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William | Hello. | 0:02 |
This is William Clark, financial editor | 0:02 | |
of the Chicago Tribune, | 0:04 | |
welcoming you to this weekly series of commentaries | 0:05 | |
on current economic development. | 0:09 | |
Reporting to you will be one of the nation's | 0:11 | |
leading economists, Professor Milton Freedman, | 0:13 | |
of the University of Chicago. | 0:16 | |
Milton | I am delighted to welcome you | 0:18 |
to this series, Mr. Clark. | 0:19 | |
I am sure that your participation in it | 0:21 | |
will make it much more valuable to our subscribers. | 0:24 | |
William | Well, thank you. | 0:27 |
I'm very pleased to be here, and I'm looking forward | 0:27 | |
to these discussions. | 0:29 | |
I'm sure it'll help my own education. | 0:31 | |
That'll be worthwhile (laughs). | 0:33 | |
You have some correspondence from subscribers. | 0:36 | |
I noticed that some of it comes from the academic world, | 0:40 | |
and some of it comes from the business world with questions | 0:43 | |
suggesting subjects they'd like you to comment on. | 0:46 | |
May I read this one in part which is | 0:49 | |
from a professor at a mid-western university? | 0:52 | |
Professor | "Will you please answer this question?" | 0:56 |
William | I am quoting from the letter. | 0:58 |
Professor | "What is the effect of our present, | 1:00 |
"fixed exchange rate system on our foreign trade? | 1:02 | |
"By holding the dollar at an artificially high value | 1:05 | |
"in terms of foreign money, | 1:08 | |
"are we not loading the dice in favor | 1:10 | |
"of the American importer and against the exporter? | 1:13 | |
"If so, why don't our industries such as steel, | 1:16 | |
"which are complaining of imports, take a stand | 1:20 | |
"for free exchange rates?" | 1:23 | |
Milton | The subscriber is entirely right, | 1:25 |
and we are loading the dice. | 1:28 | |
By maintaining the dollar at a rate which overvalues it, | 1:30 | |
that is to say, making the dollar more expensive | 1:35 | |
in terms of foreign currencies | 1:37 | |
than it would be in a free market, | 1:39 | |
we are, in effect, making American goods expensive | 1:41 | |
to foreign purchasers and foreign goods cheap to Americans, | 1:44 | |
and thus stimulating imports and retarding exports. | 1:48 | |
That's why we've been forced-- we have not been forced to-- | 1:52 | |
but have decided to put on a large measure | 1:55 | |
of direct controls to reduce imports. | 1:57 | |
At the same time it's perfectly understandable | 2:00 | |
why the import industries like steel | 2:02 | |
don't proceed to argue for free exchange rates. | 2:05 | |
As they see it, they see it as it affects themselves, | 2:09 | |
as each one of us tends to see | 2:13 | |
what affects him most personally. | 2:15 | |
And if we look, for example, at steel, | 2:17 | |
while steel would benefit from a policy | 2:19 | |
of free exchange rates, | 2:23 | |
which would lead to a lower market value of the dollar, | 2:23 | |
and hence to less competition from other countries' steel, | 2:28 | |
they would benefit from that, | 2:32 | |
but they would benefit still more, as they see it, | 2:34 | |
from an import quota on steel. | 2:36 | |
That's directed immediately at their own needs. | 2:37 | |
All of the benefit of that goes to them. | 2:39 | |
Moreover, they would argue that | 2:42 | |
from a political point of view, | 2:43 | |
once you start talking about exchange rates in general, | 2:45 | |
you're taking on a much larger range of interest, | 2:48 | |
you're taking on the banks and the financial interests | 2:52 | |
that may have a different point of view. | 2:54 | |
So that I think in the first instance, | 2:56 | |
the reason why the import industries don't | 2:58 | |
talk about exchange rates is | 3:00 | |
because they feel that they can get more by concentrating | 3:02 | |
their political power on a narrower sector. | 3:06 | |
In the second instance, the reason why they don't talk | 3:09 | |
about it is because I am sure there is not | 3:12 | |
a full understanding of the situation. | 3:13 | |
Most people do not recognize that we have been | 3:16 | |
following a policy which has been discriminating | 3:20 | |
against our own export industries | 3:22 | |
or against the industries competing with imports. | 3:25 | |
William | I suppose the most effective way to get | 3:27 |
an industry to campaign for something | 3:31 | |
like free exchange rates or something of that order, | 3:34 | |
