Tape 179 - Chile, 1976 Economic Conditions, Prime Rate, Monetary Policy
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- | Hello, this is William Clark of the Chicago Tribune, | 0:02 |
saying welcome again on behalf of Instructional Dynamics | 0:04 | |
to a visit with the distinguished economist | 0:08 | |
Professor Milton Friedman of the University of Chicago. | 0:10 | |
We're recording this visit | 0:13 | |
in the waning days of October 1975. | 0:14 | |
And Milton, before we get into | 0:19 | |
more profound economic subjects, | 0:21 | |
I must comment that I read a column | 0:24 | |
in the last few days in the Wall Street Journal, | 0:26 | |
their "Notable and Quotable" feature, | 0:29 | |
which was written by you, | 0:31 | |
which referred to your recent visit | 0:33 | |
some months ago to Chile, | 0:37 | |
and apparently to some criticism | 0:39 | |
that has been made since of that visit. | 0:41 | |
I think your subscribers would like to know | 0:42 | |
some of the background of that. | 0:44 | |
- | Well, the background of it is the following. | 0:47 |
As my subscribers recall, I spent about a week | 0:49 | |
in Chile in early April. | 0:52 | |
I was down there under the auspices | 0:57 | |
of a private banking group. | 0:58 | |
But in a country like Chile, | 1:00 | |
which is being run tightly by the Junta, | 1:01 | |
the distinction between private | 1:04 | |
and public is not very important. | 1:05 | |
And while we were down there, | 1:07 | |
Al Harberger and I from the University of Chicago | 1:09 | |
were both down there. | 1:12 | |
While we were down there, we talked to a great many people, | 1:13 | |
learned a great deal about Chile, | 1:17 | |
gave some public talks, | 1:19 | |
did talk to the General Pinochet | 1:21 | |
and other people of the ruling junta | 1:24 | |
about the problems of Chile. | 1:26 | |
The overwhelming problem with Chile, of course, | 1:28 | |
was the rate of inflation running at 20% a month, | 1:31 | |
which was destroying the economy. | 1:34 | |
Chile has since undertaken some rather rigorous policies | 1:36 | |
directed at reducing the rate of monetary growth | 1:41 | |
and cutting the government budget. | 1:43 | |
These have brought the rate of inflation | 1:45 | |
from 20% down to under 10% a month. | 1:48 | |
They've cut them in half | 1:50 | |
in the course of three or four months, | 1:51 | |
which is very significant, | 1:53 | |
but it has involved the price | 1:55 | |
of a temporary increase in the rate of, | 1:57 | |
we hope it's temporary, | 2:00 | |
of an increase in the rate of unemployment. | 2:01 | |
There is no way to avoid that. | 2:02 | |
The Chilean government has introduced | 2:04 | |
emergency programs of assistance, | 2:06 | |
essentially make work programs at very low wages | 2:08 | |
in an attempt to ease some of the immediate problems | 2:11 | |
of the transition. | 2:15 | |
How it will work out in the longer run remains to be seen. | 2:16 | |
I hear from people in Chile | 2:19 | |
that they are not absolutely sure | 2:22 | |
that they still have the quantity of money under control; | 2:23 | |
whereas the quantity of money was rising | 2:26 | |
at over 20% a month earlier, | 2:28 | |
it's now still going up. | 2:31 | |
It's something over 10% a month, | 2:32 | |
and this apparently has to do with their inability | 2:34 | |
to get the government budget under effective control. | 2:37 | |
At any rate, that's the background of it. | 2:41 | |
Now, the particular letter in the Wall Street Journal | 2:43 | |
derives from a different aspect of it. | 2:45 | |
Not long after we got back, | 2:47 | |
I started to get letters from a number of people | 2:51 | |
criticizing me very severely | 2:53 | |
for having been willing to go to Chile | 2:56 | |
and been willing to give advice | 2:58 | |
to a repressive and undemocratic regime, | 3:00 | |
such as the military junta. | 3:04 | |
In particular, I got a series of rather abusive letters | 3:06 | |
