get a hold of it, the Federal Reserve Bank of St. Louis has just done a fascinating statistical study of the period 1952, to 1968. That's about the longest recent period for which you could do a study, if you're going to get out of the troubles of the bonds support program before 1951. That will appear, or has appeared in the November bulletin in the Federal Reserve Bank of St. Louis. In this study, they have tried to separate out the separate influence of the monetary changes on the one hand, that is the changes in the quantity of money, and the fiscal changes, that is the changes in the high employment budget on the other in expenditures and deficits. And results are fascinating and striking. They find essentially to put it in its simplest terms, that the ups and downs of taxes have had no significant influence, on the ups and downs of GNP, of the national income, or, measures of this kind, ups and downs in taxes have had essentially no influence, once you allow for and hold constant what happen to the quantity of money. On the other hand, they find that the ups and downs of expenditures, of government expenditures, have had an influence, but a very interesting influence. In the first two quarters, after an increase in government expenditures, this tends to have an expansive influence on the economy. But in the next two quarters, it tends to have a contractionary influence, and for a year the hold, it all washes out. Now, that's very, very sensible from the point of view of the theory I and others have promoted. Because to begin with, the expenditures have an initial impact effect, it takes time for people to adjust to them. But then after the, if the government spends more while the doesn't tax anymore it has to borrow some more. This tends to raise interest rates, and that tends to produce a negative effect that wipes out the initial positive effect. On the other hand, they found that throughout the whole event period, changes in the quantity of money, it had a very regular, consistent, and significant influence on changes in GNP. That the changes in the quantity of money, had an influence that took about three or four quarters to make itself felt, and they traced out the influence in the first quarter, the second, third quarter, the third quarter and the fourth quarter, and they came to the conclusion that over a year as a whole, the change in the quantity of money had a very definite and significant and detectable influence on nominal income. Of course I don't want to overstate their results, there was still a lot of noise, a lot of error. Taken together the changes in the quantity of money, and the changes in expenditures accounted for somewhere between 50 and 75% of the variation in GNP. But that still leaves quite a lot left. And I urge you, if you're not on the mailing list of Federal Reserve Bank of St. Louis, ask them to put you on their mailing list for their bulletin because it so happens that, that particular Federal Reserve Bank does some of the very best economic reporting of both statistics and analysis. 

Interviewer: Our it could be that everyone likes to live in St. Louis. 

Milton: I doubt that very much. It's a very, that really is a very surprising thing. You've got 12 Federal Reserve Banks, everyone of them publishes a monthly bulletin, of all of those monthly bulletins, they're required by law as you may know to publish a monthly bulletin. Generally over the history, 50 year history of the Federal Reserve, the New York Federal Reserve Bank has been the dominate one. And it does publish a good monthly bulletin, but in the last five or 10 years, thanks to the influence of one man who went to the Federal Reserve Bank in St. Louis, Homer Jones, is a Vice President, they have turned out to be the most important single bank in the system, it's a pure accident. Although it might be, interesting to know the historical president, William McChesney Martin's father was at one time the president of the Federal Reserve Bank of St. Louis. 

Interviewer: So it has a quite a, you know nice history about it I guess. 

Milton: Yes it does. 

Interviewer: But Dr. Friedman, we just had an election and Mr. Nixon is now the President elect and he'll be taking over in January. And I'm sure that many people are wondering what the nations economic state will be under President Nixon. And there is some talk that Mr. Nixon won't have as much leeway in economic policy because of the Democratic Congress. How do you react to that? 

