Tape 145 - Money Figures and Fed Stand, Nixon-Burns Forecast about Food/Fuel "Bubble Burst Effect"
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Rose Freedman | This is Rose Friedman | 0:02 |
inviting you, on behalf of Instructional Dynamics, | 0:04 | |
to another of our bi-weekly conversations with | 0:07 | |
Milton Friedman, Professor of Economics at the | 0:09 | |
University of Chicago. | 0:12 | |
We are taping these conversations on May Day, 1974. | 0:13 | |
Is there any sign in the recent money figures of | 0:20 | |
of the tough span that the fed is supposedly | 0:23 | |
been taking recently? | 0:25 | |
Milton Friedman | No. | 0:27 |
On the contrary. | 0:29 | |
If anything the money figures have | 0:30 | |
recently been speeding up. | 0:32 | |
I have before me the weekly report of the Federal | 0:34 | |
Reserve Bank of St. Louis. | 0:38 | |
Which is labeled for the week ending April 24, | 0:41 | |
but in which the money figures, in fact, | 0:43 | |
only go through April 17th. | 0:45 | |
If we take the four weeks ending April 17th, | 0:48 | |
and compare those | 0:51 | |
with the four weeks ending two months earlier, | 0:53 | |
that is ending February 20th. | 0:57 | |
And the rate of increase in the narrow money stock, | 0:59 | |
that is in currency and demand deposits. | 1:04 | |
Is 12.1 percent. | 1:06 | |
Which is almost double the average rate | 1:09 | |
over the past three or four years. | 1:12 | |
Similarly, if we take the broader concept, | 1:17 | |
currency, plus demand deposits, plus commercial | 1:22 | |
bank time deposits, M2. | 1:25 | |
Other than CD's, that is. | 1:28 | |
There, the speed up is much less sharp. | 1:30 | |
We have for the same two months period | 1:34 | |
a rate of growth of about 9.7 percent. | 1:38 | |
Which is almost identical with the average rate | 1:41 | |
of growth over the past four years. | 1:44 | |
Now, however, I think it is a mistake. | 1:46 | |
It would be a serious mistake | 1:50 | |
to put too much stress on the figures for those two months. | 1:52 | |
What that very sharp speed up and M1, | 1:56 | |
and lack of speed up in M2 reflect, | 2:00 | |
is this phenomenon we've discussed | 2:04 | |
before of disintermediation. | 2:06 | |
Short term interest rates have been rising very sharply | 2:08 | |
in recent weeks. | 2:10 | |
As a result, depositors at commercial banks | 2:13 | |
holding time deposits, | 2:18 | |
savings and loan association, share holders and the like, | 2:20 | |
have had a strong incentive to substitute | 2:24 | |
market instruments, such as treasury bills | 2:29 | |
for deposits. | 2:33 | |
The latest issue, latest auction, on six month | 2:35 | |
treasury bill came out with a interest rate | 2:40 | |
of something like eight point, almost nine percent. | 2:43 | |
I've forgotten the exact point, | 2:46 | |
if it was 8.8 or 8.9. | 2:47 | |
That is a very much more attractive interest rate than | 2:51 | |
anything you can get on a savings deposit | 2:54 | |
or a time deposit. | 2:56 | |
And, as always, whenever there is a shift | 2:58 | |
out of time deposits, | 3:00 | |
this tends to release reserves available for | 3:03 | |
use against demand deposits | 3:07 | |
for those tends to promote a speed-up in the | 3:09 | |
growth of demand deposits. | 3:12 | |
And a slow-down in the growth of time deposits. | 3:14 | |
Tending to make M1 appear to race ahead, | 3:16 | |
while M2 holds back somewhat. | 3:19 | |
It will take a considerably longer period of time | 3:23 | |
because before we can be sure that this is more | 3:26 | |
than a temporary aberration and will not be brought back. | 3:28 | |
If we look over a longer view, | 3:31 | |
if we take the latest four weeks over the | 3:34 | |
four weeks ending a year ago, | 3:37 | |
that rate of increase for M1 is 6.8 percent | 3:39 | |
which is very much on target with the 6.5 percent, | 3:44 | |
that on the average has been the rate of increase | 3:48 | |
over the past four years. | 3:50 | |
So, I'm inclined, for the moment, | 3:51 | |
to continue with the view that we mustn't pay | 3:53 | |
too much attention to these very short run aberrations. | 3:55 | |