from an old friend of mine, an Austrian, | 3:09 | |
who had been a refugee from Austria when Hitler came in, | 3:13 | |
had taught at various universities in the United States, | 3:17 | |
had returned to Austria about six or seven years ago, | 3:20 | |
and is very definitely way over on the left. | 3:23 | |
He wrote me letters asking whether I didn't want him | 3:27 | |
to send me a picture of Hitler to display on my wall | 3:29 | |
because after all, | 3:33 | |
for me to go down and talk to General Pinochet | 3:34 | |
was equivalent to being a defender | 3:35 | |
and a promoter of Hitlerian policies. | 3:38 | |
Well in response to this letter | 3:40 | |
I wrote him a private letter, | 3:42 | |
which is what essentially has been republished | 3:45 | |
in the Wall Street Journal. | 3:47 | |
The way that came into the public print | 3:48 | |
was that sometime later, Anthony Lewis of the New York Times | 3:50 | |
wrote a column about Chile, | 3:54 | |
in which he criticized strongly the trip which I had made, | 3:56 | |
and in particular, said that the policies we had recommended | 4:02 | |
were being imposed. | 4:06 | |
I must say he gave him and me a great deal more credit | 4:08 | |
for bringing those policies around than is deserved. | 4:11 | |
You must realize that no advisor of any kind | 4:15 | |
really determines a policy anywhere. | 4:17 | |
The coincidence between the kind of an advisor | 4:21 | |
and the policy depends more on the choice of the advisor | 4:24 | |
than it does on what the advisor says. | 4:26 | |
At any rate, he argued and raised the question of whether | 4:28 | |
it was in accord with ethical standards of an academic | 4:33 | |
to give advice to a government in Chile. | 4:37 | |
This, in turn, was picked up by various groups, | 4:42 | |
and in particular, by the last remaining remnant | 4:45 | |
of the very left-wing SDS group | 4:48 | |
on the University of Chicago campus, | 4:51 | |
a relic from the 1960's. | 4:54 | |
This group which calls itself the Young Spartacist League | 4:56 | |
is a small group of Marxist revolutionaries. | 4:58 | |
Very few of them are in fact students at the university. | 5:03 | |
They draw most of their support | 5:06 | |
from Circle Campus of the University of Illinois | 5:09 | |
or from Roosevelt College or from other places | 5:12 | |
outside the campus. | 5:14 | |
At any rate, they are in their dying days, | 5:16 | |
and they are anxious and desperate for any kind of issue | 5:20 | |
in which they can arouse people. | 5:23 | |
So they picked up this issue | 5:24 | |
and they put out big posters saying | 5:26 | |
drive Milton Friedman off the campus, | 5:28 | |
or he's a fascist beast for going down | 5:30 | |
to advise the Chilean government. | 5:33 | |
Now one of the amusing paradoxes of it is | 5:36 | |
they were trying to drive me off the campus | 5:39 | |
for advising a government on the grounds | 5:41 | |
that that government was stifling academic freedom in Chile. | 5:44 | |
At any rate, this group did hold one or two | 5:48 | |
public protest meetings which were very sparsely attended. | 5:51 | |
They did get a resolution put up | 5:56 | |
before the student government of the University of Chicago | 5:58 | |
which I am delighted to say the student government rejected. | 6:02 | |
This was a resolution of censure | 6:05 | |
against Harberger and myself, | 6:07 | |
which was rejected by the student government by a vote | 6:09 | |
of something like 40 or 50 to 12 or 15, | 6:13 | |
or something of that order, overwhelmingly. | 6:15 | |
The student newspaper, The Chicago Maroon, | 6:20 | |
of course got after me immediately | 6:22 | |
upon this business developing, | 6:23 | |
and I thought that the best course | 6:26 | |
was not to respond specifically | 6:27 | |
to the Young Spartacist League. | 6:30 | |
I don't want to let them determine my activities, | 6:31 | |
but instead, I took out of my files my carbon of the letter | 6:33 | |
which I had written to my Austrian friend | 6:37 | |