Milton: Well there has been a lot of talk about that, and I think it's a very relevant point to consider. The talk has been that because of the narrowness of his election and the fact that the Congress came in Democratic he's gonna be stymied. And I personally don't believe that's the case. And the reason I don't believe that's the case is because I believe the word democratic is a very misleading word. The fact is that a Democrat in New York, and a democrat in Arizona, is a very different creature. Or take any other state. Indeed, the most striking thing, if you look at a map of the electoral votes in the presidential election, the most striking thing is that what you had at the crucial division was not Democratic versus Republican, it was New York and its saf-light states versus the rest of the country. If you take New York, Pennsylvania, Connecticut, Rhode Island and Massachuset, they provided Humphrey, if I remember the figures rightly, with more then half his electoral votes. Now, this is very interesting phenomenon to speculate on and I don't understand why it is that New York should be, so, A, so influential, but B, so different from the rest of the country. But therefore, if you want to know what Congresses sentiments are about economic matters, it isn't a very good thing to look at it in terms of Democratic or Republican. You want to ask yourself a different question. What is the division in Congress between those people, whether Democratic or Republican, who believe that the Federal Government should play a stronger, more active, more direct role in the economy, who are in favor of the whole spade of welfare, and new deal measures that we've had? What is the division between people such as that, and people whether labeled Democratic or Republican, who feel that you should reduce the power of the central government, that you should decentralize power, that you then should give more role to the state and so on? This is a division which is popularity refer to, I think those are misleading labels too, as conservative versus liberal. Now, the fascinating thing is, that for the past ten years the House of Representatives, has typically had a conservative majority for the Democratic or Republican. The only real exception to that was in the two years prior, after Johnson's landslide. That landslide, caused an unrepresentative house session for him to be elected. The coattails pulled in the eastern wing as it were of the Republican and the Democratic Party. With the result that 62, I'm sorry 64 to 66. So an enormous spate of legislation, Medicare, education and so on. From my point of view very unfortunate legislation. But nonetheless, you will note that after the 1966 mid-term elections restored Congress to it's normal relationship, then Johnson started having enormous difficulty with Congress and getting these measures through, and he couldn't get them through. So, the point I'm trying to make is, that if you look at Congress in terms of its division by beliefs and not by party labels, then this is a Nixon Congress. This is a Congress which believes the same kind of things that Nixon believes, that's why it is, that there's no inconsistency at all in my opinion, between the electoral results, which showed a great, a great revolt against the existing President. That is to say if add up the Nixon and the Wallace votes, which is what you really have to do from this point of view. You'll have a substantial vote of no confidence in the present administration. On the one hand, you had that, on the other you had a return of essentially the same Congress. I don't think there's any inconsistency in that. What that reflects was a difference before the election, between the makeup of the Congress on one hand, and the character of the presidency on the other. So I personally do not believe that the Democratic nature of the House of Representatives, or the narrowness of the election either one, involves a significant restraint upon the economic policy that Mr. Nixon will be able to pursue. 

Interviewer: You think he'll have a pretty easy time of it then for the next, at least two years? 

- Oh no. Oh no, no I don't say that. I think that he will not be handicap by political problems of this kind. But unfortunately, economic problems which he faces will provide all the difficulty that any one man might want. I think that Mr. Nixon comes into The White House with the heritage from the economic policy of the Johnson administration, which makes his position from that point of view a very unenviable one. 

Interviewer: Are you saying his hands are somewhat tied as he assumes office. 