would be through an association, wouldn't it? | 3:37 | |
You'd almost have to approach it through | 3:39 | |
the American Manufacturer's Association or | 3:41 | |
the American Banker's Association, | 3:43 | |
rather than on a one-industry basis. | 3:45 | |
Milton | I suppose so. | 3:47 |
But once you start doing that, you get the-- | 3:47 | |
as you always do in these areas of conflict | 3:49 | |
between the importers and the exporters | 3:51 | |
and between different domestic industries-- | 3:53 | |
so that, in fact, unless you have | 3:55 | |
a narrowly-defined industrial group, | 3:58 | |
like the steel people, | 4:00 | |
like the Iron and Steel Institute, | 4:01 | |
and then from their point of view, | 4:03 | |
they will see a bigger payoff in going | 4:06 | |
for import quotas on steel, | 4:08 | |
which will solve their problem regardless | 4:10 | |
of what else happened. | 4:11 | |
I say will solve their problem. | 4:13 | |
I don't mean that. | 4:14 | |
I'm using it as an example. | 4:15 | |
In fact, I think import quotas on steel | 4:16 | |
will not solve the steel industry's problem. | 4:18 | |
I'm firmly opposed to 'em. | 4:20 | |
I think it would be most undesirable. | 4:22 | |
In fact, I think that the steel industry in the long run, | 4:24 | |
would be better off in a world | 4:26 | |
with freer exchange rates and less import quotas. | 4:28 | |
But, as I've emphasized before, one of the things | 4:31 | |
that fascinates me is how short-sighted industries are | 4:33 | |
when it comes to looking at such broader issues. | 4:36 | |
In terms of as they see it, they would benefit much more | 4:39 | |
from steel quotas. | 4:42 | |
William | Doctor, here is a question from a banker. | 4:43 |
Banker | "You have expressed the belief--" | 4:47 |
William | And again I'm quoting. | 4:49 |
Banker | "You have expressed the belief | 4:50 |
"that federal tax policy, specifically as related | 4:51 | |
"to the surcharge, but as a comment on all tax policy, | 4:53 | |
"has no economic impact in and of itself. | 4:57 | |
"It all depends, you say, | 5:01 | |
"on what associated monetary policy is doing. | 5:02 | |
"But doesn't the reverse also hold true? | 5:05 | |
"Would not the effects of a given monetary policy | 5:08 | |
"be reinforced or diminished as the case might be | 5:11 | |
"by a shift in tax policy? | 5:14 | |
"Given, for example, a constant five percent | 5:16 | |
"money supply expansion, which you recommend, | 5:19 | |
"would not a higher tax rate at a specified level | 5:22 | |
"of federal spending produce a slower rate | 5:25 | |
"of economic expansion than that achieved | 5:28 | |
"with a substantially lower tax rate?" | 5:31 | |
Milton | If I were to answer this question | 5:33 |
in one word, it would be no. | 5:35 | |
But I am sure that the subscriber | 5:37 | |
wants a much fuller answer than that. | 5:41 | |
Part of the answer | 5:44 | |
is to | 5:46 | |
make sure what we mean | 5:48 | |
when we talk about an economic impact. | 5:50 | |
The subscriber says that I've urged that the surtax | 5:53 | |
has no economic impact in and of itself. | 5:57 | |
That's true and it's also false, | 6:00 | |
because we have to distinguish different kinds | 6:03 | |
of economic impacts. | 6:05 | |
Particularly, the main kind of economic impact | 6:06 | |
I have been speaking of is the impact on total spending, | 6:11 | |
on GNP movements, on inflation, on deflation. | 6:15 | |
I believe that tax policy has no significant impact | 6:19 | |
on that for a given monetary policy. | 6:23 | |
That it only has an impact if it changes a monetary policy. | 6:27 | |
It's not-- and this is a major source of misunderstanding | 6:30 | |
in this area. | 6:33 | |
Here are two different statements one can make: | 6:35 | |
The first statement is that tax policy has some effect. | 6:37 | |
Monetary policy has some effect. | 6:40 | |
What the aggregate effect will be depends | 6:42 | |
on the particular mixture of tax policy | 6:44 | |
and monetary policy you adopt. | 6:46 | |
That's really the viewpoint expressed by the subscriber. | 6:48 | |
The viewpoint I am taking in this area is | 6:50 | |
a very different one. | 6:53 | |
I am saying that it's the monetary policy that matters. | 6:55 | |
The tax policy might have an effect | 7:00 | |
if it changed the monetary policy. | 7:02 | |
It's not that the mix matters. | 7:04 | |
It's what tax policy does to monetary policy. | 7:06 | |
