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William Clark | Hello this is William Clark, | 0:02 |
Financial Editor of the Chicago Tribune, welcoming you | 0:03 | |
on behalf of Instructional Dynamics to this weekly | 0:06 | |
series of commentaries on current economic developments. | 0:09 | |
Reporting to you will be | 0:13 | |
one of the nations leading economists, | 0:14 | |
Professor Milton Friedman, of the University of Chicago. | 0:16 | |
Dr. Friedman, I'd like to start again today with a letter | 0:20 | |
from one of the subscribers. | 0:23 | |
This one comes from a gentleman in California | 0:25 | |
and it's a bit challenging. | 0:28 | |
He starts out by saying | 0:29 | |
"I subscribe to Instructional Dynamics and have been | 0:30 | |
"listening to your very interesting economic lectures." | 0:33 | |
So far so good. | 0:36 | |
Then he says, "However your statements that the economy | 0:37 | |
"has not been slowing down in spite of the tax increase | 0:41 | |
"would seem to be contradicted by the enclosed figures | 0:45 | |
"representing the coincident indicators in the economy. | 0:48 | |
"Dare you answer this criticism in your series of lectures, | 0:51 | |
"I know you dare." | 0:54 | |
Milton Friedman | I'm delighted to because | 0:56 |
the point the subscriber raises is, of course, | 0:58 | |
a very relevant one. | 1:01 | |
If you look at the usual figures, you don't have to go | 1:03 | |
to the coincident indicators, supposed you look at the | 1:07 | |
change in dollar GNP from quarter to quarter, | 1:09 | |
then it is certainly true that the change in dollar GNP | 1:12 | |
in the third and fourth quarters was moderately lower | 1:15 | |
than the change in the first two quarters. | 1:19 | |
I don't remember any more the exact figures, | 1:22 | |
but the first two quarters was a bit over 20 billion dollars | 1:24 | |
per quarter, and the third and fourth quarters was down | 1:27 | |
in the neighborhood of about 17, 18 billion. | 1:30 | |
I think that's right, isn't it? | 1:34 | |
William Clark | Yes, I believe it is. | 1:35 |
Milton Friedman | There was a slight slowing down. | 1:37 |
Does this slowing down mean, therefore, | 1:39 | |
our predictions that the tax surcharge would not have any | 1:43 | |
significant effect on the economy as a whole are wrong? | 1:47 | |
The answer is no it does not mean that. | 1:50 | |
It does not mean that for several reasons. | 1:51 | |
In the first place, there was as it happens a slow down | 1:54 | |
in the rate of monetary growth from about Novemeber of 1967 | 1:59 | |
to about May of 1968. | 2:04 | |
At least as measured | 2:06 | |
by broader monetary total. | 2:08 | |
That is currency plus all commercial bank deposits. | 2:10 | |
Given the six months lag, one might have expected | 2:14 | |
that slow down in monetary growth also to produce | 2:18 | |
a slight slow down in the economy. | 2:20 | |
I don't want to stress this too much, | 2:23 | |
because I don't want to be understood as saying | 2:25 | |
that every minor wiggle in the | 2:28 | |
money figure is going to show up in a precisely comparable | 2:29 | |
minor wiggle in income. | 2:32 | |
There's a lot of noise, | 2:34 | |
a lot of leeway in this relationship. | 2:35 | |
All I'm saying is that slow down could just has easily, | 2:36 | |
and in fact, more easily in terms of past relationships | 2:39 | |
be explained by the slow down in monetary growth | 2:43 | |
as by the tax increase. | 2:45 | |
So far as that evidence along is concerned, it's mixed, | 2:49 | |
it's neutral. | 2:52 | |
Second and more important reason why the slight slow down | 2:54 | |
in the economy can not be interpreted as evidence of the | 2:57 | |
tax effect, from looking at what predictions | 3:00 | |
were being made by two classes of people | 3:05 | |
prior to the tax increase, on the one hand there were those | 3:07 | |
who thought the tax increase would have a large effect | 3:09 | |
on the other hand there were those like myself, | 3:12 | |
and more specifically, I want to site the people | 3:14 | |
who are in the business of making specific forecasts | 3:16 | |
which I am not. | 3:19 | |
There were a group of those | 3:20 | |
who emphasized a monetary approach. | 3:21 | |
Notably I should mention, | 3:23 | |
Harris Trust Company here in Chicago, | 3:24 | |
and the First National City Bank in New York. | 3:26 | |
