- Welcome to another in a series of commentaries on the current economic scene produced and recorded by Instructional Dynamics Incorporated. Our guest again this week, the week of February 3rd, is Dr. Paul Samuelson, Professor of Economics at the Massachusetts Institute of Technology. Professor Samuelson, what's on the top of the list for this week? 

- For this first week of February, there're really many exciting things to talk about, almost too many. The new team in Washington has started out in a very low-keyed way so that I think we have no new clues as to what the tone of the economy is likely to be in 1969 coming out yet from Washington. It is necessarily still the same old guessing game. Will the 4% inflation of 1968 be tamed down in 1969 towards a 3% rate? Will the end of 1969 be on an upbeat? Or is the first half of the year to be the period of greatest exuberance as by next Labor Day we begin to feel the pinch of Federal Reserve tightening that is going on today? Let me first touch on the most current bits of information that are coming in each day. Then as time permits, I'd like to go into some deeper analysis of the forces shaping our economic destiny this year and in the future. Point number one I think is the fact that the Fed does seem to be putting on the screws. At the end of January, net free reserves had reached the record negative level of 758 million. That is net borrowed reserves of 758 million. The total of discount borrowings after we subtract from them the small amount of excess reserves of the banks came to about 3/4 of a billion and this is a 16-year record. Now, net free reserves is only one of many indicators and cannot be relied on by itself to tell us what is happening in the money markets but it is one very important straw in the winds. One Friday's report doesn't define a deflationary epoch but the most recent acts are in line with what most experts have been expecting from the Federal Reserve. The tightening action of the Federal Reserve has shown itself in a number of effects. Interest yields are again trending upward, bond prices falling. Lowered expansion in business in January seems to have been down even after seasonal corrections. The money supply has probably declined for a couple of weeks and perhaps will not be up much for the months of January and February. These acts of the Fed fit in well with what a number of the Reserve authorities have been saying. Some of you may have read a U.S. News & World Report interview with Governor George Mitchell of the Federal Reserve a few weeks ago in which he spoke of the Fed's determination to curb inflationary expectations. Some will write this off as Madison Avenue propagandizing in which the Federal Reserve says one thing and does another but not I. To predict what is going to happen to the money supply and credit conditions in the future, I find it useful to monitor very closely all the indications of attitude that I can get on the part of those who do the voting in the Open Market Committee of the Federal Reserve. The fact that George Mitchell is a Kennedy appointee with a historic record of favoring full employment policies gives his words I think particular significance. I should also call to your attention recent speeches by Andrew Brimmer of the Federal Reserve Board. Governor Brimmer is an able economist and he happens also to be black. His concern with the problem of unemployment among ghetto youth needs no documentation nor explanation. As a Johnson appointee to the Board, Brimmer has been an articulate activist on the liberal side. It is therefore I think of especial significance when Brimmer states that controlling inflation is in the long-run interest of the black community even if it means some increase in ghetto unemployment in the short run. When President Alfred Hayes of the New York Federal Reserve Bank says things like this, that's not news. Hayes is a fine Yale gentleman, a Rhodes Scholar and a pillar of the New York financial community. Hayes has been saying things like that for a long time but when Brimmer and Mitchell begin to say things like that, it suggests to me that an agonizing reappraisal is going on within the former majority of the Federal Reserve Board, the former majority which was prepared to make considerable sacrifices on the side of price instability in return for high employment. I believe we're getting a gradual shift in the position of the majority and I believe this has significance for the future. I happen to be a week or so ago at a meeting of academic experts who were called for the purpose of giving advice on macroeconomic policy. This was a completely off-the-record session. I discovered to my surprise that among most of the experts there, I was one of the, or seemed to be, one of the greatest activists for Federal Reserve tightness. Now, that perhaps is news because it's a rare session of that type when I'm not to be found on the side of the angels who put great stress upon vigorous real growth and high immediate short-run employment. Let me review that session and some of the arguments that were given. On the one hand, there were monetarists there who have believed right along that the rate of growth of the money supply has been excessive but who are very distrustful of correcting an excess of the rate of growth of the money supply in one period by a subsequent defect or deficit or shortcoming or shortfall in the rate of growth of the money supply. And a typical representative of that group would counsel the Fed to tighten up in comparison to what it has been doing. This as measured by the monistic measure of the rate of growth of the money supply. But to do is very gradually and to do it in not necessarily in one immediate step. Just to use some numbers at random, and I don't want to pin myself down precisely as to which definition of the money supply I'm using, let's suppose that a magnitude which in the long run is thought by this school properly to be at about 5% per annum has been running at nine or 10% per annum for many, many months. The exponents of this view would say we'll go from nine or 10% down to seven or 8% in one stage and then go in another stage from seven or 8% down to 5%. But don't repeat, don't go from 10 to 9% in one period of time, in a short period of time to below 5% in the thought that you atone in a later period for the sins and indulgences of an earlier period. That was one group and I would say that the counsel of that group would be to cool off any new converts towards activism against inflation within the Federal Reserve system. Perhaps an even larger group, the majority group in the country at large accepts the still fashionable view that the first half of 1969 is likely to be the weakest half and is likely to see real rates of growth that average not much different from $10 billion per quarter in each of the first two quarters and then who expect some increase in the last couple of quarters. This particular group gives ranges of estimates very much like those of the National Industrial Conference Board Panel that Paul McCracken and others were on meeting at the end of last year which has been mentioned in this tape and which