Tape 120 - Discount Rate, Current Boom, Future Prospects, Balance of Payments

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-	Hello, this is Rose Friedman	0:02
	inviting you on behalf of Instructional Dynamics	0:04
	to another of our bi-weekly interviews with Milton Friedman,	0:08
	professor of Economics at the University of Chicago.	0:11
	We are taping this interview on May 11th, 1973.	0:14
	This morning's newspaper announced further arise	0:20
	in the discount rate to 6%,	0:23
	is this another sign of the Federal Reserve's tightening?	0:26
-	It's a sign that the Federal Reserve	0:30
	is not changing its stance, it's continuing its policy,	0:33
	but it is not in and of itself	0:36
	a very important or significant measure.	0:38
	The discount rate has for some time	0:41
	been decidedly below the level of short-term market rates,	0:43
	such as the Treasury Bill rate, Federal Funds rate,	0:47
	Commercial Paper rate and the like.	0:51
	The Fed in general with respect to the discount rate	0:55
	has tended to follow the market rather than to lead it.	0:58
	The Market Treasury Bill rate	1:01
	went decidedly above the discount rate in September of 1972,	1:04
	has been above it ever since.	1:08
	The Fed did not move the discount rate from the 4.5%	1:10
	in which it had been stuck for a long time	1:14
	until early in January.	1:16
	There is little doubt I believe that the Fed continues	1:18
	and has for the past few months to recognize	1:23
	that what is called for now	1:27
	is a fairly slow rate of monetary growth.	1:29
	After all, the Fed has been effected by and reacting to	1:31
	the extraordinary boom that we have had in the economy	1:36
	in the last few months just as everybody else has.	1:38
	If you look at the rates of monetary growth	1:41
	over this past three or four months,	1:44
	they have been moderate,	1:47
	not only by the standards of late 1972,	1:49
	but also by the standards of the longer period	1:55
	going back to early 1971,	1:57
	roughly speaking from early 1970 really	2:00
	until the end of '72.	2:07
	The Fed's Monetary Growth rate has been	2:10
	roughly of the order of 6% for M1	2:15
	and roughly of the order of nine, 10% for M2.	2:19
	In the past three or four months,	2:23
	that has come way down to something like	2:25
	three or 4% for M1	2:27
	to something like six or 7% for M2.	2:29
	The latest week shows a jump,	2:33
	but no attention should be paid	2:34
	to these erratic week-to-week jumps.	2:36
-	Is there any further evidence on the sources of the boom?	2:40
-	Well, you'll recall that in the, my late last tape,	2:43
	I talked some about the sources of the boom	2:48
	and in particular the extent to which it could be	2:50
	attributed to the monetary and fiscal forces	2:55
	that had been at work earlier this year or in 1972.	3:01
	I have just recently gone back over this material	3:06
	in somewhat more detail	3:10
	in order to settle in my own mind the puzzle	3:12
	that seems to be playing, working itself out.	3:16
	And I have decided that what I have said last time	3:20
	was to some extent misleading	3:22
	and that I really ought to backtrack	3:24
	and take back some of the things I said then.	3:26
	The major point of difference	3:29
	is that my comments in my last take	3:32
	took for granted that the extraordinary boom	3:35
	was really to be located in the first quarter of 1973.	3:38
	This is what everybody has paid attention to,	3:44
	the extraordinary 14% per year rate of growth of GNP	3:47
	in the first quarter of '70.	3:52
	Three, the enormous step up in the rate of price increases	3:54
	with cost of living rising at rates of 10% per year	3:58
	and wholesale prices at even higher rates than that.	4:03
	But when I went back	4:06
	and looked at the evidence on a month-by-month basis,	4:08
	I discovered that really the extraordinary phenomenon	4:12
	or let me put it differently,	4:19
	departure from the rate of growth of total spending	4:21
	of personal income, of GNP on the one hand	4:25
	and the rate of growth	4:29
	that could have been expected from monetary changes alone.	4:31
	Now the discrepancy between these two	4:34
	really started to emerge in the fourth quarter of '72,	4:36
	well before the beginning of '73.	4:40
	But if we're gonna date back that discrepancy,	4:43
	you have to go to something like October 1972.	4:46
	Ever since October 1972, personal income and GNP	4:50
	have been rising at rates decidedly higher	4:55
	than the rate that would have been produced	4:58
	by the earlier monetary changes alone.	5:00
	Now, in the last tape, I speculated	5:04