If you look at the forecast made by these two groups | 3:29 | |
those who emphasize the tax effect forecast a much | 3:32 | |
slower rate of economic growth | 3:35 | |
in the third and fourth quarter than did in fact occur. | 3:38 | |
They were forecasting something like 10 billion dollar | 3:40 | |
increase per quarter | 3:42 | |
instead of the something like 17 billion. | 3:43 | |
On the other hand, the other two groups, | 3:46 | |
based on these past relationships were making forecasts | 3:48 | |
that came very close to hitting the thing on the nose. | 3:51 | |
In the same way that the Federal Reserve Bank of St. Louis | 3:55 | |
in their November bulletin had a regression study of the | 3:57 | |
relation between changes in GNP and monetary change | 4:00 | |
over the past 15 years or so, | 4:05 | |
that showed monetary change to be the dominate factor | 4:07 | |
on the basis of that they made projections | 4:10 | |
of what you could expect in the third and fourth quarter | 4:14 | |
if monetary growth was at various rates, | 4:17 | |
at 2%, 4%, 6%. | 4:19 | |
And it turns out that if you put in to those projections | 4:21 | |
what actually happened to monetary growth their projections | 4:25 | |
are close to hitting it on the nose. | 4:28 | |
So I would say the evidence as a whole for this period | 4:29 | |
certainly tends to be very strongly consistent with, | 4:32 | |
I won't say it proves, that what you observed | 4:36 | |
was not a consequence of the tax fact. | 4:41 | |
William Clark | And this matter of the indicators | 4:45 |
is an interesting subject in itself. | 4:46 | |
I suppose some other time I might question you | 4:48 | |
a little bit about that, but some of the other, | 4:51 | |
the GNP, the Gross National Product, is one of the | 4:53 | |
coincident indicators. | 4:57 | |
Milton Friedman | Yes it is. | 4:58 |
William Clark | Others include the unemployment rate, | 5:00 |
industrial production, personal income, among others. | 5:02 | |
Are they given different weights in this computation? | 5:05 | |
Milton Friedman | Well, there are various ways | 5:08 |
that different people combine them. | 5:10 | |
There is a Commercial Statistical Indicators Associates | 5:12 | |
that these numbers are from. | 5:15 | |
These figures are also published | 5:16 | |
in the Department of Commerce's BCD, | 5:18 | |
Business Cycle Development. | 5:21 | |
There's no single way of combining them. | 5:23 | |
The one point that should perhaps be emphasized | 5:25 | |
about them, is that they include two kinds of series. | 5:28 | |
Those which are in physical volume terms | 5:32 | |
and those which are in dollar terms. | 5:35 | |
The dollar terms series are effected by price change. | 5:38 | |
The physical term series are not. | 5:41 | |
Now whenever you come to the end of the top of an expansion | 5:43 | |
it's inevitable that the physical volume series | 5:46 | |
are going to taper off and slow down. | 5:49 | |
You've reached the, more or less, then limits of growth. | 5:50 | |
For example, when you had a lot of unemployment, | 5:53 | |
it was possible to have very rapid rates of real growth | 5:55 | |
from 61 to 64 or five. | 5:57 | |
Now that you're operating at pretty nearly full capacity, | 6:00 | |
you can't have anything like so rapid rated growth. | 6:02 | |
But what you are having instead | 6:05 | |
is a substantial increase in prices. | 6:07 | |
So, when you get into such an inflationary period | 6:10 | |
the coincident indicators are | 6:13 | |
gonna tell two different stories according as to whether | 6:15 | |
you look at those of them reflect physical output alone | 6:17 | |
like for example employment or industrial production, | 6:20 | |
or whether you look also at those like personal income, | 6:23 | |
retail sales that reflect dollar magnitudes. | 6:26 | |
William Clark | Dr. Friedman, though as some of the | 6:29 |
national magazines have noted recently, there has been | 6:32 | |
a rather significant swing in high places toward your | 6:35 | |
way of thinking of the effects of monetary supply | 6:40 | |
on business trends. | 6:42 | |
There are those who still challenge this type of thinking | 6:44 | |
and say that even with the record how can you prove | 6:49 | |
which is cause and which is effect? | 6:52 | |
Can you really demonstrate that money supply is the cause | 6:54 | |
