Tape 71 - Systematic divergences between broad and narrow money supplies

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-	Welcome once again as MIT Professor Paul Samuelson	0:02
	discusses the current economic scene.	0:04
	This biweekly series is produced	0:06
	by Instructional Dynamics Incorporated	0:08
	and was recorded March 4th, 1971.	0:10
-	Let me begin today by reviewing whether there's anything	0:13
	new on the business outlook since my last tape.	0:17
	No new information has come to my attention	0:23
	which would require me to change my general view	0:28
	about the outlook.	0:35
	You'll recall that I haven't seen any particular reason	0:37
	to depart from the modal forecast	0:41
	which is that the GNP will grow in this coming year	0:46
	to reach an average level for the year	0:54
	of somewhere around a trillion 50 billion dollars.	0:57
	I guess if I really had to make a bet	1:02
	I'd bet a little bit on a little bit more than that	1:03
	for two reasons.	1:07
	One, most of the forecasters premise their extrapolations	1:09
	on the basis of something like the President's budget.	1:15
	I think to be realistic we have to assume	1:21
	that the President's budget will err and will err	1:23
	in one direction as it did last year.	1:28
	I think it would be premature	1:32
	to expect that President Nixon will have so great an error	1:33
	in the actual expenditures when 18 months from now,	1:42
	we know what they will have been for fiscal '72	1:48
	as appears to be the error which is going	1:51
	to take place this year.	1:55
	These errors of course that I'm speaking of are not	1:57
	to be charged particularly to the President's own account.	1:58
	Some of them have to do with perhaps foreseeable errors	2:04
	in forecasting but many of them have to do with the fact	2:09
	that although the President can propose,	2:13
	as Congress which disposes,	2:14
	and also Congress itself can propose	2:16
	and there certainly are many pressures for public spending	2:19
	which the administration will not now say	2:24
	it does approve of.	2:28
	Beyond this if I'm right that the estimates	2:31
	by the President, the official estimates,	2:37
	of where the economy will be are on the rosy side	2:40
	and aren't quite warranted by the facts	2:44
	I think that the logic of the President's own team	2:46
	would be that if they're wrong they will wish	2:51
	to favor some more expansionary policies	2:57
	than have in fact taken place	3:01
	so for that reason I suppose it would be best	3:03
	if you had to make an unconditional forecast	3:07
	and a lot of your own personal money was hanging	3:10
	on that forecast to up the figures somewhat.	3:12
	Secondly, as you know, I have had some residual pessimism	3:17
	on whether we're going to have as great progress	3:23
	in the field of inflation	3:28
	as most computer estimates have forecast.	3:30
	For surely I am pessimistic about our prospect	3:36
	about having as much improvement on inflation	3:39
	as those people	3:42
	and there are a few people whom I respect	3:46
	who in the past have shown themselves to have good judgment	3:50
	before the fact who think that we might be	3:55
	in for some very pleasant surprises indeed	3:57
	on the front of inflation.	4:00
	Therefore, I would expect that we love to add something	4:03
	to the money GNP numbers for any failure	4:09
	of the inflation to improve.	4:14
	This doesn't by itself add a thing	4:16
	to the real GNP forecast that one ought to make	4:19
	and from certain viewpoints it is a reason	4:23
	for subtracting from the real GNP.	4:27
	As an example, much certainly hinges in everybody's view	4:31
	on how expansionary the Federal Reserve is	4:35
	with respect to the money supply.	4:38
	If you ask me, what is the single event	4:40
	which would make the Federal Reserve be most expansionary	4:45
	in the money supply?	4:48
	I would have to say it would	4:50
	be pleasant surprises on the side of price inflation.	4:51
	The Federal Reserve is not, I think, by its nature sadistic.	4:56
	It doesn't wish to have tightness and unemployment	5:02
	and it has lots of pressures.	5:06
	Moreover, Doctor Arthur Burns, is a true friend	5:08
	of President Nixon.	5:14
	He's an admirer of President Nixon	5:15
	and I'm sure that he would like	5:17
	to accommodate President Nixon's desire	5:20
	to have a healthy and vigorous expansion.	5:24
	He would more surely provide the increase	5:30
	in the money supply for that expansion	5:35
	if he could tell his own conscience	5:39
	that it was not beating the flames of inflation.	5:41
	Well, so much for the broad picture	5:48
	and ought perhaps to say why my residual pessimism	5:58
	on our improvement in prices still nags at me	6:03
	in the form of a doubt.	6:09
	I'll repeat what I've said on many occasions before	6:13
