- This is Rose Friedman, inviting you on behalf of Instructional Dynamics to another of our biweekly conversations with Milton Friedman, Professor of Economics at The University of Chicago. We are taping this conversation on Wednesday, August 21, 1974. The papers continue to talk about tight money. What do the figures show? 

- I have in my hands, here, the latest report of the Federal Reserve Bank of St. Louis for the week ending August 14, 1974. The introduction of that report starts as follows. The money stock is increased at a 4.4 percent annual rate in the past three months. Considerably slower than the 8.6 percent rate of increase in the previous six months. Growth of the monetary base is also slowed in the past three months to a five percent rate of increase from a 10 percent rate in the previous six months. It goes on. It is this kind of discussion of the figures which underlies the widespread belief the Federal Reserve has indeed significantly tightened money in the sense of reducing the rate of monetary growth. Having been bitten so many times in the past, by brief movements of this kind, I have gone back and looked at the figures a little bit more in detail. You will recall that I have stressed over and over again on the tapes that if you examine the monetary aggregate for the past three or four years, what you find is that they have been growing about roughly constant rate of growth trends that is straight line, logarithmic or expediential trends. At rates of growth of roughly about 6.7 percent for M1 and 9.7 or eight percent for M2. So what I did, was to calculate out the values of M1 and M2 that would lie precisely along that straight line logarithmic trend. That is, if you take the straight line fitted to the data, from March 1971 to March 1974, and extrapolate it, what numbers do you get for the M1 and M2? And how do the actual numbers compare? With respect to M1, the situation on a monthly basis. It's really a little bit hard to do this on a weekly basis because the weeks fluctuates so much. But I have calculated the monthly figures through July so it's practically current. Are very clear. In the month of July 1974, that straight line trend would have predicted for M1 281.3 billion dollars. The actual M1 was 281.0 billion dollars or three tenths of a billion dollars below the predicted. Now that's well within the range of statistical accuracy let alone, in term of the fluctuations from time to time, let me put it a little differently. I calculated for the past year and a half, that is from January 1973, what were the month by month differences between the actual value of M1 and the value of M1 that would have been predicted by this straight line? Those actual values exceeded the straight line by a maximum of 3.4 billion dollars in June of 1973. It fell short of the straight line by a little over one billion, about 1.3 billion dollars in October 1973. Hence, the present short fall of three tenths of one billion dollars is well within the range of the fluctuations of this number over the past year. However, I've overstated the case a little. For the months of March, April, May, June, and July, the actual money supply was running about one billion dollars above the trend line. It fell to three tenths of a billion in July below the trend line. This three month slow down the rate of growth that the Federal Reserve Bank of St. Louis points to is produced entirely by this shift from about a billion above the line to three tenths below the line. I hope it isn't a harbinger of a real slow down in the rate of growth. But surely on the basis of this evidence, with respect to M1, I'll come back to M2 in a moment. With respect to M1, surely it is little more than the dimmest indication of any real shift from one trend line to another. We will have to wait for more evidence. Now, when you come to M2, the situation is a little bit different. For the last month, July, the actual observed M2, is 599.9 billion dollars or just a shade off six hundred billion. The value that would have been calculated from the trend line is 603.9 or four billion dollars higher. So there is a difference of four billion dollars. Moreover, that is the largest difference in the past year and a half. The actual value was 3.6 billion dollars above the trend in January 1973, two and a half billion dollars below it in September 1973. So this four billion dollars is a little bit below. However, again, it's not very much outside the range. It's a one month, well a little more than one month shot. The actual was exactly on the trend in April. It was two billion dollars below in May and June and it dropped to four billion dollars in July. But again, if you look back over these numbers over the past few years, there is absolutely nothing unusual in that kind of a deviation. Of course, the reason why M2 has been below the trend to a greater extent than M1, is because of the so called disintermediation effect. The fact that you have had high interest rates on money market instruments and much more important, the fact that the market has been responding to the demand for ways in which savers could put up funds and get something like the market interest rate on small amounts and therefore has been producing all of the money market funds. Plus, the recent treasury issue which cut the amount, the minimum amount that could be subscribed down to a thousand instead of ten thousand and offered a relatively attractive rate of interest. These factors have of course, encouraged savers to withdrawal funds from commercial buying time deposits because remember, the M2 only includes commercial buying time deposit. It excludes the large CDs which have been relatively high. Having been encouraging people to withdrawal from time deposits and to buy directly, purchase, money market instruments at higher rates. And the effect of this, of course, has been a lower M2 relative to M1 but it is very hard to know whether one should put much stress in the economic importance to that. To summarize, such minor straws in the wind as they are are consistent with the view that the Fed is moving toward a somewhat lower rate of growth with the money supply. But the straws are as yet extremely minor and it would be very very unwise to depend on them as giving any real indication of what's going to happen in the monetary sphere. 