And that the best conjecture is still that | 3:59 | |
the pattern of growth of M1 is in the neighborhood | 4:03 | |
of six and a half percent, averaged already a | 4:06 | |
considerable period of time, | 4:08 | |
that whenever M1 gets above that, | 4:10 | |
it tends to be brought back. | 4:14 | |
That the average rate of growth for M2 is | 4:16 | |
somewhere about, oh nine and a half. | 4:19 | |
Nine to ten percent, | 4:22 | |
with essentially the same phenomenon. | 4:23 | |
I hope that is wrong. | 4:27 | |
I hope the statements by the fed mean what they say. | 4:28 | |
And that their actions will suit their words. | 4:35 | |
I really don't mean to question the sincerity | 4:39 | |
or credibility of the statements. | 4:45 | |
I believe the statements are entirely sincere. | 4:46 | |
I'm just skeptical about the consistency between | 4:49 | |
the statements on the one hand and the actions. | 4:54 | |
And until we have some real evidence that | 4:56 | |
they are to be treated differently than | 4:59 | |
similar pronouncements in the past, | 5:01 | |
I think it would be wisest to assume that the | 5:03 | |
kind of rates of growth of money that I have mentioned. | 5:06 | |
Rose Friedman | President Nixon, Arthur Burns, | 5:11 |
and other high officials commenting on the present | 5:12 | |
inflation rate, invariably assert that food | 5:15 | |
and fuel account for three quarters of the price rise. | 5:18 | |
And hence, that as soon as the food and fuel bubbles burst, | 5:21 | |
we can expect a sharp decline in the inflation rate. | 5:24 | |
Do you see it this way? | 5:28 | |
Milton Friedman | There's a sense in which that's right, | 5:31 |
but a more fundamental sense in which it is | 5:33 | |
both wrong and misleading. | 5:35 | |
The sense in which it is right is purely arithmetic. | 5:37 | |
If we simply look at what has happened to individual prices, | 5:40 | |
and ask what fraction of the recorded rapid increases | 5:44 | |
in prices in recent months and quarters, | 5:49 | |
can be accounted for by the increases | 5:52 | |
in the food and fuel components, | 5:55 | |
the answer comes out to be a very substantial fraction, | 5:58 | |
roughly three quarters. | 6:01 | |
But that's arithmetic. | 6:03 | |
And it doesn't answer the economic question. | 6:04 | |
It confuses, that is, relative price changes | 6:08 | |
with absolute price changes. | 6:12 | |
Something, there is no doubt that there were special | 6:17 | |
circumstances affecting food and fuel. | 6:19 | |
The real question is, why wasn't the rise | 6:22 | |
in the price of food and fuel offset | 6:26 | |
by a decline in the price of other things? | 6:28 | |
Given some total quantity of money, | 6:31 | |
and some desired cash balances, | 6:33 | |
or some total amount of spending that the | 6:37 | |
community wants to engage in. | 6:39 | |
The high prices of food and fuel, | 6:42 | |
in the first instance, meant that the community | 6:44 | |
was spending more money on food and fuel | 6:47 | |
than it otherwise would. | 6:50 | |
That means it had less money to spend on other things. | 6:52 | |
Just as the shortage of quantity available | 6:55 | |
in food and fuel. | 6:59 | |
And the high demand for food and fuel | 7:01 | |
drove up their prices. | 7:03 | |
You would expect that the reduction in demand | 7:05 | |
for other commodities, the indirect reduction, | 7:07 | |
would force down their prices. | 7:11 | |
So that we can not go from the arithmetic | 7:14 | |
of the situation, to the economics of the situation, | 7:17 | |
without some intermediate analysis. | 7:21 | |
If you take a period in the past, for example, | 7:23 | |
when prices were not changing at all. | 7:25 | |
Then you would find that some prices were rising, | 7:28 | |
and some prices were lowering. | 7:31 | |
And it would make no sense to say that an infinite | 7:33 | |
amount of the price increase was caused by the | 7:36 | |
particular prices that had been rising. | 7:38 | |
Similarly, in the situation today, | 7:43 | |
the arithmetic only poses a question. | 7:47 | |
It doesn't answer it. | 7:50 | |
And it is not entirely obvious how to answer the question. | 7:52 | |