and gave it to the Maroon to publish, | 6:40 | |
and that's what Wall Street Journal republished. | 6:42 | |
Now I may say that there is a very real issue involved. | 6:44 | |
Obviously, the question is that there are circumstances | 6:47 | |
under which it would be immoral to participate in | 6:51 | |
or to cooperate with or seem to give some credit | 6:56 | |
to a repressive regime, | 6:59 | |
but it's not an easy question to answer. | 7:01 | |
In our particular case, it's complicated by the fact | 7:03 | |
that over the course of years, | 7:06 | |
we have had many Chilean students | 7:07 | |
who have earned their Ph.D.'s from us. | 7:09 | |
This is as a result of a cooperative program | 7:11 | |
which we had with the Catholic University of Chile, | 7:13 | |
funded if I recall right by the Forward Foundation | 7:15 | |
and also maybe by USAID funds. | 7:18 | |
As a result, probably the largest group | 7:22 | |
of trained economists of Chilean extraction | 7:24 | |
are University of Chicago Ph.D.'s. | 7:27 | |
Some of them have become refugees from Chile | 7:30 | |
under the present government, | 7:33 | |
but some of them decided that they could contribute | 7:35 | |
more to their country by staying | 7:37 | |
and working within the government. | 7:39 | |
Now the question is, what responsibility do we | 7:41 | |
as their teachers have to this? | 7:43 | |
We supported them during the unity period, | 7:45 | |
I think we have an obligation to support and advise | 7:48 | |
those who have left Chile. | 7:52 | |
But I think we also have an obligation to support | 7:55 | |
and back up those who have stayed in Chile. | 7:57 | |
Moreover, it's a very difficult thing | 8:01 | |
to know what the alternatives are. | 8:02 | |
You have only a choice at the moment in Chile | 8:04 | |
between a repressive junta and what I think | 8:06 | |
would have been an even more repressive | 8:10 | |
and unalterable totalitarian Allende regime. | 8:12 | |
Are the chances of getting back to a democratic society | 8:17 | |
improved or worsened by good economic policy? | 8:20 | |
I think they clearly are improved. | 8:22 | |
So I have no apologies to make. | 8:24 | |
The thing that impresses me is the double standard | 8:27 | |
which is applied to these matters. | 8:30 | |
As I say in the letter, | 8:32 | |
I have advised the government of Yugoslavia | 8:33 | |
with never having gotten a peep from it. | 8:35 | |
(William chuckles) | 8:38 | |
And the fundamental thing which this illustrates | 8:39 | |
is a long-standing phenomenon, | 8:42 | |
which is that there is a bias | 8:45 | |
in intellectuals' communities' attitude. | 8:46 | |
To be expressed by the fact | 8:48 | |
that there are no enemies on the left. | 8:50 | |
- | Thank you very much Milton. | 8:52 |
I know a number of your subscribers | 8:53 | |
will have read that piece in the Wall Street Journal | 8:55 | |
and will be very much interested in this background comment. | 8:57 | |
Now I have been reading a column written for Newsweek | 9:00 | |
back in February of this year by yourself Milton Friedman, | 9:05 | |
which reads in part as follows. | 9:10 | |
"Most current talk about the 1976 presidential race | 9:13 | |
"takes it for granted that President Ford | 9:17 | |
"will be severely handicapped by the state of the economy. | 9:18 | |
"That then as now, now being February of this year, | 9:21 | |
"he will be saddled with high inflation, | 9:25 | |
"high unemployment, and high oil prices. | 9:27 | |
"My crystal ball suggests precisely the opposite. | 9:29 | |
"The state of the economy in 1976 will be | 9:32 | |
"a strong plus for President Ford," and so forth. | 9:35 | |
I wonder do you still feel that way at this point in time? | 9:39 | |
- | Yes, I still do. | 9:43 |
I don't believe that the past seven or eight months | 9:44 | |
has altered fundamentally that picture, | 9:49 | |
but on the contrary, it has tended to confirm it. | 9:50 | |
Indeed, later on in that column, | 9:53 | |