Now that's so far as inflation, deflation is concerned. | 7:10 | |
If in the case the subscriber suggests, | 7:14 | |
a constant five percent money supply expansion, | 7:18 | |
then I would say, if you really can take that for granted, | 7:21 | |
then what taxes are in relation to spending | 7:24 | |
will not in any way affect whether GNP rises | 7:26 | |
at four percent, five percent, or six percent. | 7:30 | |
In fact, under those circumstances, | 7:32 | |
GNP would tend to be rising somewhere | 7:34 | |
around four to six percent. | 7:36 | |
Somewhere in that neighborhood. | 7:37 | |
But that still doesn't mean that the tax policy | 7:39 | |
wouldn't have an economic impact. | 7:41 | |
But it would have an economic impact | 7:43 | |
of a very different kind. | 7:44 | |
It would have an economic impact | 7:46 | |
on what fraction of our income we would be spending | 7:48 | |
through the government. | 7:52 | |
It would have an economic impact | 7:53 | |
on interest rates and capital markets. | 7:55 | |
And interestingly enough, that second economic impact | 7:57 | |
is precisely the opposite | 8:00 | |
of that which the subscriber suggests. | 8:02 | |
Let me see if I can make that clear. | 8:04 | |
Suppose that with a constant five percent | 8:07 | |
money supply expansion, a higher tax rate were imposed. | 8:09 | |
Federal spending is not changed. | 8:14 | |
Let's suppose that goes so far | 8:17 | |
that the federal government is running a surplus. | 8:19 | |
It's taking in more than it's paying out. | 8:21 | |
What does it do with that surplus? | 8:23 | |
It retires bonds. | 8:24 | |
What does that do? | 8:25 | |
It provides funds to the capital market. | 8:26 | |
In effect, | 8:28 | |
that fiscal policy involves | 8:30 | |
forcing the taxpayers to save the excess | 8:33 | |
of tax payments over expenditures, | 8:37 | |
and therefore it adds to the funds available for saving. | 8:39 | |
As these funds available for saving | 8:43 | |
come on the capital markets, | 8:44 | |
they would tend to drive down interest rates, | 8:46 | |
which would tend to induce business enterprises | 8:48 | |
to expand capital formation. | 8:51 | |
As they expanded capital formation, | 8:53 | |
we would have more and more factories, | 8:55 | |
more and more machines. | 8:57 | |
We would have greater productivity of labor. | 8:57 | |
We would have a greater, a more rapid rate | 9:00 | |
of economic expansion in real terms. | 9:02 | |
GNP in nominal terms, in dollar terms, | 9:05 | |
might still be rising at, let's say, five percent. | 9:08 | |
But instead of that being say four percent, | 9:11 | |
or let's say three percent real rate of rise | 9:15 | |
and two percent price rise, | 9:18 | |
the effect of a higher tax relative to expenditure | 9:20 | |
might be a negative four percent rate of rise | 9:23 | |
instead of at a one percent tax rise. | 9:26 | |
That is, it would stimulate investment | 9:27 | |
and capital formation. | 9:31 | |
Indeed, one of the fascinating things | 9:32 | |
about the history of the last ten years | 9:34 | |
is that when Mr. Kennedy first came in as president, | 9:36 | |
the economic advisors who came in at that time, | 9:40 | |
Walter Heller came in as chairman | 9:42 | |
of the Council of Economic Advisers, | 9:43 | |
were for exactly the reasons I've been citing | 9:45 | |
in favor of what they called a tight fiscal policy | 9:47 | |
and an easy money policy. | 9:51 | |
That is, they wanted high taxes relative to expenditure, | 9:53 | |
because they thought this would enable interest rates | 9:56 | |
to stay relatively low. | 9:59 | |
And they wanted interest rates to stay relatively low, | 10:00 | |
because they were very, very strongly | 10:03 | |
oriented toward growth. | 10:05 | |
They were talking about getting the economy | 10:06 | |
moving again, you remember. | 10:08 | |
William | Right. | 10:09 |
Yes, indeed. | 10:11 | |
Milton | What happened was that they were forced | 10:11 |
to drop this policy by the pressure | 10:14 | |
of the balance of payments. | 10:15 | |
They discovered that we were having | 10:17 | |
a balance of payments outflow. | 10:18 | |
Low interest rates would discourage | 10:20 | |
inflows of capital and encourage outflows of capital. | 10:22 | |
And so they were led to shift from a tight fiscal policy | 10:25 | |
to an easy fiscal policy, to recommend the tax cut of '64. | 10:28 | |
Not really in order to stimulate the economy, | 10:32 | |
but in order to enable high interest rates | 10:34 | |