if time permits I would like from a methodological view to comment on in greater detail a little bit later. Well, according to this group, the economy is going to do some cooling off on it's own account and therefore they tell the Federal Reserve to tighten but be careful that you don't indulge in overkill. Now, as against these two groups, I seem to be in favor of greater activism. How can I explain that? One, I take it as basic as the axiom for the discussion that the authorities in question are prepared to have unemployment go up some. Now, I don't mean go up a lot, but to go up from the last figure that I have seen of 3.3% to let's say 4% as an investment in bringing the rate of inflation down from 4% to 3.5 or 3 and 1/3%. I don't say that my own value judgments necessarily endorse this axiom 100% but as an expert called in, I take that to be the axiom of the client and I proceed on that particular basis and I think that most of the people there would not in fact quarrel with that axiom. Now, I don't think that if the Fed does things in a very moderate way, you're gonna get any short-term moderation and I believe that monetary policy can do something in the short run. If I could coin a phrase, there is a widespread belief in fine distuning. There's the belief that if you let the money supply fluctuate a little bit, that you greatly de-stabilize the economy. I don't believe in that theory of fine distuning. As I read the evidence, the rate of growth of the money supply can be a very choppy time series but everything in neoclassical and post-Keynesian economic theory argues in my view towards the proposition that it's the rate of change of the money supply over a considerable period of time, what you might call its permanent component which is important and the system has great capacity to ride with and cushion fluctuations in the rate of growth of the money supply. Let me put it concretely and I'll overstate my case a little bit just in order to make the analytical argument very clear. I believe that if over a period of a year or two years, 5% happens to about the right rate of growth of the money supply, from the beginning of that period to the end of that period, that if you have gone in the first third of that period at an excessive rate, then it is good business to go in the next third of the period at a deficit rate averaging out to about the right figure and I think the system is very well adapted to react properly to that kind of action. Let me give some dramatic language not to convince you of my point and not to demonstrate my point and not to prove that I'm right in my point but for the purpose of clarifying what my point is. I do not believe that when you run the rate of growth of the money supply at 9% for a period of time when it should be run at 5%, I have no quarrel at the moment with that 5% figure, that that can be likened to a truck which runs over a pedestrian and does him great harm. But suppose I did believe that. Let us suppose that this incident is now followed by a period in which you have the rate of growth of the money supply growing by only one or 2%, a shortfall from the 5%. I don't believe that that act can be then likened to running the Mac truck backward over the patient, over the pedestrian, killing him twice or breaking the other bones in his body that you missed breaking by your first misdemeanor and felony. On the contrary, I think that one act tends to wash out the other. The homely illustration that I give comes from the fact that a number of my children are very keen and expert sailors and they tell me that if you wanna head due north, and if the wind is coming from the north, do not despair, that you tack to the north east and you go along that tack for quite a while, of course, meriting or at least getting the severe criticism of those who say you should be going due north and then after you've gone quite a while north east, you take the other tack which is north west and you end up about where you ought to be and you end up in an optimal way in that fashion. Now, I'm not going to argue that the optimal always calls for attacking that the wind is always against you and that you must always move in a bang, bang way but I come from MIT where there are lots of experts in cerebral mechanisms and one of the most efficient types of cerebral mechanisms, in fact, it's used more than any other system in the world today, we use it in our refrigerators, we use it in our homes is the bang-bang method of optimal control, namely when our thermometers goes below a certain figure, our heating systems go on, it's a question of off and on. And when the temperature now rises a certain amount above the goal level, the bang-bang mechanism goes off, it is again a case of tacking. Now, it's true that if I were designing a big airplane and if I have lots of possibilities for an optimal synthesis, I may prefer to a sledgehammer bang-bang approach a more gradual approach and in fact I do favor a more gradual approach. You know leaving all metaphors aside that my more gradual approach in this matter is to have monetary policy lean against the wind as best we can predict where the wind will be in the future after that period of lag when monetary policy takes its effect and I do not believe on the basis of the studies that I have seen that one must be an agnostic in thinking that such a prediction is possible and that following such a philosophy will do more harm than good. In a nutshell then, I think that after we have had too much inflation, and too increase increase in the money supply by the Federal Reserve, we should have its opposite. Now, I can advise this on the Federal Reserve with better conscience because my full philosophy is that the Federal Reserve does not now have to decide what it will do for the next six months, some of the experts who presume to advise the Federal Reserve talk of the following terms, they say you should have at any one time a definite policy. That policy should be in season for a long time. When I counsel you what to do, I say to myself, what should you be doing for the next six months? Because you are stuck with that policy. That isn't at all the view that I take as an adviser. My view is that the Federal Reserve should be tacking, it should be changing its course often as the best indications of the future winds come in and therefore if I'm wrong and if following my advice and having the money supply level off or growing at only 1% for a while, should turn out to give some indications of trouble in the future, I don't think the Federal Reserve should hold on to that course. I'm as near as the nearest telephone. I am perfectly prepared to tell them to ease up. It's again, to use analogies for the purpose of clarifying the position and not for the purpose of persuading, it's like playing a fish. You give him some line, and then you reel in a line whereas if somebody tells you the only way to catch a fish, a large fish and with a weak line is just a steady pressure, that's of course in the case of fishing nonsense. Well, for reasons that have nothing to do with fishing, I think that that is not good policy in the field of monetary policy. 