in talking about the end of the recession, | 9:57 | |
I said the turning point is coming later | 10:00 | |
than it actually came. | 10:03 | |
In fact if anything, the developments since then | 10:04 | |
have been much more positive from the point of view | 10:08 | |
of improvement in the economy over the short run | 10:11 | |
than they were at that time. | 10:14 | |
Therefore, I think the odds still are | 10:17 | |
that in 1976, the economy will be improving | 10:20 | |
in the sense that unemployment will be going down, | 10:23 | |
the rate of inflation will be tapering off | 10:26 | |
or staying steady, at least it will not be accelerating; | 10:29 | |
and I still stick to the view that I expressed then, | 10:32 | |
that there's a significant chance that by 1976, | 10:35 | |
the OPEC oil cartel will be disintegrating | 10:40 | |
in an even more visible form | 10:42 | |
than it has already shown signs of disintegrating. | 10:45 | |
All of those factors will therefore be working favorably | 10:47 | |
for President Ford in the election. | 10:50 | |
Obviously, that doesn't mean he's gonna be elected. | 10:52 | |
That's another question. | 10:54 | |
I think that the naive notion | 10:55 | |
that economic conditions alone determine elections | 10:57 | |
cannot be supported from the evidence. | 10:59 | |
- | Thank you, that's a very interesting | 11:02 |
and I think for most of us, an encouraging prospect. | 11:05 | |
- | I may say one thing which I think it does bring out | 11:08 |
of a rather different kind, Bill, | 11:10 | |
is the need for some sense of perspective in these matters. | 11:12 | |
Back in January or February of this year, | 11:15 | |
there was an enormous wave of pessimism. | 11:19 | |
We're entering into a major depression. | 11:21 | |
We're going to relapse into a 1929-33 situation. | 11:23 | |
Well, we need to pull out all stops | 11:28 | |
in order to get out of it. | 11:30 | |
That was the kind of atmosphere and attitude | 11:31 | |
around the early part of this year. | 11:33 | |
It wasn't justified then, as is clear from | 11:36 | |
the statements I was making in this column. | 11:38 | |
Therefore, I think the important thing for all of us to do | 11:43 | |
is to try to take a somewhat longer view | 11:45 | |
and not get tied up in this tendency | 11:47 | |
to look two months ahead. | 11:49 | |
It's understandable that Wall Street and Washington | 11:51 | |
has that short a perspective, | 11:53 | |
but the rest of us out here in the boondocks, | 11:55 | |
we don't have to be infected by the hysteria | 11:57 | |
which emanates from the canyons of Wall Street | 12:01 | |
and from the smoke-filled rooms of Washington. | 12:03 | |
Try to keep a sense of perspective | 12:05 | |
and not let ourselves be driven by momentary feelings. | 12:07 | |
- | I like that. | 12:11 |
Milton, in the last few days | 12:12 | |
there have been some reductions in the prime rates. | 12:14 | |
What does this foreshadow, as far as you're concerned? | 12:18 | |
- | I believe that this will turn out | 12:21 |
to be a very temporary phenomenon. | 12:22 | |
It may last a few months. | 12:24 | |
I believe in large part, | 12:26 | |
the reductions in the prime rate and the short-term rates | 12:28 | |
are an indirect consequence | 12:31 | |
of the New York financial situation. | 12:32 | |
The uncertainty of New York City's financial condition | 12:37 | |
has had two effects, both of which | 12:40 | |
have tended to drive down short-term interest rates. | 12:42 | |
The first effect arises out of the fact | 12:47 | |
that whenever there's great uncertainty, | 12:49 | |
this is exactly what happened | 12:51 | |
at the time of the Penn Central disaster in 1970. | 12:52 | |
It's what happened when there have been | 12:56 | |
other financial emergencies. | 12:59 | |
Whenever there is a great increase in uncertainty, | 13:01 | |
there is an attempt by people to become liquid. | 13:03 | |
How do people become liquid? | 13:06 | |