and not simply the effect? | 6:59 | |
Milton Friedman | Well, the interesting thing to me | 7:00 |
about the discussion along this line, and I think you are | 7:02 | |
quite right about the fact that the evidence, | 7:05 | |
the crude evidence doesn't prove it. | 7:09 | |
The interesting thing about this is that the discussion | 7:11 | |
has been mostly about the tip of an iceberg. | 7:13 | |
There is an enormous mass of detailed study about | 7:17 | |
monetary relationships that underlies the particular | 7:20 | |
views that I and others have expressed about the | 7:24 | |
relation of money. | 7:26 | |
What appears in the press is a small part of that. | 7:27 | |
In particular, what most emphasis is put on our assertion | 7:30 | |
which turns out to be reasonably accurate, | 7:37 | |
that changes in the quantity of money, | 7:40 | |
tend to be accompanied by changes in business | 7:43 | |
in the same direction at a somewhat later date. | 7:45 | |
That is to say, just as I was saying earlier, | 7:48 | |
that a slow down in the first half of 68 in the money supply | 7:50 | |
tends to be reflected in economic activity | 7:53 | |
in the second half. | 7:56 | |
That a speeding up, we have been arguing | 7:57 | |
that the rapid speeding up in the rate of monetary growth | 7:59 | |
in the second half of 68 portends rapid expansion | 8:02 | |
in the first half of 69. | 8:07 | |
What point that needs discussion, and the point | 8:12 | |
that other people have emphasized, for example, | 8:16 | |
Professor Samuelson mentioned in one his earlier tapes, | 8:18 | |
is that the mere fact that one series | 8:21 | |
moves along with the other and indeed that it moves | 8:24 | |
earlier than the other doesn't mean that the first | 8:27 | |
is the cause of the second, and that criticism | 8:28 | |
is entirely valid. | 8:30 | |
If that were the only evidence you had, | 8:31 | |
if the only thing you knew, was this statistical correlation | 8:33 | |
it would no longer prove | 8:37 | |
that one was the cause of the other, | 8:39 | |
then the fact that every single morning | 8:41 | |
you will hear a rooster crow, | 8:43 | |
proves that he makes the sun rise. | 8:44 | |
Clearly the coincidence doesn't prove it, | 8:49 | |
but then it looks a little bit more plausible | 8:50 | |
that the fact that one occurs before the other proves it. | 8:52 | |
But even that doesn't, and let me illustrate that | 8:55 | |
with something particularly economic. | 8:57 | |
As we all know, over a long period, the stock market | 9:00 | |
has tended to move earlier than business. | 9:03 | |
That is to say, as you know, the stock market | 9:05 | |
tends to move down before business tends to move down. | 9:09 | |
The stock market tends to move up before business moves up. | 9:11 | |
And lots of people have argued, therefore the stock market | 9:15 | |
dominates business, that it somehow | 9:18 | |
through the stock market that it effects a business. | 9:20 | |
Indeed one of the most widely believed misconceptions, | 9:22 | |
in my view, is that the crash in 1929 | 9:27 | |
in the stock market caused the business depression | 9:30 | |
from 29 to 33. | 9:32 | |
William Clark | Oh, I see. | 9:34 |
It is widely believed, I should say so. | 9:36 | |
Milton Friedman | Oh yes, John Kenneth Galbraith's | 9:38 |
written a whole book on that. | 9:39 | |
But it's not true. | 9:42 | |
If you look at the facts, you will find in the first place | 9:43 | |
that the business decline started in August 1929 | 9:45 | |
when the stock market crash came in October. | 9:48 | |
So the decline in the business started earlier. | 9:50 | |
But much more generally, there's a lot of evidence | 9:53 | |
that leads me to believe it's not true. | 9:56 | |
Well, then how do I explain the fact that the stock market | 9:57 | |
moves before business? | 9:59 | |
Very easy. | 10:00 | |
There is some third factor, and I'll come back to what | 10:03 | |
I believe it is, there's some third factor | 10:05 | |
that effects both the stock market and business. | 10:07 | |
But it works on the stock market more rapidly | 10:11 | |
than it works on business. | 10:13 | |
Now what I think that third factor is, as I've suggested, | 10:16 | |
is monetary change. | 10:18 | |
What I believe the correct story is, | 10:20 | |
is when you have a change in the rate of monetary growth, | 10:21 | |