	that almost all of the forecasts,	6:15
	whether of the computer or judgemental type	6:19
	and this includes some of my own, some,	6:22
	have erred on the side of optimism with respect	6:25
	to the progress against inflation.	6:30
	It seems to me that this may well be a case	6:33
	of auto-correlated errors, persistent errors	6:36
	errors which continue to be in the same direction.	6:40
	Some stubbornness in the existing situation	6:46
	we are missing in our forecasting equations	6:49
	and this stubbornness will still be with us in the future.	6:54
	What about the straws in the wind?	7:01
	After all one peek is worth a thousand finesses	7:02
	or least two finesses.	7:04
	The recent behavior of prices has not particularly been	7:07
	that which would hearten an observer looking	7:14
	for swallows of spring, looking for signs	7:20
	that the inflation has really turned a corner	7:25
	with respect to its degree of virulence.	7:28
	It's a mugs game to linger with each month's statistics	7:33
	seasonally corrected, seasonally uncorrected particularly	7:36
	one which is most favorable to your preconceived viewpoint.	7:40
	We all know that you get a little good news	7:44
	in terms of consumer's price index	7:48
	and the same time you get a little bad news	7:49
	with respect to the wholesale price index	7:52
	and vice versa.	7:53
	When things are really going your way however,	7:55
	you don't have to choose and pick	7:57
	everything goes your way.	7:59
	Well that hasn't been happening lately.	8:01
	There's been some disquieting behavior	8:03
	in the wholesale price field.	8:06
	Moreover, we have a pension for excluding things	8:10
	like food prices.	8:13
	We say oh well we would have looked inflation	8:15
	if it hadn't been for food prices	8:17
	but of course to the person on a budget	8:19
	food prices are like any other price,	8:24
	in fact a little worse	8:25
	since the demand for food tends to be in the short run	8:27
	on the inelastic side.	8:30
	You can't shrug that off	8:31
	and I've talked to some people in the livestock field	8:33
	who are of the opinion and the future markets	8:38
	in some degree reflect this opinion that the corn blight	8:42
	was a really very serious thing.	8:46
	The consequences are not over even	8:48
	if we do not have, as we very well may have,	8:50
	a resumption of the corn blight in the crop season to come.	8:53
	The hog cycle is changing and the feed ratios,	8:59
	how profitable it is to buy feed in comparison	9:03
	to the prices of meat for example.	9:06
	One of the most familiar sources of oscillation,	9:10
	the hog corn cycle in the American cycle record	9:13
	that is extremely unfavorable.	9:18
	Now in the short run people slaughter their hogs	9:20
	when it's unfavorable and we're getting quite a run	9:23
	to market but not all of it is storeable	9:26
	and in the longer run according to many experts	9:30
	in the field we may be in for some surprises.	9:35
	This may have an importance greater than actually shows up	9:38
	in the official cost of living index	9:41
	or Consumer Price Index.	9:44
	I don't know why it is but meat,	9:45
	the unavailability of meat, the expensiveness of meat	9:48
	seems almost to have an exaggerated political importance	9:53
	in the mind of the American public.	9:58
	You may remember that OPA finally foundered after the war	10:01
	when it was still being carried on by the effects	10:07
	of the unavailability of meat, the meat shortage.	10:12
	Now, of course when you have price controls you sometimes	10:15
	have shortages to the buyer	10:19
	when there are no concurrent equivalent shortages	10:21
	in the situation and being able to get no meat at all	10:25
	does drive people frantic	10:29
	but the housewife seems to remember what it is	10:31
	that she pays for hamburger of about the same degree	10:34
	of leanness, she remembers what a tenderloin steak costs,	10:36
	she is beginning to forget what a kidney lamb chop costs	10:39
	and so we could very well have some fireworks	10:44
	on the side of inflation consciousness	10:47
	because of this rather fortuitous event	10:51
	namely the genuine scarcity	10:56
	of livestock products which will be had.	10:59
	Well I added up altogether I do not see anything	11:02
	in the news,	11:07
	after all we are two thirds	11:08
	of the way through the first quarter of the year.	11:11
	We are more than a quarter away from the settlement	11:14
	of the GM strike	11:20
	and just sniffing the air one does not feel	11:22
	that this is a year like 1955 that we're off to the races.	11:27
	In 1955 which was a very strong year	11:32
	showed itself as going to be a strong year in a way	11:35
	as early as the fall of 1954.	11:40
	The new automobile designs, primarily in that case	11:43
	the General Motors designs,	11:49
	just seemed to hit the American people where they lived.	11:51