- There is much speculation about what Ford's succession to the presidency will mean and in particular, his tough talk about inflation. Some people think this will mean a recession in 1975. What is your opinion on it? 

- In a way I would like to say, I would like to hope that those people are right. Recessions are bad things of course but inflation is a bad thing. On a minor digression from this, I am always getting the question, "How much will it cost us to stop inflation?" And I've increasingly come to believe that that's like a when did you last beat your wife question. Because I am inclined to reply, "How much will it cost us not to stop the inflation?" The economy is in a situation where we have a serious disease. If you have a really serious appendicitis, you can ask how much will it cost you to stop the appendicitis to have an operation. But you also must ask how much will it cost you not to do it? And that's, I believe, our situation. So that I believe that from a long run point of view, given that we have a serious disease, we are better off getting the cure right now, than we are postponing it and letting the illness get worse. So that all things considered, if the public were willing to stand for it, it would be desirable if Mr. Ford, President Ford would and could, I'll come back to the could in a moment, because I think it is a could that is really crucial. If he would and could follow a policy that would tighten the situation sufficiently to produce a recession in '75, which would in effectively bring inflation back to a level of two or three or one percent a year that we could live with indefinitely. But, that's talk. Let's look at the realities. Number one, President Ford has no control over the monetary authorities. The monetary authorities will behave independently. There have been a spade of newspaper stories recently, criticizing the Fed on the grounds that it acted politically in 1972 in order to win the election for Mr. Nixon and adopt an excessively policy for that. As I have states on these tapes before, I cannot accept any such interpretation. I believe the Federal Reserve Board is much influenced by political atmosphere and politics, but not in that kind of a crude and direct way. It's a last thing in the world that they would do. Especially, one of the curious things about all these charges is that nobody seems to take into account the fact that the overwhelming proportion of the members of the board and of the governors and the presidents of the banks are Democrats. But in any event, you've got to have a much more subtle analysis of political influences to see how politics interact with monetary policy. But in any event, President Ford will have no direct effect, and I believe, very little indirect effect, on the course of monetary policy. So in judging whether there's going to be a recession next year, we have to ask, "How will a Fed behave?" And has President Ford's succession, in any significant way changed the pressures on the Fed? My answer to that is no. I do not see that it has changed the pressures on the Fed. The Fed has been restrained in the past and has tended to be inflationary because of the pressures on it from Congress on the one hand and from its constituents on the other, that is the bankers, who all say they're against inflation except that they want the Fed to give them easier credit. And from their own concern about the temporary unemployment that would be produced by tightening. Plus, from their continuous mis-assessment of the situation. They have continuously, over years now, mis-analyzed the situation in terms of underrating the significance of their own monetary expansion for subsequent inflation. I believe they have learned something. I believe that accounts for their tougher talk and it may lead them to hold the rate of monetary growth down to the neighborhood of the 6.7 percent rather than speeding it up to another notch. Perhaps, they will show the courage and independence and understanding to bring it down to a five percent rate of growth. If so, then that would be very likely to mean a continued slow rate of growth of the economy and what will be called a recession. I cannot see any possibility of it converting into a serious recession. In order to do that, I think they would have to bring monetary growth down very much more sharply than I've indicated. Now let's look at the next component: Fiscal policy. It's relevance is mostly, in my opinion, what effect it has on Fed monetary policy. When they treasury runs a large deficit, it absorbs a large fraction of the capitol market. It tends to drive up interest rates and given the Feds preoccupation with interest rates, it tends to lead the Fed to engage in a more expensive monetary policy than they otherwise would. There are many people, of course, who also think that the fiscal policy has a more direct influence. This issue really isn't relevant to what I'm going to say now and so what I'm going to say seems to be equally relevant to those who believe it does have a direct influence and those who believe it does not. And here my point is President Ford may talk tough but