when monetary growth speeds up, | 10:26 | |
this tends to effect the stock market first of all. | 10:28 | |
Very early. | 10:30 | |
Because the stock market reacts very quickly | 10:31 | |
to things that happen. | 10:33 | |
But it doesn't effect business until it's worked | 10:35 | |
its way through the stock market, | 10:37 | |
has effected people's portfolios, | 10:38 | |
the amount of cash they hold. | 10:41 | |
This is turn has effected how much they spend and so, | 10:42 | |
it may be that it hits the stock market now, | 10:45 | |
and it shows up in income six months later. | 10:47 | |
And therefore you observe regularly | 10:49 | |
that the stock market moves before income, | 10:51 | |
before business, not because the stock market causes | 10:53 | |
business movements but because the both are the results | 10:57 | |
of a common force. | 11:01 | |
For example, let me go back to my rooster crowing. | 11:02 | |
The rooster, might get himself into a pattern | 11:05 | |
where he always wake up a half an hour before | 11:09 | |
the sun came up. | 11:11 | |
You wouldn't argue that because he was waked up | 11:12 | |
a half an hour before the sun came up, | 11:15 | |
therefore that caused the sun to come up | 11:16 | |
a half and hour later. | 11:18 | |
The fact that one series comes before another doesn't prove | 11:21 | |
the first causes the other. | 11:27 | |
That's a great fallacy. | 11:28 | |
Poked a hole, ergo home. | 11:30 | |
Well, how can it? | 11:33 | |
Why is it that I have confidence that the same thing | 11:33 | |
isn't true about the relation between money and business? | 11:36 | |
Maybe they are both consequences of some third factor. | 11:38 | |
What would be the third factor in that case? | 11:42 | |
Well, along the lines of recent theories, | 11:45 | |
that third factor of course would be government spending, | 11:47 | |
investments, autonomous expenditures. | 11:49 | |
That would be the third factor. | 11:51 | |
What's the evidence that I have on that? | 11:53 | |
Well, the evidence that's available, | 11:56 | |
in my opinion, enormous. | 11:59 | |
Very, very large volume of detailed evidence | 12:02 | |
of a variety of kinds which argues that the | 12:05 | |
relation between money and business | 12:10 | |
is not like the one I described between the | 12:12 | |
stock market and business | 12:14 | |
or the rooster waking up and the sun coming up. | 12:15 | |
But is rather the relationship of cause and effect. | 12:17 | |
And I'm a little at a loss to know just where to start | 12:20 | |
digging into this mountain of evidence. | 12:24 | |
Let me suggest first one kind of evidence which may be | 12:30 | |
a little easier to talk about. | 12:33 | |
This is evidence by studying the historical circumstances | 12:35 | |
surrounding particular episodes. | 12:39 | |
From those you can sometimes have almost | 12:44 | |
the equivalent of a controlled experiment. | 12:47 | |
You see the great advantage of the physicist | 12:48 | |
is he can know in a sense which is cause and effect | 12:51 | |
because he knows what it was that produced | 12:53 | |
the initial change. | 12:56 | |
He planned it that way. | 12:57 | |
Well, we have almost the equivalent of | 12:59 | |
some controlled experiments in the United States | 13:00 | |
since the establishment of the Federal Reserve Board, | 13:03 | |
because we happen to have a few occasions | 13:05 | |
on which it is absolutely crystal clear | 13:07 | |
what caused the change in the money supply. | 13:09 | |
It's almost as if you had an experiment. | 13:11 | |
Let me give you one most dramatic example. | 13:14 | |
After World War I, after the arms dis 1918, | 13:17 | |
you had very rapid price rises, as you may recall, | 13:25 | |
for the next year and half, until the middle of 1920. | 13:27 | |
In fact of the total price rise in World War I, | 13:32 | |
a third of it came after the war was over. | 13:34 | |
Also, it so happens in that case, | 13:38 | |
that the federal budget came into surplus | 13:40 | |
about the middle of 1919. | 13:42 | |
Price rises still kept going on very rapidly. | 13:44 | |
During that period the money supply | 13:47 | |
was going up very rapidly. | 13:49 | |
It was going up very rapidly | 13:50 | |
first because the Federal Reserve was pouring money out | 13:52 | |