However, the answer that one gives to the question | 7:57 | |
of why is it that we have had such rapid price increases | 7:59 | |
in the past year, and the past few months, | 8:02 | |
is very critical, I believe. | 8:06 | |
For understanding what is likely to be the price | 8:09 | |
pattern in the future. | 8:11 | |
Clearly, to stick for the moment, with the immediate | 8:15 | |
past period, when we have a year to year change | 8:18 | |
in prices of roughly ten percent. | 8:21 | |
A rate of growth of, I'm talking with consumer prices. | 8:24 | |
The rate of growth of consumer prices in the first | 8:27 | |
quarter alone of this year of close to 14 percent. | 8:30 | |
The question is how do we account for them? | 8:35 | |
We cannot account for them arithmetically, | 8:39 | |
simply by the rise in food and fuel prices. | 8:41 | |
That assumes that each price sort of behaves independently, | 8:44 | |
and that the absolute price change is simply | 8:46 | |
the arithmetic average of the separate price changes, | 8:50 | |
which would deny everything we think we know | 8:53 | |
about the way in which the system operates. | 8:56 | |
That is a characteristic fallacy of building | 8:59 | |
from the pieces up instead of from the top down. | 9:03 | |
We do have to recognize that there are constraints | 9:06 | |
on the grand total. | 9:09 | |
We cannot explain such rapid increases in prices | 9:13 | |
by either the contemporaneous or the immediately preceding | 9:17 | |
increases in money. | 9:24 | |
Those increases in money have been | 9:26 | |
at a much lower rate, as I've already indicated. | 9:30 | |
One element, to get out of the way, | 9:35 | |
which could it explain it arithmetically, | 9:38 | |
is that there is something wrong with the statistics. | 9:42 | |
That the actual rate of rise of prices is not nearly, | 9:44 | |
and not been as rapid as the reported rate | 9:46 | |
of rise of prices. | 9:49 | |
Now that certainly is possible for either of two reasons. | 9:51 | |
One reason is that food and fuel are weighted more | 9:54 | |
heavily than they deserve and the price index. | 9:58 | |
But a second reason is that the price index | 10:01 | |
tends to record quoted prices in many cases, | 10:04 | |
rather than actual transactions prices. | 10:07 | |
There is not doubt, that for the prices that rose rapidly, | 10:10 | |
like food and fuel, | 10:13 | |
transactions prices were, and quoted prices were, | 10:15 | |
not far apart and were being reported. | 10:19 | |
But in the cases of those items on which there | 10:24 | |
was downward pressure in prices, | 10:26 | |
it's very much not as clear. | 10:28 | |
In the first place, if you had any possibility | 10:30 | |
of doing so, and you were forced to make concessions | 10:34 | |
in some items, you would certainly make | 10:37 | |
them in indirect ways, which would not | 10:39 | |
show up in the prices that were quoted. | 10:42 | |
To the BLS or to other government officials, | 10:43 | |
for the very simple reason that you would be | 10:45 | |
foolish not to recognize the possibility | 10:49 | |
of price control in the future, or the kind | 10:51 | |
we've had in the past. | 10:53 | |
And therefore, we can be sure that from now on | 10:55 | |
every producer of every product is going to make | 10:57 | |
every effort he can. | 10:59 | |
To make sure that quoted prices are kept, | 11:02 | |
that is the prices that would later be used | 11:06 | |
as a basis for control, | 11:08 | |
are kept as high as possible. | 11:10 | |
And so, it is perfectly possible that there's a | 11:13 | |
purely statistical element of | 11:15 | |
of inflation, of exaggeration, in the inflation rates. | 11:20 | |
I'm not, myself, inclined to attribute enormous | 11:26 | |
importance to that. | 11:29 | |
Maybe that's true. | 11:30 | |
But, I think I can't account for more than a | 11:31 | |
small part of the increase. | 11:35 | |
The major reason I say that, is because if | 11:40 | |
it were purely statistical, | 11:45 | |
you might expect it to show up in a discrepancy | 11:48 | |
between the behavior of consumer price index, | 11:50 | |
and the behavior of GNP, that is of total dollar spending. | 11:53 | |