Milton: Yes, his hands are tied, in one part, but it's a different thing. After all he inherits the state of the various problems which were left by the policy of the preceding administration. As I mentioned last week, I think the three major problems that are going to be facing the Nixon administration in the economic-sphere, the three major broad problems, and neglecting for the moments such problems as the problems of the city and so on, which are in some ways more important. But, if you look at the broad economic problems, the three major ones are inflation, on the one hand, balance of payments, the second, and getting control of the budget. And in each of these, the crucial thing is, and Mr. Nixon comes in after an administration which has left these economy in a critical position the Kennedy administration came into office under favorable circumstances. At the time Mr. Kennedy came into office in the first place, you had, had stable prices, you had broken the inflationary expectations of the public. There was some leeway in the economy so you could have rapid economic expansion by absorbing unemployed without having to, without problem of inflation. And so, Kennedy inherited a favorable bequest as it were, from his predecessor. Now, Mr. Kennedy, and Mr. Johnson between them, have in the last eight years squandered this bequest, by pushing too hard, by promoting very rapid expansion, by encouraging the Federal Reserve Board in a very expansionary policy on the average over that period, there've been ups and downs. They in fact was reinforced of course by the Vietnam war, what has happened is that you have converted a stable price expansion, a steady expansion into a very rapid inflationary expansion. You now have consumer prices raising at something like 5% per year. Where as at the end of the Eisenhower era, they were going up at the rate of about 1% of the year, and most of that was probably quality change and not a real price change. Now, it's a very different thing to come into an economy which has a stable price history, and keep it on a noninflationary course, and to come into an economy which has a very rapidly raising price history and to keep that on a stable course that's with inflation. Next, you go to the balance of payments, now there, I must in all fairness admit, that Mr. Kennedy did not come into a good situation either, there was a great balance of payments deficit in 1960. There was a kind of a miniature, a mini gold crisis at the time and therefore from that point of view, you did have a real problem. But even in that area, the preceding eight years have moved us farther away from where we want to be then we were before. When Mr. Kennedy came in, there were essentially no exchange controls. Our gold stock, I now do not remember the exact figure but it was probably somewhere not far from double where it is now, if I remember rightly it was somewhere in the $15 to $20 billion range, so it was much higher. Now, after eight years of the Kennedy-Johnson administration our gold stock has been cut in half, it's now down to less than $10 billion. We have introduced a whole series of foreign exchange controls including an interest equalization tax, which is a concealed devaluation of the dollar. Including, control over the lending of US commercial banks abroad, including a control over the investment activities of private enterprises. This was the latest measure, which Mr. Johnson took early in January imposing formal, explicit exchange control on private investment. We have seen an addition to this, the erection of a great many gadgets and gimmicks designed to conceal the true difficulties in the balance of payments. These include special kinds of bonds, you will remember that Bob Rosa, was under secretary of the treasury of the beginning of this period, and he invented something which were called Rosa Bonds. Which I always said at the time were really Sub Rosa bills, because they were suppose to look as if they were long term securities, and thus not be a deficit these were things which he got the central banks to acquire. So, that on paper it looked as if they were lending this money on a long term. But in fact they had an agreement attached to them that at any time they could be turned into a short term assets into essentially bills which could be drawn down upon. So, we had an enormous proliferation of these devices as a result of which are fundamental balance of payments is really worse then it looks on the surface. So, that as I say in this respect too, in the balance of payments respect too, Mr. Nixon comes into an extremely difficult situation where you not only have to follow a good policy now but you have to unwind, all of the bad things that have been done particularly along the lines of controls. You will recall that during the campaign Mr. Nixon stressed his dissatisfaction particularly with the investment controls, but also with other exchange controls and I know he is determined to move in a direction to free the nation from controls. But that itself is a very difficult problem and therefore you have a problem of undoing that. And finally, with respect to third of these problems with a budget, again Mr. Nixon inherits a very difficult situation. You will recall that Congress, when it made the tax increase to impose the surcharge also, imposed on President Johnson the duty of cutting governmental expenditures by $6 billion with some exceptions at an annual rate. Now, a month after I have no privy information and I am speaking entirely from what I read in the newspaper and what I say now may be wholly wrong, but I must confess I'm kind of cynical, and I have a evil mind so I maybe conjuring things up, but as I read in the newspaper, month after month I read a report from the budget bureau which says, the current figures do not in fact show as deep a cut as Mr. Johnson had promised to make and is required to make. But this says each months report, is due to special circumstances of this month and everything is going fine and the next month is gonna turn it around and show it looking better. Well I hope that's right, but I very much fear, that it will turn out, that when Mr. Nixon comes into office on January 20th he will be handed the fe-ti-cum-pli, that very little of that cut has been accomplished and that if the $6 billion is to be achieved it will have to be achieved mostly in the next four or five months of his administration, which will be an almost impossible task. So, in all three of these areas of inflation, balance of payments and getting control of the government budget, Mr. Nixon comes into a situation which is froth with great economic difficulties where he's behind the eight ball to start with. And those are in my opinion his basic underlying problems not so much the problem of whether he will be able to deal with the recalcitrant Congress very effectively. 

Interviewer: Well from what you say he's not gonna have too much time for anything else besides economic problems. 

Milton: Oh well unfortunately, he has many other problems to face, he has a problems, of course the foreign policy problems. And indeed one of the great difficulties with our, one of the reasons why we ought to dismantle some of these controls, why in my opinion we ought to have more rules and less discretionary policy is a simple elementary fact, that the President of the United States, who is at the top of the heap, simply does not have enough time, to handle the enormous variety of problems that comes his way. Now, what I, so that the he unfortunately will not have enough time to give to this and that means that some of these things may of course not be, not be given the degree of attention they should. First thing a President has to do is to assign priorities and decide what are the important issues. Now, the reason I picked out these three problems from among the many problems which the President faces is because it seems to me these are the three that will have to be at the top of his priority list. The other problems, problems with what to do about the cities of tax credits, about what to do about the housing problem, what to do about jobs and so on, the minor part. These are part of this, the broad problems I have mentioned, but they will unfortunately have to take a back seat to handling some of these problems. 

Interviewer: Well Dr. Friedman, perhaps we can take a closer look at some of the problems, economically speaking, that will be facing Mr. Nixon when he assumes office, during our next discussion next week. 

Milton: That will be our plan. I had hope today to get farther then I did into the more detailed problems of inflation. Maybe next week we can start right off on what his problems will be in the inflation area. Thank you Mr. Shephard. 

Interviewer: Thank you very much Dr. Milton Friedman. If you have questions or comments or suggestions for topics you'd like to have discuss in this series, please send them to Instructional Dynamics Incorporated, 166 East Superior Street, Chicago, Illinois, 60611.