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 |
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