But its true, not only that the price rise is higher, | 11:58 | |
than can be accounted for by the contemporaneous | 12:02 | |
monetary increase. | 12:06 | |
But so is a total rate of growth of spending. | 12:07 | |
Let me leave out, for the moment, | 12:11 | |
the first quarter of 1974, | 12:12 | |
where you had a clear sign of recession of the | 12:16 | |
effect of a sharp decline in auto sales, and the like. | 12:20 | |
Suppose you take the rate or rise of money GNP | 12:22 | |
from the fourth quarter of 1972, | 12:26 | |
to the fourth quarter of of 1973. | 12:28 | |
That was a rate of 11 and a half percent. | 12:30 | |
That's an extremely high rate, given that | 12:33 | |
the rate of monetary increase over that period | 12:35 | |
was only about 8.8 percent. | 12:37 | |
So, what you have observed over the past year, | 12:39 | |
has been an increase in velocity of circulation of money. | 12:42 | |
That is, for whatever reason. | 12:47 | |
And some people might argue it's because of the | 12:52 | |
rise in food and fuel prices. | 12:54 | |
Total spending has risen relative to the quantity | 12:56 | |
of money, relative to cash balances that people have held. | 13:00 | |
People have been willing to hold lower cash balances. | 13:03 | |
Now, why is it important to analyze | 13:07 | |
the explanation for that? | 13:10 | |
And what accounts for the discrepancy between | 13:12 | |
the rapid rise in prices, and the much lower | 13:15 | |
rise in prices that you would've expected | 13:19 | |
for monetary forces alone? | 13:21 | |
The reason it is important is because of | 13:23 | |
what it may tell us about the coming year. | 13:25 | |
Or more. | 13:30 | |
What it may tell us about the future course of prices. | 13:31 | |
Consider two alternative scenarios. | 13:33 | |
First, once scenario, which as I understand it | 13:35 | |
has been, more or less adopted and followed | 13:38 | |
is implicit in the predictions of a number forecaster, | 13:42 | |
such as Auto Extine and Alan Greenspan. | 13:47 | |
This scenario takes it that the | 13:50 | |
rise in prices is fundamentally attributable | 13:53 | |
to the food and fuel phenomenon. | 13:56 | |
That therefore is a temporary bubble, | 13:59 | |
and for whatever reason, by whatever device, | 14:01 | |
the rise in the problems in food and fuel, | 14:04 | |
have caused a transitory increase in velocity. | 14:08 | |
That this food and fuel bubble will burst, | 14:12 | |
as surely it will, that is true. | 14:15 | |
That has to do with relative prices, | 14:16 | |
not absolute prices. | 14:18 | |
But that, similarly, just as it's occurrence | 14:19 | |
raised the whole consumer price index and price level. | 14:23 | |
So, it's bursting will lower the whole | 14:27 | |
consumer price index and level. | 14:29 | |
And thus, that in the process of bursting, | 14:34 | |
it will carry the rate of inflation down to | 14:36 | |
a very much lower level than any we have experienced | 14:38 | |
for some time. | 14:42 | |
Or, then the very much lower level, | 14:43 | |
that is implied in recent monetary increases. | 14:45 | |
If you follow this course of analysis, | 14:49 | |
you can get to a rate of price inflation | 14:52 | |
by the end of 1974 as low as three or four percent. | 14:56 | |
As a, just a counterbalance, to the very high rate. | 15:00 | |
Now, that scenario is certainly a possible one, | 15:04 | |
and I don't mean to deny its possibility. | 15:06 | |
But I want to consider and contrast it with | 15:11 | |
an alternative one. | 15:13 | |
This alternative one says | 15:15 | |
that the rapid rise in prices in recent year or months, | 15:17 | |
is not simply a food fuel reflection. | 15:24 | |
But is much more fundamentally a catch up phenomenon. | 15:28 | |
It's a phenomenon of adjusting to the fact | 15:31 | |
that in the earlier period there was a slower rise | 15:35 | |
in prices and you would've expected from the | 15:39 | |
quantity of money alone. | 15:41 | |
That is to say, to put it monetary terms, | 15:43 | |
that what you had in 1971 and 72 was a | 15:47 | |
slight decline in velocity. | 15:50 | |