to enable people to buy bonds to finance | 13:55 | |
the government deficit and then after the | 13:58 | |
government budget went into equality | 14:00 | |
the Fed held the discount rate low | 14:02 | |
and this produced a large increase in loans to | 14:06 | |
banks which in turn loaned to business communities. | 14:10 | |
So money supply went up very rapidly. | 14:14 | |
There was a big fight going on all during 1919 | 14:17 | |
between various people who thought the Fed should | 14:19 | |
move sharply to counter the inflation, | 14:22 | |
and the Treasury, who up for the time, | 14:25 | |
was more interested in keeping | 14:27 | |
the interest rates on it's refundings low. | 14:30 | |
You know, things don't change over 50 years. | 14:31 | |
They stay the same, | 14:34 | |
and the Treasury's always interested in low interest rates. | 14:35 | |
For some reason, in January 1920, the Treasury | 14:38 | |
suddenly reversed itself, presumably because it had | 14:41 | |
completed it's financing. | 14:45 | |
The Treasury came into a meeting | 14:46 | |
at the Federal Reserve Board | 14:47 | |
of the Open Market Investment Committee | 14:49 | |
in favor of raising the discount rate. | 14:50 | |
And the Fed and the Treasury, you see at that time, | 14:53 | |
I should say, the Secretary of the Treasury was an | 14:57 | |
ex officio member of the Federal Reserve Board. | 15:00 | |
That's no longer the case, but it was true then. | 15:02 | |
And also, I should say, that the Federal Reserve Board | 15:05 | |
at that time was headed by a man who had a back-bone of, | 15:07 | |
what is the opposite of steel? | 15:12 | |
Whatever it is. | 15:13 | |
William Clark | Like a wet noodle they say. | 15:16 |
Milton Friedman | Yes. | 15:17 |
In his memoirs he wrote at one point, | 15:19 | |
you see subsequently, | 15:25 | |
there were Congressional hearings at which | 15:27 | |
the Federal Reserve was sharply criticized | 15:29 | |
and correctly criticized | 15:31 | |
for it's inflationary policy during 1919. | 15:32 | |
He wrote in his memoirs at the time, subsequently, | 15:36 | |
referred to that episode and said, | 15:41 | |
but there was such a thing on the books | 15:43 | |
called the Underwood Act I think, if my memory is right. | 15:46 | |
I'm digging back in my memory, he wrote, | 15:49 | |
under which, if we hadn't done what the Treasury wanted, | 15:52 | |
the Treasury could have arranged to see us fired. | 15:55 | |
This is essentially what he says. | 15:57 | |
And so of course we had to go along. | 16:00 | |
It's extraordinary. | 16:02 | |
This is a very interesting personal thing. | 16:03 | |
It's extraordinary how much personal character | 16:05 | |
matter in these things. | 16:07 | |
I've always been impressed by the contrast between | 16:08 | |
that case where the Federal Reserve | 16:11 | |
was supposedly independent, | 16:12 | |
and yet the head of it went right along with the Treasury. | 16:14 | |
And a corresponding case in France, a few years later | 16:17 | |
in 1926, seven, or eight, I'm not sure the exact year. | 16:21 | |
When the governor of the Bank of France was a man | 16:26 | |
by the name of Emile Moreau. | 16:28 | |
Under the laws of France, | 16:29 | |
the Central Bank was not independent at all. | 16:31 | |
The Treasury could give direct instructions | 16:34 | |
to the Central Bank what to do. | 16:37 | |
Well, one of these episodes when they were having inflation, | 16:39 | |
and this was before they stabilized the franc, | 16:41 | |
Poincare, who was the Premier of France at that time, | 16:46 | |
called Moreau in and gave him an order | 16:48 | |
to buy government bonds in order to provide | 16:52 | |
the government with finance. | 16:55 | |
Moreau said to the Premier, he said, I'm sorry. | 16:57 | |
I can not do that. | 17:01 | |
It is against the law. | 17:02 | |
The law had specified how much the Central Bank could buy | 17:03 | |
government bonds. | 17:07 | |
Moreau said I'm sorry, I can not do that. | 17:09 | |
It's against the law. | 17:11 | |
I will not do that. | 17:13 | |
You may fire me if you want Mr. Premier, | 17:14 | |
but I will not do what you tell me. | 17:16 | |
And of course what happened is | 17:19 | |
that the Prime Minister backed down. | 17:20 | |
That Moreau did in fact carry out the policy he suggested. | 17:23 | |
France stabilized the franc and was able then | 17:27 | |