to be associated with the full employment at home | 10:37 | |
and to solve the balance of payments problem. | 10:40 | |
I think this is a great mistake to mix up these things. | 10:43 | |
In my opinion, the sensible thing to do, | 10:47 | |
as I indicated in the answer to the first question, | 10:50 | |
is to allow free exchange rates, | 10:52 | |
movements in exchange rates to solve the | 10:54 | |
balance of payments problem. | 10:56 | |
Then to use monetary policy to give you | 10:58 | |
a stable internal economy, | 11:00 | |
that is to keep income rising at a steady rate | 11:04 | |
to avoid inflation. | 11:06 | |
And then use tax policy for the other objectives | 11:08 | |
for which tax policy is appropriate. | 11:11 | |
Namely, for deciding what we want to do | 11:13 | |
through government rather than privately. | 11:15 | |
And indeed I can understand people who might think | 11:17 | |
that the rate of private saving is too low | 11:19 | |
and who might want to have a large volume | 11:21 | |
of government savings. | 11:23 | |
And that seems to me to be a very, very | 11:24 | |
effective and efficient way of organizing our economy. | 11:28 | |
We've got three tools as it were. | 11:31 | |
We've got three kinds of objectives. | 11:33 | |
Why not use each tool for that objective | 11:35 | |
for which it's best suited? | 11:37 | |
Exchange rates for foreign balance of payments, | 11:39 | |
monetary policy for inflation, deflation, | 11:42 | |
taxes for deciding how to use our resources. | 11:44 | |
William | Now you referred to the policies of the advisors | 11:47 |
and monetary authorities during the Kennedy's | 11:52 | |
and the Johnson administrations, Doctor. | 11:54 | |
How do you read, and I know you're pretty close | 11:56 | |
to the current team in Washington, the new team. | 11:59 | |
What is your reading on the views of the new group | 12:02 | |
of advisors to President Nixon? | 12:06 | |
Milton | Well there is no doubt that that new group | 12:09 |
of advisors has a very different slant | 12:11 | |
and a very different view than the new economists | 12:13 | |
who have just left. | 12:16 | |
The new group of advisors include, of course, | 12:18 | |
Paul McCracken as chairman | 12:21 | |
of the Council of Economic Advisers. | 12:23 | |
Bob Mayo as new Budget Director, | 12:24 | |
David Kennedy as new Secretary of Treasury. | 12:28 | |
And more recently, three more individuals | 12:31 | |
who have been named. | 12:34 | |
Charlie Walker who has been named as the | 12:35 | |
Under Secretary. | 12:38 | |
William | Charls without the "e" at the end of Charles. | 12:39 |
The poor fellow gets his name wrong in print | 12:42 | |
more than anybody I know of (laughs). | 12:44 | |
Milton | And, interestingly enough, | 12:45 |
he's very sensitive about it. | 12:47 | |
William | Yes, I know (laughs). | 12:48 |
Milton | Charls Walker is Under Secretary | 12:50 |
to the Treasurer. | 12:51 | |
Paul Volcker-- | 12:53 | |
Folker. I'm not sure how he pronounces it. | 12:54 | |
It's V-O-L-K-E-R. | 12:57 | |
I met him, but I don't know him well. | 12:58 | |
As Under Secretary to the Treasury for Monetary Affairs. | 13:00 | |
And most recently of all, President Nixon has just named | 13:02 | |
Arthur F. Burns, who was the Chairman of the Council | 13:06 | |
of Economic Advisers under Eisenhower, | 13:08 | |
as his Special Counselor. | 13:11 | |
Now all of these gentlemen have views that differ | 13:13 | |
sharply from the former team in two respects. | 13:18 | |
First place, all of 'em will feel | 13:23 | |
that fine-tuning has been carried too far. | 13:27 | |
They all feel that when the government tries to intervene | 13:30 | |
very sensitively from day to day and week to week, | 13:33 | |
it's likely to cause more trouble than it cures, | 13:36 | |
that it's far better for the government | 13:38 | |
to maintain a longer period stance, | 13:40 | |
try to influence the general environment, | 13:42 | |
and allow the private enterprise economy | 13:44 | |
and the private markets to adjust | 13:46 | |
within that general environment. | 13:48 | |
In the second place, all of them, without exception, | 13:50 | |
I think, would give greater weight to monetary policy | 13:52 | |
as opposed to fiscal policy | 13:56 | |
as a tool for short-term economic adjustment | 13:57 | |
than would the outgoing set. | 14:02 | |
Now that doesn't mean necessarily that they would to | 14:07 | |