So the total spending went up less rapidly | 15:52 | |
than the monetary figures alone would've suggested. | 15:54 | |
And that what you had in 1973 was a catch up, | 15:58 | |
a higher velocity. | 16:02 | |
And I'll come back in a moment to why you might have | 16:04 | |
had those reactions. | 16:06 | |
But let me site some evidence | 16:08 | |
that rather tends to support this notion. | 16:10 | |
If we take the three years as a whole, | 16:13 | |
from the fourth quarter of 1970, | 16:16 | |
which I take it was a trough of the 1970 recession, | 16:18 | |
to the fourth quarter of 1973, | 16:22 | |
which was probably beyond the peak of that expansion. | 16:25 | |
But many people are taking it as the peak, as a beginning. | 16:31 | |
But take that three year period. | 16:36 | |
For that three year period as a whole, | 16:37 | |
just those particular quarterly days, | 16:42 | |
GNP went up on an average annual rate of 10.5 percent. | 16:45 | |
And the quantity of money went up at an average | 16:50 | |
annual rate of 10.3 percent, almost identical. | 16:52 | |
So that for the three years as a whole | 16:55 | |
the GNP is reflected precisely | 16:57 | |
the rate of increase of the quantity of money. | 17:00 | |
Now, over that period, over that three year period, | 17:03 | |
prices as measured by the CPI, the Consumer Price Index, | 17:07 | |
went up just a trifle over five percent. | 17:12 | |
Which meant that you had real output going up | 17:14 | |
at a rate of five percent per year, a little over that. | 17:17 | |
Which is perfectly feasible for that period, | 17:20 | |
because remember it takes you from the trough | 17:23 | |
of a recession, when output is below normal, | 17:25 | |
to something like the peak or near the peak, | 17:28 | |
when output is probably above the sustainable level. | 17:30 | |
Now, let's break that down into two periods. | 17:35 | |
Let's take the period from the fourth quarter 1970, | 17:37 | |
to the fourth quarter '72, that is the first two years. | 17:40 | |
And then the last year from '72 to '73. | 17:42 | |
And what do we find? | 17:45 | |
GNP growth was less than ten percent | 17:48 | |
in the first two years. | 17:51 | |
11 and a half percent in the third. | 17:52 | |
A consumer - | 17:57 | |
M2 growth was the other way around, | 17:58 | |
it was 11 percent in the first two years, | 18:00 | |
and nine percent in the third. | 18:02 | |
The Consumer Price Index rose from fourth quarter | 18:06 | |
'70 to fourth quarter '72 at the annual rate of 3.4 percent. | 18:11 | |
In the final year, from the fourth quarter '72 | 18:18 | |
to the fourth quarter '73, | 18:21 | |
it rose at 8.4 percent. | 18:23 | |
What this picture suggests | 18:25 | |
is therefore very much that the recent price rise | 18:28 | |
is simply bringing the price level | 18:32 | |
to the point, which is in accord with what has | 18:36 | |
been happening to the underlying stock of money. | 18:40 | |
And on this interpretation, there is nothing to | 18:42 | |
be made up. | 18:45 | |
On this interpretation, when the food and fuel price | 18:47 | |
bubbles burst, that will simply be reflected | 18:50 | |
in more rapid increases. | 18:54 | |
In other elements in the price level, | 18:56 | |
and other items so that the overall price index | 18:59 | |
ought then to resume the kind of rise that | 19:02 | |
you would expect from the monetary figures. | 19:05 | |
Now, that kind of a rise, is somewhere in the order | 19:09 | |
of six or seven percent. | 19:11 | |
And therefore, on this scenario, we ought by assuming | 19:13 | |
that a velocity is now back and stays roughly at | 19:16 | |
it's present level. | 19:20 | |
Then we ought to be seeing, over the next year, | 19:22 | |
rates of increase of prices of somewhere in the order | 19:25 | |
of six or seven percent. | 19:28 | |
That is by the end of the year, or by early 1975, | 19:29 | |
we ought to be seeing on this interpretation | 19:33 | |
a nominal dollar GNP | 19:37 | |
rising at something like the rate of increase in | 19:41 | |
the quantity of money. | 19:44 | |
M2, that is, which is something like | 19:45 | |
nine and a half percent. | 19:48 | |