	that this development, an antonymous increase in velocity,	5:10
	an increase in spending relative to income,	5:14
	which has its source in a faster turnover of money	5:17
	rather than in a more rapid increase	5:21
	in the quantity of money.	5:24
	I expected it last time that that might be attributable	5:25
	to such things as the international monetary crisis	5:28
	in February of this year,	5:31
	to the shift from two to the phase three,	5:34
	to the rapid jump in food prices.	5:37
	But all of these developments occurred in early 1973,	5:40
	no one of these could possibly explain	5:45
	why you should have had an antonymous increase	5:48
	in velocity starting back in October.	5:50
	As a consequence,	5:52
	I am inclined to retract any emphasis on those explanations	5:54
	and try to look at the thing	5:59
	from a rather different perspective.	6:01
	What impresses me	6:04
	is the similarity of this episode in these last few months	6:05
	to an episode in precisely the opposite direction	6:09
	immediately after the wage price freeze	6:13
	of August 15th, 1971.	6:15
	Those of you	6:19
	who were my subscribers at that time will recall	6:19
	that I pointed out month after month after that freeze	6:23
	that it seemed to have had the effect	6:28
	of slowing the economic expansion.	6:29
	That during the six or nine months following the freeze	6:32
	the rate of growth of personal income and of GNP	6:36
	was decidedly less than you would have expected	6:39
	from the prior rate of rise in the quantity of money.	6:43
	That prior rate of rise in the quantity of money	6:49
	called for a more rapid expansion than we have.	6:52
	I attributed this difference at that time	6:55
	to an autonomous decline in velocity	6:57
	arising out of two sources.	7:00
	In the first place I argued that the	7:03
	institution of the freeze and of price control	7:06
	created a great deal of uncertainty	7:09
	for the business community, made businessmen uncertain	7:11
	about what prices they could charge,	7:14
	about whether they would get materials and so on.	7:16
	And as a result it had the effect on them	7:18
	of leading them to wanna be more liquid	7:20
	and led them to try to add to their cash balances.	7:23
	At the same time, the freeze had some effect perhaps	7:28
	and I think one must grant that it had some effect	7:32
	on causing people to believe	7:36
	that the rate of inflation was going to slow down,	7:37
	whether it should have had this effect or not is irrelevant,	7:39
	but it apparently did have this effect.	7:41
	The evidence that it had this effect	7:43
	comes not only from people's statements, polls is on,	7:45
	but much more impressively	7:50
	from the fact that short-term interest rates	7:52
	started to declining very sharply,	7:54
	almost immediately after the freeze.	7:56
	And it looks very much as if that decline	7:58
	is to be attributed	8:00
	to a reduction in the expectations of inflation.	8:01
	Well again, a reduction in the expectations of inflation	8:05
	would lead the community at large,	8:08
	not merely businessmen, but consumers and others	8:12
	to wanna hold somewhat larger cash balances.	8:14
	And I estimated that these two effects together	8:17
	accounted for the slower rate of growth in spending	8:21
	than you would have expected	8:26
	from the prior monetary experience.	8:27
	This discrepancy appeared to come to an end	8:30
	in the second quarter of 1972	8:33
	and at that time I calculated that the aggregate affect	8:36
	if you interpreted phenomena along these lines	8:41
	was to lead people to wanna hold	8:43
	roughly 2% more cash balances	8:45
	than they otherwise would have held.	8:48
	Now, that's past history,	8:51
	but what has been unfolding since October	8:54
	is the same story only in reverse.	8:57
	Instead of the rate of growth of total spending	9:00
	being less than you would have expected	9:03
	from monetary developments, it's been greater.	9:05
	There's been an increase in velocity,	9:07
	people have decided to hold less cash balances	9:09
	than they did before.	9:11
	And again it seems plausible to attribute this	9:14
	to two different things	9:16
	very similar to those that occurred in August '71	9:19
	except operating obviously in the reverse direction.	9:23
	In the first place, October as (mumbles) date,	9:26
	it's a date a month before the election,	9:32
	it's a date by which time it became abundantly clear	9:34
	that Mr. Nixon was going to be reelected	9:37
	in something of a landslide.	9:41
	It's not unreasonable that the increase in uncertainty,	9:44
	which arose as a result	9:49