	You could tell from the amount of cigarette smoke	11:53
	in the showrooms in the early months of that model year	11:55
	that it was going to be a great model year	11:59
	and of course it was.	12:01
	Well nothing like that seems as yet to be recorded	12:02
	by even the most sensitive seismographs	12:07
	so I'd say we should reserve judgment.	12:11
	It takes a lot of patience in connection	12:15
	with the forecasting people tend to be in a hurry	12:17
	and from one two week period	12:21
	to another very little happens.	12:25
	This is a time for watchful waiting.	12:29
	Let me now shift to another topic which has	12:34
	to do with the current situation.	12:37
	There is some dispute as to what kind of money	12:40
	one should regard as important, M1 currency	12:45
	and demand deposits.	12:50
	Even in connection with M1 there is some dispute	12:53
	as to whether the massive shifts in government deposits	12:57
	which contaminate and cloud the picture	13:02
	whether some variant of M1 ought not to be used	13:06
	or at least looked at simultaneously	13:11
	with the usual demand deposits adjusted.	13:14
	Of course we've all known about the purely definitional	13:17
	changes incident to the growth of the Euro dollar market.	13:22
	I'm not concerned here now with the intricacies	13:31
	of that question, which M1 you use	13:36
	but I am interested in thinking about the relationship	13:40
	between M1 and M2.	13:44
	Now, M2 broadly speaking is currency	13:46
	plus checkable demand deposits	13:53
	but in addition it includes time deposits, saving deposits.	13:56
	According to your authority it will include those	14:02
	wherever they may be.	14:05
	Here is Massachusetts I could have a saving deposit	14:08
	in the Mutual Savings Bank or I could have it	14:10
	in a workman's cooperative or I could have it	14:12
	in the credit union or I could have it	14:15
	in an SNL federal charted	14:17
	or state charted savings and loan association	14:22
	or I could have it in a commercial bank.	14:26
	I guess actually over the years I've had accounts	14:30
	in all of those	14:34
	and I've also had accounts at postal saving	14:35
	but I guess that does still not exist.	14:38
	As far as I'm concerned in the management of my own money	14:42
	these are all pretty much the same.	14:47
	I expect to be able to withdraw my money	14:51
	from them whenever I want to.	14:54
	Some people have neighborhood habits	14:57
	so they would be very convenient for them	15:01
	to have their savings accounts only at the commercial back	15:03
	then you'd have one stop banking.	15:08
	Now, some authorities for historical reasons	15:12
	and perhaps other reasons like to include some	15:16
	and exclude others.	15:20
	I don't suppose it matters in most times	15:22
	because one definition of M2 swells and contracts	15:24
	pretty much like another.	15:29
	We all know that M2 has been growing very rapidly	15:33
	in comparison with M1 in this particular period.	15:35
	We also know that Regulation Q in the past few years	15:39
	has clouded the picture and made it difficult	15:46
	for us to interpret the behavior of certain M2 magnitudes.	15:49
	In particular when the ceilings on interest rates	15:55
	under Regulation Q fall far	15:59
	below the supply demand intersection	16:02
	of equivalent 90 day, six month, one year commercial paper	16:06
	and other kinds of deposits	16:16
	so Euro dollar deposits.	16:18
	We find the CDs contracting, shrinking away	16:20
	almost to nothing.	16:24
	This is particularly apparent at the large level,	16:26
	over $100,000 items.	16:31
	Consequently, everybody I think would be inclined	16:35
	to follow the suggestion which Professor Friedman has made	16:39
	which is to try to get a second best end	16:43
	to a concept.	16:49
	Perhaps take out CDs from your M2	16:51
	because of their aberrations	16:56
	and look at that total.	16:57
	That total too I think has been growing rapidly	17:03
	relative to M1.	17:07
	Now, what are we to think about this?	17:10
	We can attribute much of this,	17:14
	some will attribute all of it	17:18
	to Regulation Q as Regulation Q is very effective	17:20
	and as you move from a time when Regulation Q	17:26
	is very effective to lower interest rates	17:27
	when it becomes less effective you get re-intermediation	17:30
	just as earlier you got dis-intermediation.	17:35
	I don't for a moment wish	17:40
	to minimize the contaminating influences	17:42
	of Regulation Q for the analyst pouring over	17:46
	the ups and downs of the rate of growth	17:51
	of the money supply	17:53
	but suppose there were no Regulation Q	17:54
	or suppose that it becomes quite ineffective	17:57
	because we're going for a long time	18:00
	to be in a period where interest rates are definitely	18:02
	below the ceiling	18:06