as far as I would in attributing essentially no influence | 14:09 | |
on this area in respect of aggregate demand, | 14:14 | |
no influence to fiscal policy, | 14:17 | |
and dominant influence to monetary policy. | 14:20 | |
But all of them would go much farther | 14:23 | |
than the former administration did | 14:24 | |
and the former economists did in this respect. | 14:26 | |
William | How would their feelings, do you think, | 14:29 |
be translated to the Federal Reserve Board, | 14:31 | |
or can they be or will they be? | 14:32 | |
Milton | Well that's a very interesting problem, | 14:36 |
because of course, if monetary policy is the key, | 14:37 | |
as I think it is, to whether we're going to have | 14:41 | |
a stepping up of inflation in the next six months | 14:43 | |
or next year, or whether we're going to be able | 14:46 | |
to taper it off. | 14:48 | |
If it is a key, then the Federal Reserve Board | 14:50 | |
becomes critical, and of course, | 14:53 | |
constitutionally the Federal Reserve is independent. | 14:54 | |
Now the interesting thing about that problem | 14:58 | |
is the problem is not one of willingness | 15:00 | |
or anything like that. | 15:04 | |
President Nixon will, of course, be talking | 15:06 | |
with the members of the Board, | 15:08 | |
and the members of the Board will be listening. | 15:10 | |
Moreover, I believe the basic objectives | 15:12 | |
of the members of the Federal Reserve Board | 15:15 | |
and of President Nixon are exactly the same. | 15:16 | |
Both of 'em would like to see a tapering off of inflation. | 15:18 | |
I think the problem is a very different one. | 15:22 | |
I think the problem is, in a sense, | 15:24 | |
within the Federal Reserve Board. | 15:26 | |
Whether the Federal Reserve Board can achieve, | 15:28 | |
has itself organized in such a way as to achieve | 15:30 | |
the objectives it would like to achieve. | 15:35 | |
Here we have the evidence of the past six months. | 15:37 | |
During the past six months, the Federal Reserve Board | 15:40 | |
has been extraordinarily expansionary. | 15:43 | |
Quantity of money measured by currency, | 15:46 | |
demand deposits, and commercial bank time deposits | 15:49 | |
has been rising at a rate | 15:51 | |
of about 12 percent a year. | 15:52 | |
What the Federal Reserve Board looks at | 15:55 | |
is sometimes called the Bank Credit Proxy, | 15:56 | |
which is essentially in its essence, | 15:59 | |
the deposits of commercial banks, | 16:01 | |
who rose in the last six months of 1968 | 16:04 | |
at an annual rate of 12.9 percent. | 16:07 | |
Close to 13 percent a year. | 16:09 | |
Now suppose you asked a | 16:11 | |
Federal Reserve Board member, | 16:12 | |
did you plan it that way? | 16:14 | |
Did bank credit rise at 13 percent a year | 16:16 | |
because you intended it to? | 16:18 | |
I am sure. | 16:21 | |
I have asked similar questions to Federal Reserve | 16:22 | |
Board members in the past. | 16:24 | |
And I am sure that each and every one of them | 16:25 | |
would say to you, no, we didn't plan it that way. | 16:27 | |
We would really have preferred it if bank credit | 16:31 | |
had risen let us say at seven percent | 16:33 | |
instead of thirteen percent. | 16:35 | |
William | Well couldn't they have done something about it? | 16:36 |
Milton | Yes, indeed. | 16:39 |
In my opinion, they could. | 16:40 | |
They have the power to do something about it, | 16:41 | |
if they wish to exercise their power that way. | 16:43 | |
Well, then you'll ask me the question, | 16:46 | |
which I've asked them. | 16:48 | |
Why didn't they? | 16:49 | |
William | Why didn't they? | 16:50 |
Exactly. | 16:51 | |
Milton | Well I have been repeatedly frustrated | 16:51 |
over the years and asking that question. | 16:54 | |
And the reason seems to be that they have a mechanism | 16:55 | |
of operation, of adjustment, | 17:01 | |
a way of exerting their influence, | 17:03 | |
which is not very well suited to achieving | 17:07 | |
specified money supply or credit growth targets. | 17:11 | |
Their method of operating grew up during a period | 17:14 | |
when the Federal Reserve Board emphasized interest rates, | 17:18 | |
not money supply, not quantity of money as a major factor. | 17:21 | |
And it's a method of operation that is pretty well suited | 17:24 | |
to controlling short-term movements and interest rates. | 17:28 | |
You see, part of the big problem is that you've | 17:34 | |
got a creature whose head is in Washington | 17:36 | |