	of the wage prize freeze and price control	9:50
	was maintained at a high level	9:53
	by the concern the development about	9:55
	George McGovern's policies	9:57
	and about what it would mean if he were elected.	9:59
	So one can argue, plausibly I think,	10:02
	could add about this time,	10:05
	you had a reduction in the degree of uncertainty.	10:07
	That businessmen felt a little bit more certain	10:10
	about what was going to develop in the future	10:12
	in the way of the economic activity	10:15
	and economic development.	10:17
	At the same time,	10:19
	you had a beginning of a rise in the rate of price rise.	10:20
	Whatever tapering off in real inflation occurred	10:25
	came to an end very much about the middle of 1972	10:28
	and since then	10:32
	you have clearly been having a rising rate of inflation.	10:32
	Moreover, the effect of a shift in inflationary expectations	10:37
	would be a once for all effect,	10:43
	it was absorbed, it no longer remains.	10:45
	Now once again, this interpretation of the developments	10:48
	tends to be confirmed by the behavior of interest rates.	10:51
	If you look at short term interest rates,	10:56
	they started to rise at a fairly rapid rate	10:58
	just about September, October of last year,	11:01
	just about in line	11:03
	with the developments that I'm speaking of.	11:05
	And that would be entirely consistent with the idea	11:07
	that the rise in those short term interest rates	11:09
	to some extent reflected	11:12
	a reawakening of inflationary expectations	11:15
	and the emergence of higher expectations of inflation.	11:19
	Now up to the moment,	11:23
	if I follow the same method of approach I did before	11:25
	and asked what is the magnitude of the effect	11:28
	up to this point, up to this point it's been about 1.5%,	11:32
	that is to say it would look from the figures of today	11:35
	as if holders of money	11:39
	are holding about 1.5% less cash balances	11:41
	than they would have held	11:44
	if they had continued on their prior path.	11:45
	I said before the total effect of the other was 2%	11:48
	and what we're now having	11:51
	is simply a reversal of the earlier one,	11:52
	well that means that we outta be coming back onto track.	11:54
	And again, if you plot the charts of what would be expected	11:58
	and what would be observed,	12:01
	you find that it looks as if you are coming back on track,	12:03
	so it looks as if this episode	12:06
	of unduly rapid monetary economic expansion might	12:08
	if it were to repeat the course of the earlier episode,	12:13
	might be coming to an end in the next few months.	12:19
	However, that's by no means certain.	12:22
	There is no doubt the phenomena I described last time,	12:25
	the international monetary crisis,	12:29
	the rapid rise in food prices,	12:31
	the shift from phase two to phase three,	12:33
	while they apparently did not initiate the present episode,	12:35
	they are perfectly capable of prolonging it.	12:39
	There is just no doubt	12:43
	that you have a degree of widespread concern	12:44
	and fear about inflation today,	12:47
	that is out of all proportion	12:49
	to what you had six, nine, 12 months ago.	12:50
	And so it may well be that that will continue	12:53
	to not only keep velocity higher	12:55
	than it otherwise would have been,	12:58
	but to raise it still further.	12:59
	Now I might make one more point	13:02
	that impressed me as I looked over recent figures,	13:07
	the emphasis has largely been on GNP.	13:11
	And the very rapid rate of growth of GNP	13:14
	did come in the first quarter of '73,	13:16
	however, it turns out	13:19
	that if you look at personal income instead of GNP,	13:21
	the rapid rise in personal income	13:24
	came in the fourth quarter of '72.	13:26
	And the rate of rise in the first quarter of '73	13:29
	has been decidedly lower	13:32
	than the rate of the fourth quarter of '72.	13:34
	The discrepancy between personal income and GNP,	13:38
	the behavior of the two	13:41
	is accounted for so far as I can see by two phenomena,	13:42
	one is there was a very big expansion	13:45
	in transfer payments to the public by government	13:48
	in the fourth quarter,	13:51
	essentially a standstill in the first quarter.	13:53
	This presumably was a result	13:56
	of a higher level of social security benefits	13:57
	that were paid out in the (mumbles).	13:59
	Second, there seemed to have been a rapid increase	14:02
	in the first quarter in profits earned by enterprises,	14:04
	but not paid out.	14:07
	It may well be that this underlies the appearance	14:09
	of a very sharp boom	14:11