to restore the franc. | 17:30 | |
It seems to me, those people who talk | 17:33 | |
about the importance of institutional independence | 17:34 | |
are barking at the wrong door. | 17:38 | |
The character of the man is much more important. | 17:40 | |
William Clark | How important is the personality | 17:42 |
and character of the gold then | 17:44 | |
in more recent times, certainly? | 17:45 | |
Milton Friedman | Absolutely. | 17:48 |
An excellent example of exactly the same kind of thing. | 17:49 | |
Go back to the story in 1920. | 17:51 | |
In January 1920, at their meeting, the Federal Reserve | 17:52 | |
raised the discount rate sharply. | 17:55 | |
Nowadays, we tend not to worry too much | 17:58 | |
about the discount rate. | 18:01 | |
It's not very meaningful number. | 18:02 | |
But the situation was wholly different in 1920, | 18:04 | |
because at that early stage in the Federal Reserve system | 18:07 | |
there had not yet arisen the tradition | 18:10 | |
against discounting by member banks. | 18:13 | |
The idea that discounting was a privilege and not a right | 18:16 | |
developed as a result of the episode I'm describing | 18:19 | |
and it wasn't true. | 18:22 | |
At that time in 1920, member banks were borrowing | 18:23 | |
from the Federal Reserve system a sum which was larger | 18:27 | |
than the whole of their total reserves. | 18:31 | |
That is borrowed reserves were not only negative, | 18:35 | |
they were larger than total required reserves. | 18:38 | |
If you were to look at it in today's figures, | 18:40 | |
I'm not exactly sure what the numbers are, | 18:42 | |
but today's borrowings are about a billion dollars | 18:44 | |
and what are total member bank reserves? | 18:47 | |
They must be in the, | 18:50 | |
I'm not at all sure, let me say. | 18:54 | |
With member bank reserves today are about the order of | 18:57 | |
26 billion dollars. | 19:01 | |
So the comparable situation today would be | 19:04 | |
if member banks were borrowing 30 billion dollars | 19:06 | |
not one billion dollars. | 19:08 | |
Well, now if member banks were borrowing | 19:10 | |
30 billion dollars today, what happened to the discount rate | 19:12 | |
would be of more than minor importance. | 19:15 | |
Well, similarly back in January 1920, | 19:18 | |
that was the situation of member banks, | 19:20 | |
and when the discount rate was raised, | 19:22 | |
it really had an impact. | 19:24 | |
Well, it didn't have an impact over night. | 19:26 | |
Immediately, you started to have a slow down in the rate | 19:31 | |
of monetary growth, but it didn't really turn around | 19:34 | |
for about four or five months because it took time | 19:38 | |
for banks to contract their outstanding loans and so on. | 19:40 | |
But the crucial thing is, this occurred in January. | 19:44 | |
It's traceable to this particular meeting to the decision | 19:48 | |
of people to raise the discount rate. | 19:50 | |
Three months or four months later the rate of growth | 19:54 | |
and the money supply slowed down very sharply. | 19:57 | |
About six months later the economy stopped inflating. | 20:00 | |
You turned around from 1920 to 21, | 20:03 | |
you had one of the sharpest recessions on record. | 20:06 | |
Wholesale prices fell more rapidly than they have ever | 20:10 | |
fallen in that period of time in the history | 20:12 | |
of the United States. | 20:14 | |
Fell, if I remember rightly, by close to something like | 20:16 | |
30% in the course of a six or nine or 12 months. | 20:20 | |
Something like that. | 20:24 | |
I no longer remember the details. | 20:25 | |
Now, that's a beautiful controlled experiment, | 20:27 | |
because it is impossible to and there is no way at all | 20:30 | |
in which you could argue that change in the money supply | 20:33 | |
was itself a consequence of the change in business. | 20:36 | |
If there was any relationship between the money supply | 20:39 | |
what subsequently happened to business, | 20:42 | |
it clearly must have been because money supply | 20:44 | |
influenced business. | 20:46 | |
Well, that's a particular dramatic historical episode | 20:47 | |
of that kind. | 20:49 | |
William Clark | Yes it is. | 20:51 |
Milton Friedman | But it's far from the only one. | 20:52 |
See, come back later in Federal Reserve history. | 20:53 | |
At 29 to 33, is a little more complicated business | 20:56 | |