And that means we outta see over the next | 19:50 | |
six or nine months, real output going up | 19:52 | |
at something like two, two and a half percent. | 19:55 | |
That is what we ought to see over the next six | 19:57 | |
or nine months, then, would be a recovery | 19:59 | |
from the sharp decline in output from the first | 20:02 | |
quarter of 1974. | 20:04 | |
But nothing like a boom, nothing like a new real expansion. | 20:06 | |
And in any event, on the price level front, | 20:10 | |
a sharp decline in the present rate of inflation. | 20:12 | |
But not to anything like the very low levels | 20:15 | |
that would offset the bubble that I'm talking about. | 20:18 | |
Now, I left one item out. | 20:20 | |
And I outta go back to it. | 20:22 | |
Why has there been this pattern? | 20:25 | |
Well, in part the pattern I've been describing | 20:27 | |
is to be expected. | 20:29 | |
It's an old pattern. | 20:31 | |
It's a pattern of the effect of the affective lags | 20:32 | |
in the reaction of the GNP to money supply. | 20:36 | |
You had a rather slow, a very slow rate of increase | 20:45 | |
in the quantity of money in '69. | 20:48 | |
A more rapid increase from sometime in '70 to now. | 20:52 | |
There was a delayed impact of that slow | 20:58 | |
rate of increase in the money supply on GNP. | 21:01 | |
There was a delayed increase, or there was a delayed | 21:04 | |
reaction of the more rapid increase | 21:07 | |
in the money supply on GNP. | 21:09 | |
But this lag pattern cannot explain the whole thing. | 21:12 | |
Because on this lag pattern, the more rapid increase | 21:15 | |
of GNP should've started earlier. | 21:19 | |
I think there is a supplementary explanation. | 21:21 | |
Which I have stressed at various times, here. | 21:24 | |
I believe that the initial affect | 21:28 | |
of the price wage freeze in August, '71, | 21:32 | |
was to alter people's anticipations and expectations | 21:36 | |
about inflation. | 21:40 | |
They were wrong to believe that price wage controls | 21:42 | |
were going to be an effective | 21:45 | |
means of cutting down inflation. | 21:46 | |
But the fact that they were wrong | 21:48 | |
does not mean that they didn't react that way. | 21:50 | |
The fact that they reacted that way | 21:52 | |
shows up very sharply in the behavior of interest | 21:54 | |
rates shortly after the freeze was announced. | 21:56 | |
Interest rates came down considerably. | 21:59 | |
The inflation premium built into interest rates | 22:03 | |
was sharply reduced. | 22:05 | |
The result of a slowdown inflationary expectations | 22:10 | |
combined with the fact that the freeze introduced | 22:16 | |
a great deal of uncertainty in the business planning | 22:19 | |
by making it uncertain what they could do, | 22:21 | |
the combination of those two was to increase | 22:23 | |
the demand for money. | 22:25 | |
It was, therefore, to lower velocity. | 22:27 | |
I calculated it, one earlier point, | 22:30 | |
that the combined effect had been to lower velocity | 22:33 | |
by about two percent. | 22:35 | |
And that doesn't seem like much. | 22:37 | |
But it is enough to bring the rate of increase | 22:40 | |
in CPI, from something like seven percent, | 22:43 | |
to something like five percent, | 22:45 | |
which is exactly what we have to explain. | 22:47 | |
That's exactly the order of magnitude of the effect. | 22:49 | |
Now, by 19, late '72 and certainly early '73, it | 22:56 | |
became perfectly clear. | 23:01 | |
That the price controls were not going | 23:03 | |
over any long period to taper down inflation, | 23:06 | |
and thus what you had there | 23:09 | |
was exactly a reaction the other way. | 23:11 | |
Now, you had a speed up of inflation of the expectations. | 23:13 | |
And when the price controls were removed | 23:17 | |
in early - | 23:22 | |
well, when you had elections in '72, | 23:23 | |
which removed some of the uncertainty about | 23:27 | |
whether McGovern was going to come in at that time. | 23:29 | |
You had essentially a change in whole climate | 23:33 | |
toward a far greater and far more widespread | 23:39 | |
inflationary climate of opinion. | 23:42 | |