	in capital expenditures and investment by corporations.	14:14
	At any rate and my main point here is	14:20
	that there has been a rather curious difference of behavior	14:22
	of personal income on the one hand and GNP on the other.	14:25
	Presumably this will come back into line again,	14:30
	but at the moment it is something of puzzle.	14:34
-	And now the big question, where is it all going to end?	14:37
-	Well, the crystal ball as usual is somewhat clouded,	14:41
	but as usual	14:45
	I think we outta make a stab at looking into it.	14:46
	I have been saying all along	14:49
	that this boom is not sustainable,	14:51
	that we are going to have to come off of it	14:53
	and that we are likely to have,	14:58
	very likely to have a recession.	15:00
	As I have reexamined these figures,	15:03
	I'm now inclined to believe that	15:06
	the slowdown in the rate of GNP growth	15:07
	may come decidedly earlier than I had expected.	15:10
	The reason for this is that this kind of a	15:13
	autonomous velocity increase	15:18
	typically does not last and has to be reversed,	15:22
	tends to come back.	15:27
	That is to say you have for example	15:29
	an amazing run up in retail sales in the first quarter,	15:32
	which caused a sharp decline	15:37
	in the rate of personal saving by consumers,	15:39
	it's very unlikely that that kind of a phenomenon	15:43
	is going to continue.	15:45
	If the rate of growth of personal income were to come back	15:47
	to the level that you would have expected	15:51
	from the earlier behavior of money,	15:54
	that would mean a decided decline	15:57
	in the rate of personal income growth	16:00
	although it would still be a very high rate.	16:01
	It would imply that personal income growth	16:03
	instead of running in the neighborhood	16:06
	an annual rate of something like 12%,	16:09
	would come back down to the range	16:11
	of something like the annual rate of 9%.	16:13
	Still too high for a 3% inflation,	16:16
	still wouldn't mean be consistent	16:18
	with a longer inflation of four or 5%,	16:20
	but not consistent with an inflation rate of 10%.	16:23
	So I should not be at all surprised	16:28
	if by the third quarter of this year	16:29
	you had an appreciable slowdown in the rate of growth of GNP	16:32
	and of personal income.	16:38
	Since the inflation move will have momentum	16:40
	and will continue,	16:43
	this may well mean a decline in the rate of growth	16:45
	of real output.	16:48
	It may mean that while you will have further reductions	16:50
	in unemployment over the next three or four months,	16:54
	by the time you come to the end of the year,	16:56
	the rate of unemployment instead of going down further	16:59
	may be starting to come up.	17:01
	But if you do not have that development by the third quarter	17:03
	and you may not as I say I had in the past, earlier,	17:10
	then dating it somewhat later,	17:13
	I suspect that it will surely come	17:16
	by the fourth quarter or the first quarter of 1974.	17:18
	Now it's too early of course to know	17:22
	whether the recession will be severe or not,	17:24
	that depends in part	17:27
	on what monetary policies are followed from here on out.	17:29
	If the Fed were to stick	17:32
	to its recent fairly low rate of growth of M1 and M2,	17:34
	keep it down around, M2 around seven or 8%,	17:39
	M1 around three or 4%,	17:42
	that would imply a recession	17:45
	something of the order of magnitude of the 1970 recession,	17:48
	but nothing more severe than that	17:51
	and perhaps something milder.	17:53
	But if the Fed should step still harder on the brake	17:55
	as it has in the past sometimes been it's proclivity,	17:58
	well then you have to revise that particular forecast.	18:01
-	We have a letter from Richard F. Schmidt	18:05
	of the Ruben Donally Corporation.	18:08
	Mr. Schmidt writes, you have frequently pointed out	18:10
	that inflation is made in Washington	18:13
	and that by imposing wage price guidelines	18:15
	or outright controls,	18:17
	the government is trying to shift blame	18:19
	from where it belongs, i.e. itself,	18:21
	to innocent parties, i.e. labor and management.	18:23
	Former Secretary of the Treasury John Connally	18:27
	at a recent talk to the Wharton Club of New York	18:29
	laid much of the blame for our balance of payment troubles	18:32
	at the doorsteps of countries, such as Japan,	18:35
	which maintained barriers	18:37
	against the entry of American goods into their country.	18:39
	My question is, is blaming foreign countries	18:42
	for our balance of payment problem	18:45
	as unjustified as blaming the U.S. business community	18:47