By trying to move from long-term securities | 13:08 | |
to short-term securities in their assets. | 13:10 | |
Therefore, the effect of uncertainty | 13:13 | |
is to steepen the yield curve. | 13:15 | |
That is to say, to make the differential | 13:18 | |
between rates on short-term securities | 13:21 | |
and rates on long-term securities | 13:23 | |
larger than it otherwise would be. | 13:25 | |
If you look at what's been happening to interest rates, | 13:26 | |
long-term interest rates haven't come down particularly. | 13:29 | |
They've stayed roughly the same. | 13:31 | |
It's short-term interest rates that have come down. | 13:33 | |
That's the effect of this desire for liquidity. | 13:35 | |
The second effect of the New York crisis, | 13:38 | |
which I think I mentioned in an earlier tape, | 13:41 | |
is that by drying up the municipal market, | 13:44 | |
by making people hesitant about putting money | 13:46 | |
into the municipal market without altering | 13:48 | |
the total amount of funds available for investment, | 13:50 | |
is has tended to divert funds to the other securities. | 13:52 | |
To federal securities, to private securities, and the like. | 13:57 | |
That in turn, has tended to drive down the whole structure | 14:00 | |
of rates of interest on private security. | 14:03 | |
The two have reinforced one another in this respect, | 14:07 | |
and I think are primarily responsible | 14:10 | |
for the decline in the rate of interest | 14:14 | |
that we've seen in the prime rate. | 14:20 | |
Now this, in turn, given the way, | 14:22 | |
and we may come back to this, | 14:25 | |
but given the way in which the Fed operates, | 14:26 | |
this, in turn, helps explain | 14:28 | |
the extremely restrictive monetary policy | 14:30 | |
of the Fed in the last few months. | 14:32 | |
As this is turned around, we may have for a couple of months | 14:34 | |
a continuation of relatively low short-term rates. | 14:39 | |
I say relatively low. | 14:43 | |
7 3/4% percent is not exactly | 14:44 | |
what at one time we would have called a low rate. | 14:46 | |
- | That's right. | 14:48 |
- | But at any rate, you may have softness on the rates. | 14:49 |
But as and if as I believe will happen, | 14:52 | |
the economy picks up and the recovery gathers steam, | 14:56 | |
that will be reversed. | 14:59 | |
And I think if you look down the line | 15:00 | |
four, five, six months from now, | 15:02 | |
the prime rate will not stay where it is. | 15:04 | |
It will tend to go up. | 15:06 | |
The only thing that in the long run | 15:07 | |
will drive down those rates, | 15:09 | |
is a very significant and | 15:10 | |
continued decline in the rate of inflation. | 15:15 | |
May I hope that's in the offering, but I wouldn't bet on it. | 15:18 | |
- | Allude to monetary policy, and if I'm not mistaken, | 15:23 |
Chairman Burns, Arthur Burns is to testify | 15:25 | |
before the Senate Banking Committee | 15:28 | |
within a day or two regarding the resolution | 15:29 | |
requiring the Fed to specify monetary policy, | 15:33 | |
and that you are going to testify about week after that. | 15:36 | |
I wondered if you would give us a little background | 15:41 | |
and maybe a little forecast of what you plan to say. | 15:43 | |
- | Well, as you recall, the concurrent resolution | 15:46 |
which was passed by Congress last spring, | 15:51 | |
requires the Fed to report supposedly once every six months | 15:53 | |
about what its projected targets for monetary growth | 15:57 | |
are for the next year. | 16:00 | |
Now the the average six months | 16:02 | |
has turned into every three months, | 16:03 | |
because the House Committee | 16:05 | |
wants to have them every six months, | 16:06 | |
and the Senate Committee wants to have them every six months | 16:07 | |
so it's turned out to be every three months. | 16:10 | |
This time it's the Senate Committee's turn | 16:13 | |
with William Proxmire in the chair, | 16:18 | |
and Arthur Burns is to testify this week on his targets. | 16:19 | |