And the combination of those, | 23:45 | |
was to lead people to restore | 23:47 | |
the cash balance behavior that they had been | 23:50 | |
moving toward before. | 23:53 | |
The effect of this, therefore, was a rise in velocity | 23:56 | |
of about two percent. | 23:59 | |
Which has, by now, just about offset | 24:01 | |
the earlier increase. | 24:06 | |
And that is why, it turns out, that averaging | 24:09 | |
over a three or four year period, | 24:11 | |
you just about eliminate the special effects. | 24:13 | |
And everything falls into line. | 24:17 | |
The one element of uncertainty that I still have | 24:22 | |
about this picture, is that while velocity | 24:25 | |
in the first quarter of 1974 declined a little, | 24:29 | |
as an almost invariably does in cyclical periods, | 24:31 | |
that is whenever you have a cyclical contraction, | 24:34 | |
you have velocity tending to come down some. | 24:36 | |
And whenever you have a expansion, velocity tends to rise. | 24:38 | |
But you must realize, I'm talking about changes | 24:41 | |
of a very small order of magnitude. | 24:44 | |
Over the ten year period, if you take it on an annual basis, | 24:46 | |
from 1964 through 1973, | 24:50 | |
velocity of M2 averaged 2.359. | 24:56 | |
And the lowest value was 2.304, | 25:00 | |
and the highest value was 2.406. | 25:03 | |
Well now, those seem like small changes, | 25:06 | |
but note that the difference between | 25:08 | |
2.30 and 2.36 is merely three percent. | 25:10 | |
And if that change occurs in the course of a year, | 25:15 | |
it can raise or lower the rate of growth of GNP | 25:18 | |
and indirectly it prices by something like | 25:21 | |
three percentage points. | 25:24 | |
So, these are not, these are small, but not negatable | 25:25 | |
fluctuations that I am talking about. | 25:28 | |
Well, to go back, my real doubt is whether | 25:31 | |
the extraordinary intensification of | 25:34 | |
the influctionary climate may not, | 25:37 | |
after this temporary recession is over, | 25:39 | |
lead to a renewed expansion in velocity of | 25:42 | |
circulation of money. | 25:47 | |
If that is the case, well then, | 25:48 | |
the recession that we are engaged in will | 25:51 | |
come to a fairly speedy end. | 25:53 | |
But more important, the six or seven percent | 25:56 | |
rate of inflation that I have been speaking about | 25:59 | |
will turn out to be an underestimate, | 26:01 | |
and the rate of inflation we will face will be higher. | 26:03 | |
I must say, that kind of a development seems to be | 26:06 | |
much more likely than the opposite development, | 26:09 | |
which is implicit in the judgements | 26:12 | |
that we will be experiencing inflation at only | 26:15 | |
three to four percent by the end of this year. | 26:18 | |
Rose Friedman | We have time for about one | 26:24 |
question, I believe. | 26:27 | |
And we have one from Kenneth Steel, Vice President | 26:28 | |
Economist of the United Carolina Bank Shares Corporation. | 26:31 | |
He asks you to discuss the contrast between | 26:35 | |
the comment of Tilford Gaines of Manufacturers Hanover Bank | 26:38 | |
that the notion that there is a fixed | 26:42 | |
relationship between a level of unemployment | 26:45 | |
and a level of price inflation is hopelessly naive. | 26:47 | |
And the fact that a generation of American's has | 26:51 | |
been brought up to believe in the Phillips Curve concept | 26:54 | |
from their exposure to it in Paul Samuelson's text. | 26:57 | |
Milton Friedman | Well, this is a - | 27:03 |
there is a real contrast between these two | 27:05 | |
because there is no doubt that one of the most | 27:06 | |
widespread beliefs among economists, | 27:08 | |
and especially among policy makers in Washington. | 27:12 | |
And one, which has affected very much their behavior, | 27:16 | |
has been the belief that there is a consistent | 27:19 | |
relation between the level of unemployment, | 27:22 | |
on the one hand, and the rate of price rise, | 27:25 | |
or wage rise, on the other. | 27:28 | |
We have been told that there is a trade-off | 27:30 | |
between these two. | 27:32 | |
We had repeated statements during the late 60's, | 27:33 | |