and whose hands are in New York, and it's not always clear | 17:38 | |
that the head and the hands are the same. | 17:42 | |
William | What do you mean by that, Doctor? | 17:43 |
Milton | Well, the policy-making body | 17:45 |
in the Federal Reserve system | 17:48 | |
is the Open Market Investment Committee. | 17:50 | |
The Open Market Investment Committee, | 17:52 | |
that's the most important single policy-making body. | 17:53 | |
It consists, as a technical matter, | 17:56 | |
of the seven members of the Federal Reserve Board | 17:59 | |
plus five selected Federal Reserve Board bank presidents. | 18:01 | |
New York Bank president is always a member of that group. | 18:05 | |
I think the Chicago Bank president is. | 18:08 | |
Some of the others rotate. | 18:10 | |
Technical matter, it's those twelve. | 18:12 | |
As a matter of fact, not what's true on paper, | 18:14 | |
all Federal Reserve Bank presidents | 18:17 | |
come to those meetings, and as a matter of fact, | 18:19 | |
what you really have is a group of nineteen, | 18:21 | |
seven board members and twelve presidents, | 18:24 | |
although only of those nineteen, only twelve of them, | 18:27 | |
the seven board members and five presidents, have a vote. | 18:31 | |
Now this Open Market Investment Committee, | 18:34 | |
it makes policy once every three weeks | 18:36 | |
when it meets in Washington. | 18:38 | |
It passes that policy on. | 18:40 | |
That's what I call the head. | 18:41 | |
On the other hand, the people who execute that policy | 18:43 | |
are in New York. | 18:46 | |
They are what the Fed refers to as the people at the desk. | 18:47 | |
The man in New York who buys and sells. | 18:50 | |
The man in New York who every morning at 10:00, | 18:52 | |
or whenever he opens for business, I don't know exactly. | 18:55 | |
He picks up the telephone and calls, I don't know, | 18:57 | |
seven or ten dealers and asks them what their | 19:00 | |
situation is today. | 19:02 | |
By dealers I mean dealers in U.S. government bonds. | 19:03 | |
And then he will call banks. | 19:06 | |
[Inaudible] The man at the desk is in New York. | 19:09 | |
The instructions are transmitted from Washington | 19:11 | |
to New York in the form of the so-called directive, | 19:14 | |
the Open Market directive. | 19:17 | |
If you read that, it's like reading a coded message, | 19:19 | |
because there are words in there that seem | 19:22 | |
to have no meaning. | 19:24 | |
You look at it week after week, | 19:25 | |
and it seems to be saying the same thing. | 19:26 | |
But every slight change has some significance. | 19:28 | |
However, the instructions are not very precise | 19:30 | |
in money supply terms. | 19:34 | |
They are expressed in terms like keeping credit conditions | 19:35 | |
as they were last week, | 19:40 | |
provided that bank reserves don't expand too rapidly, | 19:41 | |
or don't expand by more than x dollars. | 19:47 | |
That's the way it's written. | 19:50 | |
And in fact, the way in which the Board-- | 19:51 | |
the desk has always operated | 19:54 | |
is through this so-called feel of the market. | 19:56 | |
Through saying, well, if the market looks tight, | 19:58 | |
we have to provide a little reserves, | 20:00 | |
if it looks easy, as they see it. | 20:02 | |
But what looks tight or easy in New York | 20:04 | |
in terms of interest rates, | 20:06 | |
may have very little relationship to what's happening | 20:07 | |
to the total quantity of money. | 20:11 | |
Take this last six months. | 20:13 | |
As I say, I have no doubt that the Fed | 20:14 | |
would have preferred the quantity of money | 20:16 | |
to go up less rapidly. | 20:17 | |
Why did it go up so rapidly? | 20:19 | |
Well, I have no full explanation, because, as I say, | 20:21 | |
I've been baffled by this process. | 20:24 | |
But I think that there are two factors that explain | 20:26 | |
why they made, what I regard | 20:29 | |
and what they would regard, as a mistake. | 20:32 | |
The first factor is that whenever interest rates | 20:35 | |
are tending to rise as they-- | 20:39 | |
You will remember the initial impact | 20:44 | |
of the surcharge was a decline | 20:47 | |
in interest rates as you would expect. | 20:50 | |
But subsequently interest rates started to rise, | 20:51 | |
and they continue to rise. | 20:53 | |
Whenever they start to rise, it looks to the people | 20:55 | |
in New York as if conditions are "tight" as they seem, | 20:58 | |
because people are trying to borrow | 21:01 | |