I don't know what he's going to say | 16:24 | |
but I would be willing to wager | 16:26 | |
that he will stick pretty much by roughly the same targets | 16:28 | |
that he's stated earlier: | 16:33 | |
5-7.5 % for M1, 8.5-10.5% for M2. | 16:34 | |
Now if you look at actual performance, | 16:38 | |
what happened is that the Fed, as I reported here, | 16:40 | |
was in July, above the upper limit of its objectives. | 16:44 | |
When Arthur Burns testifies, | 16:50 | |
the Fed will be below its lower limit. | 16:52 | |
It has swung from a very rapid expense | 16:54 | |
into a very restrictive policy. | 16:57 | |
That is why I say in the past from July to now, | 17:00 | |
the rate of growth of M1 has been essentially zero, | 17:04 | |
it had been flat. | 17:06 | |
Now, what this brings out, in my opinion, | 17:08 | |
is that the big problem in Federal Reserve policy | 17:12 | |
is no longer the objectives they are seeking, | 17:14 | |
but the techniques by which they are trying | 17:16 | |
to attain those objectives. | 17:18 | |
I believe that that congressional resolution, | 17:21 | |
for reasons I've explained on these tapes earlier, | 17:23 | |
has been a major in a very important | 17:25 | |
and very salutary change in monetary policy. | 17:26 | |
For the first time, it forces the Fed | 17:29 | |
to reach long-term targets, to set long-term targets, | 17:30 | |
to state them publicly, and to be held accountable for them. | 17:35 | |
The real problem is, and I have very little quarrel | 17:38 | |
with the objectives they've stated. | 17:41 | |
Personally, I would have had somewhat lower rates of growth, | 17:43 | |
but on the whole it's in the right ballpark. | 17:46 | |
But I believe that the performance | 17:49 | |
has not matched the objectives. | 17:51 | |
The objectives have been good; | 17:54 | |
the performance has been terrible. | 17:55 | |
Why? | 17:56 | |
Fundamentally, because the Fed continues to try | 17:57 | |
to control the money supply by techniques | 18:01 | |
which were developed for a wholly different purpose, | 18:04 | |
namely, to control interest rates. | 18:06 | |
The way in which the Fed operates, as you all know, | 18:08 | |
is that it has a money supply target | 18:11 | |
let's say of 6% for next month, | 18:13 | |
it gets its staff to convert that | 18:15 | |
into what federal funds rate is estimated to be required | 18:17 | |
to keep the monetary growth at 6%, | 18:22 | |
and it then instructs New York | 18:25 | |
to keep the federal funds rate there. | 18:28 | |
Now the problem with what is, | 18:30 | |
that it's logically, in principle, | 18:31 | |
a possible way to operate. | 18:34 | |
There is at each moment of time a federal funds rate, | 18:36 | |
at which the amount, the number banks would wish | 18:39 | |
to add to their reserves would be just the right amount | 18:42 | |
in order that the money supply | 18:45 | |
should increase at the desired level. | 18:46 | |
As you can see, there are many slips | 18:48 | |
'twixt that cup and the lip. | 18:50 | |
There are two major slips. | 18:51 | |
The first is that the Fed is very bad | 18:54 | |
at estimating what the required interest rate is. | 18:56 | |
The reason they're bad is because there are many forces | 18:59 | |
going on in the interest rate market | 19:02 | |
that they have no control over. | 19:04 | |
As for example, I've just been describing | 19:05 | |
these effects of New York. | 19:06 | |
It's because of these effects of New York | 19:08 | |
that they have misestimated | 19:10 | |
what federal funds rate they want, | 19:11 | |
and they have set the federal funds rate too high. | 19:14 | |
But the second slip is even more important. | 19:16 | |
It is that if they make a mistake, | 19:18 | |
the mistake tends to be reinforcing | 19:20 | |
and to be cumulative to drive them away. | 19:23 | |
It's like trying to keep an egg standing on its pointed end. | 19:25 | |
You can do it in principle, | 19:30 | |