he does not really, is not really likely to have any effective power to make Congress cut the government budget very sharply. After all, I cannon believe President Ford will really talk tougher than President Nixon talked in 1969 and 70. He had very limited or no success. President Ford can veto some bills. That will be all to the good. The most I can see his doing, is slowing down the rate at which government spending are accelerating. Perhaps, he can keep the increase in the budget next year to 25 billion dollars instead of 30 billion dollars. That's more comfort when what we ought to be doing is cutting the budget down by a definite amount making next year's budget smaller than this one. And moreover, there are some roadblocks along the way. The budget, the optimistic budget watchers ought not to omit. There is enormous pressure for a public employment measure. I think on an earlier tape I discussed why that's an absolutely false and useless measure which would not do a thing to reduce unemployment. But that doesn't reduce its political appeal. Chairman Burns has come out for a four billion dollars public employment measure. Many republicans are coming out for a public employment measure. I think we shall be very very fortunate indeed. If we do not get enacted something like a four or five or six billion dollar public employment measure in the near future. In the second place, the thrift institutions are another major roadblock. There is no question about their problems, which we've talked about many times. The question is how is it going to be handled and how soon will it come to the surface? I have no doubt that if serious, major problems arise about the thrift institutions, Congress will legislate money and with the support of President Ford to bail them out. What's involved are not trivial sums. Various estimate get up to 10 billion dollars a year as the amount that is needed to bail the thrift institutions out. After all, they have something like 350 billion dollars in liabilities and the market rate of interest differs from the rate of interest they have been paying on their liabilities by something like three percentage points. That's 10 billion a year. I doubt very much that you will have any bail out on that scale. But a four or five billion dollar a year bail out I find it hard to see how it's going to be avoided. In the third place, where much talk about compromise on a national health insurance bill. There is no compromise that isn't going to make a major increase in the budget. The only compromise is whether the increase in the budget will be open or hidden. After all, if Congress requires employers to pay for additional health insurance employees, where is that fundamentally different from Congress enacting a tax on employers which they then use to pay for the cost of health? So that however this compromise is developed it's going to be another thing expanding government budget. Is it easy to see any sharp cuts otherwise? President Ford has already expressed himself strongly as being against cuts in defense. And it is true that the defense budget in real terms has been declining and is lower now than it has been for many years. Where else is there any looming major cuts? It's very hard to see them. Thus my conclusion on fiscal policy is that while President Ford will talk tough and while I hope he will have some success in slowing down the rate at which government expenditure programs expand, I think it will be a miracle if we see any substantial slow down in the rate of government spending. Well then, what else is there left? There is no other effective policy available to President Ford with which he can effectively slow down the inflation. I think there are other initiatives open to him that might strengthen his hand. Maybe not immediately but in the long pull. I am strongly in favor, as I have said many times here, on inflation proofing the tax system. On having the government issue securities with purchasing power clause. Those are options open to the President. He can perhaps encourage and support the development of variable rate mortgages and variable rate payments by thrift institutions. These will ease the cost of the inflation. They may lay the ground work for some future time, cutting the inflation, but the inflation will not, in fact, be put under control. We will not, in fact, have a severe recession as part of the price of getting the inflation under control until it has become clear that that is politically advantageous. I happen to believe that there is a cultural lag in the apperception by legislators and people in Washington of public attitude. I happen to believe that public attitudes have moved very far in the direction of putting inflation ahead of temporary unemployment as a major problem. I do not think the politicians in Washington have yet recognized that apperception. Unless that apperception is correct and unless they recognize it, we should not have any effective move in the near future. Although we may have and probably will have a minor recession as a result of a continued waffling back and forth of the kind we've had for some years. 