	for our domestic inflation problem?	18:50
-	That's a very good and thoughtful question	18:52
	and the answer I think is mixed,	18:55
	the answer is yes and no.	18:58
	But I think in elaborating the answer	19:00
	one has to pull out the words balance of payment problem	19:02
	and ask what that means.	19:05
	I think, I am increasingly impressed	19:07
	that the biggest trouble in all of the discussions	19:09
	of the balance of payments in foreign trade	19:11
	is in the implicit tendency on the part of everybody	19:14
	to continue to use mercantilist views	19:19
	and to regard it as a problem	19:21
	that our balance of payments are in deficit,	19:23
	that we are able to import more than we export.	19:26
	That's not a problem, quite the contrary.	19:29
	If foreign countries like Japan	19:33
	are willing to send us goods and services	19:37
	and take back either our IOU's	19:39
	and non-interest barring IOU's or interest barring IOU's,	19:42
	we have no complaint, they're doing us a favor,	19:45
	they're hurting themselves and helping us.	19:47
	That's not a problem, that's a reward.	19:49
	We have what's called a deficit,	19:53
	that is to say foreign countries	19:55
	like Japan, Germany and others accumulate dollars.	19:58
	That phenomenon is attributable primarily	20:04
	to the behavior of other countries.	20:10
	It is not quite the same as inflation made in Washington.	20:12
	Our balance of payments deficit is not made in Washington,	20:16
	it is made in Berlin and Tokyo, in other countries.	20:18
	The fundamental reason for that is	20:22
	that some of all the surpluses and deficits	20:24
	of all the countries of the world	20:30
	have to find on a consistent basis must add up to zero,	20:31
	a point which I have stressed time and again on these tapes.	20:34
	Given the fact that the U.S. dollar is the world's currency,	20:38
	that the world is on a dollar standard,	20:44
	this means that we can have a balance in our payments,	20:48
	if and only if all of the other countries of the world	20:56
	are willing to let us have it,	20:58
	if they are willing to follow a policy	20:59
	under which they have no surpluses.	21:01
	And because the world's on a dollar standard,	21:03
	they have the initiative.	21:06
	Therefore in this sense	21:07
	our balance of payments deficit is made not in Washington,	21:09
	but in Berlin and in Tokyo and the like.	21:12
	But if you turn to another aspect	21:15
	of our balance of payments,	21:17
	the situation is rather different.	21:19
	You could eliminate the balance of payments deficit,	21:23
	have an absence of a surplus or a deficit	21:26
	and yet, if countries like Japan, Germany and the like	21:30
	impose tariffs or restrictions as they do,	21:35
	the structure of trade would be distorted	21:39
	and both we and other countries would be harmed	21:43
	by the fact that the international division of labor	21:47
	was not carried out most economically, most efficiently.	21:50
	In this respect however, the U.S. is just as much at fault	21:54
	as almost any of the other countries,	21:57
	we have a host of restrictions on trade, we have tariffs,	21:59
	we have oil import quotas, we have had medium port quotas,	22:03
	we have had import quotas on a variety of things,	22:05
	voluntary agreements to restrict exports to us	22:08
	from Hong Kong and other places,	22:12
	(mumbles) tax and the like.	22:15
	In this collection of protectionist,	22:18
	interventionist, mercantilist measures	22:23
	has made the structure of our trade distorted.	22:25
	It means that we export the wrong things	22:29
	and import the wrong things.	22:31
	And with respect to this aspect	22:32
	of the distortion in world trade,	22:34
	the U.S. has just as much responsibility on its shoulders,	22:36
	that is Washington does as do the other captains.	22:40
-	Once again, I'm afraid we've come to the end of our time.	22:44
	Thank you very much.	22:47
	Remember subscribers, if you have any questions or comments,	22:48
	please send them to Instructional Dynamics Incorporated,	22:51
	166 East Superior St., Chicago, Illinois, 60611.	22:54

Item Info

Title:

Tape 120 - Discount Rate, Current Boom, Future Prospects, Balance of Payments

Date:

May 11, 1973

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Friedman, Milton, 1912-2006

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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: Milton Friedman

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Tape 120 - Discount Rate, Current Boom, Future Prospects, Balance of Payments

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