at lower interest rates, and they can't do it. | 21:02 | |
And so they have a tendency to try | 21:05 | |
to keep interest rates from rising quite as fast. | 21:06 | |
And in the short run, for a brief period, | 21:09 | |
they can do it by buying more on the open market. | 21:12 | |
And so you will observe that in those periods | 21:15 | |
when interest rates have tended to be rising, | 21:17 | |
the banks have been tending to-- | 21:19 | |
the Federal Reserve system has been expanding | 21:21 | |
the quantity of money. | 21:24 | |
Now I may say this is not a new phenomenon. | 21:25 | |
Exactly the same phenomenon helps to explain | 21:27 | |
the disastrous policy of the Federal Reserve | 21:30 | |
from '29 to '33. | 21:32 | |
At that time interest rates were tending to fall. | 21:34 | |
And they were acting in such ways | 21:37 | |
to keep 'em from falling, which meant that they | 21:38 | |
were pulling money out of the system and contracting it. | 21:40 | |
So coming back here, I think that this tendency | 21:44 | |
to operate in terms of what's happening to interest rates, | 21:46 | |
is a major factor that makes their-- | 21:48 | |
Well, within the system, they call this a linkage. | 21:52 | |
Well, you can see what it means. | 21:55 | |
A linkage between the [inaudible]. | 21:56 | |
And it's one of the major factors that makes this linkage | 21:58 | |
a very ineffective one. | 22:01 | |
A second factor, which I should mention, | 22:03 | |
is that the Federal Reserve Board economists, | 22:07 | |
like most other economists, | 22:09 | |
have grossly overestimated the importance | 22:10 | |
of fiscal policy relevant to monetary policy. | 22:12 | |
They have been taken in by the general line of thought. | 22:14 | |
And so when the surtax was passed, | 22:17 | |
the Federal Reserve Board economists | 22:19 | |
thought that there was danger, | 22:21 | |
that there would be a slow-down in the economy; | 22:22 | |
and as a result, wherever they were in doubt, | 22:25 | |
they leaned in the direction of pouring in money. | 22:27 | |
And the combination of these two factors | 22:30 | |
has led to a very large deviation | 22:31 | |
in this past six months between what the Fed | 22:33 | |
would have liked to achieve and what it, in fact, achieved. | 22:36 | |
And that's why, as I see it, the real problem in this area | 22:38 | |
is not how do you get the Federal Reserve | 22:41 | |
to want to do the right thing? | 22:45 | |
But how does the Federal Reserve reorganize | 22:48 | |
its own operating procedures | 22:50 | |
so as to be able to do the right thing? | 22:52 | |
Let me emphasize that what I'm saying is more true today | 22:54 | |
than it would have been three or four years ago. | 22:58 | |
As of three or four years, or five years ago, | 22:59 | |
and certainly the farther back the more, | 23:01 | |
the greater the extent to which the Federal Reserve | 23:03 | |
would have denied completely that the money supply | 23:06 | |
had anything to do with anything, and to which they | 23:08 | |
would have deliberately defended the interest rate target. | 23:10 | |
But the thing that has fascinated me | 23:15 | |
as the years have gone on, | 23:18 | |
is that the Fed has begun to shift on this area. | 23:19 | |
William | This was what I was going to ask, Doctor. | 23:22 |
You do see some little indications of a shift. | 23:24 | |
Milton | Oh, I think there are very large indications. | 23:27 |
But you know, this is a large organization, | 23:29 | |
it's slow for it to move, and it takes a long time | 23:32 | |
between shifts in the head of it to get down | 23:35 | |
to the hands and the feet. | 23:37 | |
William | The personnel of the board | 23:38 |
itself changes slowly. | 23:40 | |
I suppose there's a very large staff, | 23:43 | |
a rather permanent staff that may [crosstalk] on this. | 23:46 | |
Milton | Oh yes. | 23:49 |
There's a large staff of economic research. | 23:49 | |
But most of those are not really concerned | 23:51 | |
with this problem. | 23:52 | |
The largest part of their staff is concerned with things | 23:53 | |
like computing the Federal Reserve Board | 23:55 | |
Index of Industrial Production, | 23:57 | |
what's happening to consumer purchases. | 24:00 | |
The interesting thing to me has been that over the years, | 24:02 | |
if you look at the Federal Reserve Board | 24:04 | |
staff in Washington, in addition there are staffs | 24:06 | |