	so that the ceilings in fact are not binding.	18:07
	Under those circumstances I believe	18:13
	you still would see, in many situations,	18:14
	undulations in the rates of growth of M2 relative to M1.	18:19
	Let me illustrate.	18:28
	At any time when the economy is beginning	18:32
	to run a little weakly,	18:36
	when the sources of investment opportunity	18:38
	and animal spirits	18:43
	and consumers sentiment are running a little bit weakly	18:45
	in terms of ownership of liquid wealth,	18:50
	in terms of recent disposable incomes,	18:55
	in terms of longer run permanent incomes	19:01
	and we know how unpredictable these relationships are.	19:05
	They do fluctuate.	19:09
	They are not exact scientific relations which can	19:10
	with great confidence be extrapolated	19:13
	and be regarded as reversible in both directions.	19:16
	When such a time comes, the economy tends	19:19
	to have a little more slack than the authorities want.	19:22
	It tends to have more unemployment than anybody considers	19:26
	to be desirable.	19:31
	At such times of course it's incumbent upon the government	19:34
	to have expansionary fiscal policy.	19:36
	I said of course forgetting	19:40
	that there are some respected analysts who don't think	19:42
	that expansionary fiscal policy has much influence	19:47
	but I needn't enter into that discussion here	19:50
	because I want to move on	19:53
	to what the Federal Reserve is likely to be doing	19:55
	at that time.	19:59
	The Federal Reserve is likely at that time	20:00
	to want to improve the situation to lean against the wind,	20:05
	to engineer some degree of recovery by means	20:10
	of a more expansionary increase in the money supply.	20:15
	Even if the Federal Reserve were not of the persuasion	20:20
	that it must exercise discretionary power	20:24
	in order to improve the situation,	20:28
	in order to have a better stabilization policy.	20:32
	If the Federal Reserve is following the recommendations	20:35
	of monetarists and is determined to keep one or another	20:37
	of the money supplies growing at pretty much a constant rate	20:46
	in the face of market weakness,	20:52
	in the face of some decline in the velocity	20:55
	of the circulation of money,	20:57
	in the face of some increase in the demand for money.	20:58
	The Federal Reserve will find itself	21:02
	putting downward pressure on interest rates	21:05
	just as it's been doing in the past.	21:08
	Now, I come to my point,	21:11
	in such an epoch it seems to me	21:13
	that there is a foreseeable tendency,	21:18
	a predictable tendency.	21:23
	I'm not going to argue what kind of an R square you'll get	21:25
	if you put it in a reduced form statistical relationship	21:27
	but I am thinking of what an informed analytical observer	21:30
	would be inclined to bet if he were forced	21:37
	into a bet on one side or the other.	21:39
	In those situations it seems to me that M2 will grow	21:42
	relative to M1	21:45
	and of course the opposite side of that coin	21:48
	is when the economy, as in 1955,	21:51
	is going through a very vigorous upswing	21:55
	then I would suppose transaction needs become very important	21:58
	and the M1 part of the M2 grows faster	22:03
	than the total of M2.	22:10
	Now we've been having that,	22:14
	granted the process that I've been describing	22:19
	is obscured by the effects of Regulation Q	22:22
	and much of what's being observed may be attributable	22:27
	to Regulation Q.	22:31
	I am here arguing that there is a residual amount	22:33
	of what is actually now being observed which is part	22:35
	of the process that I've described and nothing	22:40
	to do with Regulation Q.	22:42
	It's a manifestation in a way of certain aspects	22:47
	of kinks in liquidity preference.	22:51
	The division between M2 and M1 is not the same thing	22:54
	as the old fashioned Keynesian distinction	22:57
	which was never too operational in most cases	23:01
	between active money and inactive money	23:03
	but that was a suggestive terminology	23:06
	of the phenomenon that I'm now speaking of.	23:10
	This phenomenon that I'm speaking of doesn't bother me.	23:17
	It's part of the game,	23:20
	it's the way things are,	23:22
	it's something that the monetary authorities have	23:24
	to take into account	23:28
	but it would bother me if I were a believer	23:30
	in some uniform rule of constancy of the rate	23:33
	of increase of the money supply	23:36
	because in that case when there are undulations	23:39
	we get quite different testimony.	23:42
	If, for example, you always had M1 and M2 growing	23:44
	at about the same rate	23:50
	in the short run as well as the long run	23:52
	there'd be no conflict in the use of one rule or the other.	23:53
	I presume if in the longer run	23:58
	they grew at the same rate	24:02
	but there were certain characteristic differences	24:04