- You talk about a mild recession and a severe recession and this may be misunderstood, I think, by your subscribers. People are always talking about 1929. Are we going to have a 1929? You don't mean that kind of a recession - 

- No, no I think - 

- a severe recession. 

- I don't. You're quite right. I think a deep depression of the '29-33 variety is impossible without a monetary collapse. I do not see any chance of a monetary collapse. What I am talking about is whether we are going to have a recession of a kind in which the unemployment rates gets up to six, six and a half percent. Or whether we're going to have a recession of a kind in which the unemployment rate hits eight, eight and a half percent for a brief period of time. Those are things of an altogether different magnitude than the situation in the 1930s when the unemployment rate got up to something like 20 or 25 percent. More importantly, the unemployment rate is not what's important. What's important is long term unemployment. At the moment, long term unemployment in the sense of the number of people who are unemployed over six months. I don't know what the exact figure is, I forget it. But it's something like a half or one percent. It's not a very large sum. In the 1929-33 episode, it's that rate which got up into a very large sum and which became a serious problem. In the same way a deep recession would be one in which that rate got up to two or three percent. 

- President Ford has been jawboning General Motors about its announced price increase. General Motors is sticking to it's guns. Also, Ford Motor has announced a large price hike. What do you see in this? 

- Well I think these price hikes by Ford and General Motors have been widely misinterpreted. They have been taken to mean a signal that price inflation is going to continue because it is said the actual price paid for cars will go up by 10 percent if that's what roughly GM and Ford have done. I think that's only misconceiving the nature of the price increase. In the first place, it's worth emphasizing that the actual price at which cars are sold is one of the most flexible prices in their system. Because it doesn't depend on list prices. It depends on discounts. It depends on the trade in value which is assigned to cars that are traded in. The price that a buyer pays for a car is a market determined price of high flexibility. So that it is perfectly conceivable that you can have these high list price increases and yet the actual price paid for a car would show nothing like a similar increase. If it became impossible to handle that through a trade in and the dealer's discount, there is not doubt that in the course of the model year, GM or Ford would make special deals with their dealers or give them special discounts and you would have talk about sales campaigns and the like. The question to ask is why then did Ford and GM announce such hikes? And the answer is simplicity itself. They are not fools. They know what happened to them when we had price and wage control imposed. They can see that price and wage control is one of the possibilities that cannot be ruled out. I interpret these very large price hikes as simply measures which they are taking to ensure themselves against the possibility of price control being reimposed. They want to be sure they have a high base when and if price control is imposed. The fact that they make these large increases does not mean for a moment that they necessarily expect that those price increases will stick or will be effective. They may expect it, but whether they expect it or not it would be sensible for them to do what they are now doing. 

- What are the prospects for price and wage controls? 

- Well President Ford has been saying he does not want price and wage controls. This morning's newspaper again carried announcement of another statement by Mr. Ford, President Ford. He was not going to ask Congress for wage and price controls and so on. That again has to be looked at in the context of experience. Don't misunderstand me. I have no doubt whatsoever that President Ford is completely sincere and serious in saying what he is saying. Yet, if we look not at what he's said but what he has done, the one action he has already asked Congress to undertake is to establish a monitoring program. A monetary agency, a cost of living counsel, to monitor price and wage increases. Now what conceivable function does that counsel have? All past history suggest that it's only possible role is as a Trojan horse for the subsequent introduction of price and wage control. If it's really only going to monitor wage and price movement, we already have the bureau of labor statistics, the department of agriculture and perhaps three or four different agencies within the government that are collecting price and wage statistics that can be published. There's no need for such monitoring agency. If it's purpose is supposed to be to collect the statistics from other agencies and get front page headlines about Lambo's best basting General Motors or somebody else, that's utterly ineffective unless those headlines carry with them the implicit threat that failure of actions by the private parties to reduce the prices, or to reduce the wage increases will bring subsequent government action. Thus the cost of living counsel is a very bad sign of future prospects. Moreover, experience in other countries is a very bad sign. If there is any country which you would think would had it's fill of price and wage control is you would think it was Great Britain. It's now in its third or fourth, I don't know, I've lost count, episode. Mr. Heath, when he came in, whenever it was at the earlier point, came in on a platform of abolishing them and he abolished them. When unemployment reached a million, he lost his nerve and he reimposed. He got kicked out because he insisted on trying to impose them and make them stick on trade unions. I understand that the conservative party preparing for a very likely electoral campaign this September or October has announced that if elected, it will re-introduce the system of price and wage controls. Well, the same situation exists in the United States. The memory of the recent failure is very fresh. Right now, nobody is said to be in favor of wage and price controls except that NBC reported on a telephone poll of the American, 1500 people in which 54 percent said that they were now in favor or wage and price control. As Ford's Presidency goes on, as inflation rolls on, unless we have a major success in inflation, I think we will have some success as I said before, I continue to expect the recorded indexes of the rate of inflation to come down sharply from their present level to somewhere in the neighborhood of six, seven, eight percent. But even then, we will have continued talk about how we have to do something effective about inflation. If the cost of living counsel is set up, it will be the first step. We will have further talk about the importance of voluntary restraint. Voluntary restraint will again not work. I think it would be a bold man who would rule out the possibility that within the next two or three years we will have another episode of price and wage control. It will very likely come, as it came before in 1971, as it came in Britain under Mr. Heath, when the government wishes to embark on an inflationary policy. It must, I cannot repeat too many times, the real function of price and wage control. There is nobody who has any knowledge about history or any analysis of economic matters with a possible sole solitary exception of John Kenneth Galbraith. There is nobody who really believes that price and wage controls can be effective in stopping inflation. They are introduced for a very different reason. They are introduced because the government which wishes to produce inflation also wishes to give the public the impression that it is doing something effective to stop inflation. That is their role and their purpose. It is very hard to believe that within two years we may not be in a position where that will seem to be an attractive tactic to the whoever is in a position of power. 

- I think we have come to the end of our time. Thank you very much. Remember subscribers, if you have any questions or comments, please send them to Instructional Dynamics Incorporated. Chicago, Illinois 60611. We shall be visiting with you again in two weeks.