at each of the 12 Federal Reserve banks. | 24:08 | |
But if you look at the Federal Reserve staff | 24:10 | |
in Washington, most of them are concerned with things | 24:12 | |
other than monetary policy. | 24:14 | |
If you look at the Federal Reserve staffs over the country, | 24:16 | |
most of the economists who could be regarded | 24:18 | |
as working on money, have been in the Federal Reserve system | 24:22 | |
for the last 10 years. | 24:26 | |
In fact, I would say that if you took the number | 24:27 | |
of man-hours available for research | 24:28 | |
on monetary economics and banking economics | 24:30 | |
of a general kind, | 24:34 | |
most of them, ninety percent of them, | 24:36 | |
would have been in the Federal Reserve system somewhere. | 24:38 | |
But unfortunately, their productivity | 24:42 | |
has not been proportional. | 24:43 | |
If you look at the significant literature | 24:45 | |
on monetary economics, | 24:47 | |
I think two percent would be a high estimate | 24:49 | |
for the fraction which has come from the ninety percent | 24:51 | |
who are in the [Inaudible]. | 24:52 | |
Maybe I'm being biased, because I'm in an academic, | 24:54 | |
in a university environment. | 24:57 | |
William | Doctor, I'm looking at the Wall Street Journal, | 25:00 |
which every week has a regular story on, well, | 25:02 | |
this one this week is headed | 25:05 | |
Federal Reserve Keeps Firm Hold on Credit Reins. | 25:06 | |
And the first paragraph, the Federal Reserve system | 25:09 | |
maintained its firm hold on the nation's credit range | 25:12 | |
in the weekend [and Wednesday?] pressing the bank's | 25:15 | |
net reserve position to the tightest level | 25:16 | |
in more than nine years. | 25:19 | |
According to figures released yesterday | 25:21 | |
by the New York Federal Reserve Bank. | 25:23 | |
What is the significance of that? | 25:25 | |
How significant is it? | 25:27 | |
Milton | Well most of that weekly article is boiler plate. | 25:28 |
That has some numbers and words changed from week to week, | 25:32 | |
and is almost utterly meaningless. | 25:35 | |
I think it does more harm than good to try | 25:37 | |
to follow what it does. | 25:39 | |
The reason for that is, that they concentrate | 25:40 | |
on the wrong criteria, and we're back again | 25:44 | |
on the position we were looking at before. | 25:46 | |
They keep looking at-- | 25:48 | |
The thing they cite week after week | 25:49 | |
is net borrowed reserves. | 25:52 | |
That's not a very meaningful figure. | 25:53 | |
It's not a very meaningful total. | 25:57 | |
Now, we're in a complicated area, | 25:59 | |
which I think it's worth going into to some extent, | 26:03 | |
but I'm not sure we have the time today-- | 26:05 | |
William | Well, we are getting a little close on time. | 26:09 |
What would it be more meaningful for them to treat | 26:11 | |
in an article like this, Milton? | 26:14 | |
Milton | It would be much more meaningful for them | 26:17 |
if they dropped all the references to net borrowed reserves, | 26:19 | |
and concentrated their article on what was happening | 26:22 | |
to monetary totals. | 26:25 | |
In particular, what was happening to the quantity | 26:27 | |
of reserves, base money, and the amount of money | 26:31 | |
that's available for banks to use as reserves. | 26:34 | |
What was happening to the money as narrowly-defined | 26:37 | |
currency plus demand deposits, | 26:40 | |
what is happening to money as broadly-defined currency | 26:42 | |
plus demand plus time deposits. | 26:44 | |
They ought to present these figures, and then it would be | 26:46 | |
perfectly appropriate for them also to present | 26:49 | |
figures on interest rates and what interest rates are doing. | 26:51 | |
But the particular magic numbers of net borrowed reserves | 26:54 | |
that they have concentrated on, are, | 26:57 | |
as I say, extremely misleading. | 26:59 | |
William | Well, that suggests something | 27:02 |
we can discuss another time, perhaps. | 27:03 | |
Thank you very much, Dr. Freedman. | 27:05 | |
If you subscribers have questions, or comments, | 27:06 | |
or suggestions for topics you would like discussed | 27:09 | |
in this series, please send them to | 27:12 | |
Instructional Dynamics Incorporated, | 27:14 | |
166 East Superior Street, | 27:16 | |
Chicago, 60611. | 27:19 | |
This is William Clark. | 27:22 | |
Dr. Freedman and I will be talking to you again next week. | 27:23 |
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