because it also, I think gives an example of this kind | 21:01 | |
but it would be a little more complicated to describe it. | 21:04 | |
Next major episode, 37 to 38, | 21:06 | |
is almost just as clear as 20, 21. | 21:09 | |
In this case, what happened was a big argument | 21:14 | |
within the system about required reserves. | 21:16 | |
The Banking Act of 1934 or 35, I forget which year, | 21:20 | |
established a power which did not before exist, | 21:26 | |
namely the power of the Federal Reserve to change | 21:29 | |
required reserves. | 21:32 | |
As you know, Federal Reserve may now make the | 21:33 | |
required reserves of member banks a different number | 21:37 | |
one day than it was a prior day. | 21:41 | |
But it's limited. | 21:44 | |
It must do it within certain minimums and maximums limits. | 21:45 | |
At that time, and I think it's still true today, | 21:49 | |
the maximum limit is twice the minimum. | 21:51 | |
In 1935 there started a discussion within the system | 21:55 | |
whether, with the large excess reserves that then existed, | 21:59 | |
you should not raise the reserve requirement, double it. | 22:02 | |
In fact, it's interesting, | 22:08 | |
one of the reasons why this argument came, | 22:10 | |
really had little to do with economics of it. | 22:12 | |
It so happened that 34, 35 saw a shift of power | 22:15 | |
within the system from the banks | 22:19 | |
to the Federal Reserve Board in Washington. | 22:21 | |
The banks had really run the system before 33. | 22:22 | |
The Board was not out before 29. | 22:25 | |
It so happened that the ability to change | 22:30 | |
the discount rate is technically lodged in a member bank. | 22:33 | |
The power to change the reserve requirement | 22:38 | |
was lodged in the Federal Reserve Board. | 22:40 | |
Therefore some of the banks wanted to have the | 22:42 | |
reserve requirements raised to the maximum amount | 22:45 | |
in order to immobilize one of the powers | 22:48 | |
of the Federal Reserve Board | 22:51 | |
and leave them as the active participant. | 22:52 | |
The interesting thing about these historical episodes | 22:56 | |
are all these extraneous things that enter in. | 22:58 | |
But going back to my main point, | 23:00 | |
this argument finally resulted | 23:03 | |
in a decision by the Federal Reserve Board | 23:05 | |
to double the Reserve requirements | 23:07 | |
in two steps. | 23:13 | |
One, in the middle of 1936 and another in early 1937. | 23:13 | |
Shortly after the first step when the reserve requirements | 23:21 | |
were raised the first time, the rate of growth | 23:23 | |
of the money supply tapered off and started to slow down. | 23:24 | |
After the second one, the money supply turned around | 23:28 | |
and started coming down, absolutely declined. | 23:31 | |
Shortly thereafter, you had the recession of 37 to 38 | 23:34 | |
again a very severe recession in the United States. | 23:37 | |
Here again, you know exactly what produced the change | 23:40 | |
in the money stock and so either you have to argue | 23:44 | |
that the decline in the money stock and in business | 23:47 | |
was a pure accident and a coincidence, | 23:50 | |
or you have to say, that the change in the money stock | 23:52 | |
was the cause of the change in business. | 23:55 | |
It couldn't have been produced by the change in business. | 23:58 | |
Well, as I say, I can multiply such cases. | 24:01 | |
Of course on the basis of any one episode | 24:04 | |
you can't rule out the possibility that it was coincidence. | 24:06 | |
It could be that the 37, 38 case, it was coincidence. | 24:09 | |
But it is very hard to believe | 24:14 | |
that a very, very systematic tendency, for every recession | 24:16 | |
to be preceded by a decline | 24:22 | |
in the rate of growth of the money supply, | 24:24 | |
and every expansion to be preceded by a | 24:26 | |
rise in the rate of growth in the money supply. | 24:29 | |
It's very hard to believe that that uniform relations | 24:32 | |
is pure coincidence. | 24:36 | |
That's not accident. | 24:37 | |
And it's hard to accept any interpretation of that then | 24:38 | |
either both are consequences of some third thing or | 24:42 | |
one is causing the other, and if one is causing the other, | 24:45 | |
then the fact that you know for these particular episodes | 24:49 | |