	in the short run	24:06
	that well, I don't know what the proper answer would be	24:09
	in that case.	24:16
	It's so hard for me to put myself into the shoes	24:18
	of somebody who thinks that a constant rule makes sense	24:22
	that I find a little hard to make sense	24:27
	between those two cases.	24:29
	I would say that the majority of the monetarists	24:34
	whom I talk to more and more these days seem	24:36
	to talk in terms of M1 and there's only one exception	24:38
	to that, at least one exception that's come	24:43
	to my attention and that is an important exception of course	24:46
	that's Professor Friedman who still attaches a good deal	24:50
	of importance to M2.	24:54
	One last taxonomic case,	24:58
	if as I think likely actually there probably is a longterm	25:02
	secular increase in M2 relative to M1	25:06
	and you could really count upon magnitude	25:10
	of that then somebody would say well I'm for a 4% increase	25:13
	in M1 and a 6% increase in M2	25:17
	and I don't think that these two criteria	25:21
	will ever be in conflict.	25:25
	Well I have said enough I think to indicate	25:29
	that I think that they will be in conflict	25:31
	in a systematic way in the course of the ups	25:35
	and downs of the business cycle.	25:38
	My time is almost up	25:42
	let me just say a word about interest rates.	25:44
	We have an extremely interesting treasury yield curve.	25:47
	Short-term rates have come down mightily,	25:54
	longterm rates have been more slow to come down.	25:56
	For a long time, last year, year before,	26:00
	we had the kind of pattern that used to prevail before 1930	26:05
	and which had almost completely disappeared	26:09
	from 1930 into the years well after World War Two	26:12
	namely, short-term rates higher than longterm rates.	26:17
	Very easy to explain such a pattern,	26:19
	people are expecting the stringency of interest rates	26:21
	to be temporary.	26:24
	Now we've gone with a vengeance	26:25
	and I saw somewhere a tabulation which suggested	26:26
	that we have the most steep forward angle	26:30
	of the treasury curve almost in our history.	26:36
	The greatest discrepancy between short-term rates	26:39
	and longterm rates.	26:41
	This discrepancy is not great between three months	26:43
	and a year, actually that's a surprisingly flat phase	26:45
	of the treasury curve.	26:48
	Now, what is the outlook?	26:50
	It seems to me that if the pack is right	26:54
	and the government official forecast is not right	26:59
	that there is definitely further room	27:02
	on the downside for longterm interest rates.	27:05
	I think I saw just today that one bank has lowered	27:07
	the mortgage rate to 7%.	27:10
	That's the kind of number I like to hear.	27:11
	It's getting closer to what we all so fondly remember	27:14
	as against 9%, 9 1/2% and money not available for mortgages	27:17
	even at those rates.	27:21
	So if the economy is relatively weak the longterm rate	27:23
	still has a distance to go.	27:30
	The short-term rate may move some upward	27:33
	to meet that longterm rate just from the ordinary expansion	27:35
	even if the expansion, mind you,	27:38
	is not enough to satisfy me as a humanitarian	27:40
	who wants unemployment to come down.	27:42
	The expansion by everybody's reckoning is going	27:44
	to be much greater than in 1970	27:46
	and so short-term rates and demand for loans	27:51
	from the banks might very well be expected to be stronger	27:54
	in the future.	27:58
	If the President's forecast is right	28:00
	and we really have, as they have been predicting,	28:03
	for the four quarters ahead 6% real growth	28:06
	then I am not at all sure that longterm rates	28:10
	have not reached at least a temporary plateau.	28:14
	I'm not sure there's much in it for say a speculator	28:17
	in longterm bonds if the rather more rosy forecast	28:19
	of the President turns out to be correct.	28:25
-	If you have an questions or comments	28:27
	for Professor Samuelson address them	28:29
	to Instruction Dynamics Incorporated	28:30
	166 East Superior Street Chicago, Illinois 60611.	28:33

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Title:

Tape 71 - Systematic divergences between broad and narrow money supplies

Date:

circa 1970 to circa 1971

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Samuelson, Paul A. (Paul Anthony), 1915-2009

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Paul A. Samuelson papers, 1933-2010 and undated

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Paul A. Samuelson papers, 1933-2010

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Economics Cassette Series: Paul Samuelson

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Tape 71 - Systematic divergences between broad and narrow money supplies

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