early 70's | 27:36 | |
that in order to get unemployment, | 27:38 | |
I'm sorry, in order to get price inflation | 27:42 | |
down to zero, we would have to have unemployment | 27:45 | |
of X or Y or Z, with everybody giving his own | 27:48 | |
horrendous number. | 27:50 | |
Alternatively saying that in order to get | 27:53 | |
unemployment at four percent, you have to be | 27:55 | |
willing to accept inflation of five percent. | 27:58 | |
Now, no one will talk this way anymore. | 28:02 | |
And what Tilford Gaines is saying is a statement of fact. | 28:05 | |
That everybody recognizes that that kind of a | 28:08 | |
fixed, stable relationship that you could count on | 28:11 | |
over any long period of time, | 28:14 | |
simply does not exist. | 28:16 | |
Recent stagflation, etc. in this country | 28:18 | |
and Britain and elsewhere has just put to rest | 28:21 | |
the idea which Bill Phillips, in his original | 28:24 | |
article produced on the basis of experience | 28:27 | |
over a century in Britain. | 28:30 | |
Because that century happened to be one in which, | 28:34 | |
on the average, prices were relatively stable. | 28:37 | |
And therefore, what he was observing were fluctuations | 28:41 | |
around a stable trend, and not movements that might | 28:44 | |
possibly go in one direction or the other. | 28:47 | |
But that does not mean that there isn't an element | 28:49 | |
of validity to it. | 28:51 | |
There is a real element of validity in the important | 28:52 | |
element, is a short-run relationship, | 28:54 | |
as opposed to a long-run relationship. | 28:57 | |
The true trade-off is not between inflation | 29:00 | |
and unemployment. | 29:03 | |
It is possible to have any level of unemployment | 29:04 | |
with any level of inflation. | 29:06 | |
The true trade-off is between changes | 29:08 | |
in the rate of inflation and unemployment. | 29:10 | |
If you accelerate inflation, if you speed-up inflation | 29:14 | |
if you go from five percent inflation | 29:17 | |
to ten percent inflation, | 29:19 | |
that will temporarily have a stimulating affect | 29:20 | |
which will tend to reduce unemployment. | 29:22 | |
It will have that affect because prices at which | 29:25 | |
people sell goods and services will tend to rise | 29:29 | |
more rapidly than the cost that they incur, | 29:31 | |
or the cost they believe the incur. | 29:33 | |
And in consequence, it will be a tendency to expand | 29:35 | |
income and output. | 29:38 | |
On the other side of the picture, | 29:41 | |
if you slowed, tried to slow down inflation, | 29:46 | |
there will be a temporary reduction in output | 29:50 | |
and employment, a temporary recession. | 29:54 | |
And the effect of that will be higher unemployment. | 29:56 | |
But in both cases, the effect is temporary. | 30:00 | |
In the sense that if you keep, | 30:03 | |
if accelerate inflation and keep at the higher | 30:04 | |
level of inflation, after all. | 30:07 | |
After a while people will adjust to it, | 30:09 | |
they will accept the notion that higher level | 30:12 | |
of inflation is to be expected. | 30:14 | |
They will adjust to it. | 30:17 | |
The temporary stimulus will disappear, | 30:19 | |
and you will fall back into the situation | 30:21 | |
of whatever may be. | 30:23 | |
The average level of unemployment, | 30:26 | |
and maybe you will go beyond that, | 30:28 | |
and that's what produces a stagflation phenomenon. | 30:29 | |
Similarly, the other way around, | 30:33 | |
if you slow down inflation, while it may temporarily | 30:35 | |
increase unemployment, as people come to recognize | 30:37 | |
that inflation has really been slowed down. | 30:40 | |
They will adjust in such a way as to restore output. | 30:42 | |
So, in both of these cases the trade-off is temporary. | 30:45 | |
Rose Friedman | I guess our time has run out. | 30:49 |
Thank you very much. | 30:51 | |
Remember, subscribers, if you have any questions | 30:52 | |
or comments, please send them to | 30:55 | |
Instructional Dynamics Incorporated, 166 E Superior Street, | 30:56 | |
Chicago, Illinois, 60611. | 31:01 |
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