precisely what caused the money supply | 24:52 | |
is very strong evidence as to which it is. | 24:55 | |
Well, another kind of historical evidence | 24:57 | |
of a very different kind has to do with the fact | 25:00 | |
that we have observed the same kind of relatiohship | 25:06 | |
in many different countries and at many different times. | 25:09 | |
Let's suppose that the truth is what people sometimes say, | 25:12 | |
that it's the change in business | 25:15 | |
that's causing the change in money. | 25:16 | |
Then what the relationship would be | 25:18 | |
between business and money would depend | 25:20 | |
on the kind of monetary system you have. | 25:22 | |
Surely, it would be a very different thing | 25:24 | |
in a monetary system which used only gold, | 25:26 | |
with no banks playing a part in it, | 25:29 | |
in a monetary system which used banks | 25:32 | |
but had no central bank, | 25:34 | |
and a monetary system which used banks | 25:35 | |
but had a central bank. | 25:37 | |
For example, the monetary institutions in the United States | 25:38 | |
have changed very greatly over the past century. | 25:44 | |
If you go back a century ago, | 25:46 | |
gold played a much more important part in our money | 25:49 | |
than it does now. | 25:53 | |
It plays no part now. | 25:53 | |
The currency was much more important. | 25:58 | |
Banks were much less important. | 26:00 | |
Up until 1913 there was no central bank. | 26:03 | |
After 1913, you had the Federal Reserve system. | 26:06 | |
In consequence, if the real relatiohship was round one | 26:09 | |
running from business to money, | 26:12 | |
you would expect the | 26:15 | |
relation would have changed its character | 26:18 | |
in the course of the past hundred years. | 26:22 | |
That is you would expect to find a different relationship. | 26:24 | |
For example, you would expect that the movements in money | 26:27 | |
would have come at a different time in relation to the | 26:30 | |
movements in business and so on. | 26:32 | |
Similarly, you would expect that this relationship | 26:34 | |
would be different in other countries | 26:37 | |
than it is in the United States. | 26:38 | |
The fascinating thing is, that over that whole hundred years | 26:40 | |
so far as we can tell from our studies, | 26:45 | |
the timing relationship between the changes in money | 26:48 | |
and the changes in business have been roughly the same. | 26:50 | |
Obviously there have been variations. | 26:53 | |
I'm not saying it's perfectly precise. | 26:54 | |
But there's no secular change. | 26:56 | |
If you separate out the period before 1913 | 26:58 | |
and the period after 1913, you find no difference. | 27:00 | |
Again, I've studied in some detail the monetary figures | 27:03 | |
for some foreign countries. | 27:07 | |
Let me illustrate with Japan. | 27:08 | |
If you look at the figures for Japan, | 27:11 | |
the timing relationships and the behavior | 27:13 | |
is exactly the same as it is for the United States. | 27:15 | |
Indeed the Japanese case is beautiful, | 27:18 | |
because the Japanese have not been as delectate | 27:21 | |
in their manipulations of the money supply as we have. | 27:24 | |
As a result there are much sharper changes, | 27:27 | |
much sharper increases and decreases and yet | 27:30 | |
the kind of relatiohship you have is exactly the same. | 27:33 | |
William Clark | So this is not | 27:38 |
a purely American phenomenon. | 27:40 | |
This is a world-wide situation | 27:41 | |
Milton Friedman | Oh yeah. | |
I've looked at these relationships for countries | 27:44 | |
as disparate as Yugoslavia, which is a communist country. | 27:46 | |
Yugoslavia is a wonderful case, | 27:50 | |
because it shows the same relationships, too. | 27:51 | |
Greece, Turkey, Israel, Japan, everywhere you have, | 27:54 | |
not precisely, but very nearly the same relationships. | 28:00 | |
William Clark | Well, thank you very much, Dr. Friedman. | 28:03 |
If you have questions or comments or suggestions | 28:05 | |
for topics you would like discussed in this series | 28:08 | |
please send them to Instructional Dynamics Incorporated | 28:11 | |
166 East Superior Street, | 28:14 | |
Chicago, 60611. | 28:17 | |
This is William Clark. | 28:20 | |
Dr. Friedman and I will be talking with you again next week. | 28:21 |
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