- Professor Samuelson, earlier you mentioned that you were gonna make some methodological comments about the kind of forecast the Conference Board put out at the end of last year. Would you like to do that right now? 

- I think, I'll pass up that opportunity. There will be plenty of time to go into those matters. I'd like to spend some more minutes on evaluating as objectively as I can certain aspects of monetarism by which I mean only a view that the primary macroeconomic variable to watch for the purpose of predicting and controlling aggregate demand in the period of a year or two ahead is the money supply and its rate of growth with definitely secondary emphasis to be placed upon fiscal policy variables like changes in tax rates or changes in expenditure. I've just been reading an interesting article on monetarism that my colleague, Robert Solow of MIT has written for The London Times. Professor Solow is a very eminent economist in many fields and he's this year the Visiting Eastman Professor at Balliol College in Oxford. And so, he naturally has a special interest in the debate that has been going on in England over whether the rate of growth of the money supply is a trivial variable or is the all-important variable that macroeconomic policy should concentrate on. As I mentioned in an earlier tape, for a long time many British experts poo pooed the role of money. Actually concluding in the infamous official Radcliffe Report in effect that money does not matter. Now, a number of us have been trying to convert these experts back to commonsense. In particular Harry Johnson who was originally a Canadian but who now holds the Chair at the London School of Economics part of the year and the Chair at the University of Chicago the other part of the year has written an article in The Times earlier in November I believe in which he chastised the British economists for not believing in monetarism and Professor Solow is taking a more eclectic position in which he is scolding the English economists for being so doctrinairism thinking earlier that money did not matter and he's also scolding them for having accumulated so little evidence on the subject but he is awarding them I guess swallowing a simplest version of monetarism. Now, I won't go into his particular arguments because I think they overlap with some things that I wrote for the British in The Sunday Telegraph and which I've mentioned in earlier tapes but I'd like to go into some new material that I find in his article. First, there's a chart which shows from 1956 on the behavior of the money supply in Britain and the behavior of the Gross National Product. And to my surprise, the trend of the rate of growth of the money supply in England is quite a smooth one. Now, I don't think it would in every period conform to the Joint Committee's stipulation that it always be between 2% and five or 6% but I think over any year's period, it would be quite smooth. So, looking at this chart, we have almost a laboratory experiment to see how monetarism might work out. It's interesting by the way that it's only a smooth trend but it's a smooth trend at what one supposes is about it's right rate because there's a chart of the rate of real growth of the British GNP and the two curves just hug each other and go along in parallel. You might think then that everything that was proper in a macroeconomic field was done in Britain and what's all the shooting about? Well, we know that the British economy has had a very unsatisfactory performance on many counts and the third diagram chart shows that the rate of growth of the actual GNP in money terms, not its real growth was quite inflationary. So, we have here a simplest demonstration that just controlling the rate of growth of the money supply as your primary macroeconomic variable is not conducive to controlling inflation in the British case. Finally, since my time is almost up, I will quote from Professor Solo who refers to the only test that he has seen for the United Kingdom of the role of the money supply and it is by no means so favorable to the money supply. Quote it was done C.R. Barret and Professor A.A. Walters then of the University of Birmingham who were aware of the difficulties I've just been raising. Even so, they give the pound to the money supply only before the First World War. The simple Keynesian approach which I may say I myself do not advocate, this is not Solow speaking, Samuelson speaking, wins out in the inter-war period and it does slightly better after the Second World War period. Well, I don't think that such tests are worth very much 'cause I don't think you can settle these by simple tests as to which of them by itself did better. I believe that you have to mix the two together and an eclectic position is the best one, you've heard that before from me and as I sign off, I make the prediction that you'll hear it again from me in the future. 

- Thank you for Professor Paul Samuelson of MIT. If you have questions, comments or suggestions, write Instructional Dynamics Incorporated, 166 East Superior Street, Chicago, 60611.