but you have to do an awful lot of fine-tuning | 19:31 | |
to keep it there. | 19:32 | |
And they are in exactly that position, | 19:33 | |
because what happens? | 19:35 | |
Suppose they set the rate too low | 19:37 | |
as they did earlier this year. | 19:40 | |
They set it too low because they didn't figure | 19:43 | |
on the figure of the expense. | 19:45 | |
They set it too low; the market is trying to drive it up. | 19:46 | |
In order to hold it down, they have to print money. | 19:50 | |
They have to create money. | 19:52 | |
They have to add to reserves. | 19:53 | |
This intensifies the boom, | 19:55 | |
and intensifies the forces driving the rates up, | 19:57 | |
and if they kept that rate there, | 20:00 | |
the only way they could do it | 20:02 | |
would be by letting money grow indefinitely. | 20:03 | |
That's what ultimately killed the bond support program | 20:05 | |
during World War II. | 20:09 | |
Now on the other hand, if they set it too high, | 20:11 | |
then they have to pull money out | 20:14 | |
and they drive you into a deflate. | 20:15 | |
Of course, they don't stick to the rate. | 20:17 | |
When they finally get persuaded | 20:18 | |
they've gone too far, they adjust. | 20:20 | |
But then they have a strong tendency to adjust too far. | 20:22 | |
That's why, in my opinion, | 20:25 | |
throughout the history of the Fed for 62 years, | 20:27 | |
the standard pattern has been one of swinging too far | 20:29 | |
from one side of a monetary explosion | 20:32 | |
to too far to the other side of a monetary contraction. | 20:34 | |
There is an alternative method of operating | 20:38 | |
that's perfectly accessible too, | 20:39 | |
that has been proposed and recommended | 20:41 | |
by people within the system. | 20:43 | |
I've been arguing this way for at least seven years. | 20:45 | |
Before Arthur Burns was chairman, | 20:51 | |
I wrote to William McChesney Martin | 20:52 | |
trying to persuade him to have a joint research project | 20:54 | |
between my group at the University of Chicago | 20:58 | |
and some of the Federal Reserve people, | 21:00 | |
to develop an alternative technique | 21:02 | |
for controlling the money supply. | 21:04 | |
He wouldn't go along because he said to me then, | 21:06 | |
"Oh, we know how to control the money supply. | 21:09 | |
"That's not an issue. | 21:11 | |
"The only issue is do we want to control the money supply." | 21:12 | |
Well in 1970, they decided they wanted | 21:15 | |
to control the money supply. | 21:17 | |
It's five years later, | 21:18 | |
and they still have not adjusted their procedures. | 21:19 | |
The alternative procedure would be for it | 21:22 | |
to forget about federal funds rate altogether, | 21:24 | |
and simply ask how much high-powered money, | 21:26 | |
how much additional reserves do we have | 21:30 | |
to feed into the system in order to able | 21:32 | |
to get the monetary growth we want? | 21:36 | |
There still are errors in that. | 21:38 | |
It will not be precisely accurate. | 21:40 | |
And it might be even that for a month or two ahead | 21:43 | |
it would be no more accurate than the present system. | 21:45 | |
But it has the overwhelming advantage | 21:47 | |
that the errors would be random and offsetting, | 21:49 | |
and would not have this same tendency to cumulate. | 21:52 | |
It would be like laying the egg down on its side, | 21:54 | |
instead of on its point. | 21:57 | |
The burden of my testimony before the Senate | 21:59 | |
will be to try to stress the importance | 22:02 | |
of having the Federal Reserve shift its mode of operations. | 22:05 | |
Now as to what's actually going to happen, | 22:07 | |
I think the Fed is under enormous pressure | 22:10 | |
to reverse its recent highly restrictive policy, | 22:12 | |
and I think it will do so. | 22:16 | |
But I'm afraid that we'll once again | 22:18 | |
jump to the other extreme, | 22:20 | |
and that what we will experience | 22:21 | |
over the next four or five months | 22:23 | |
is another monetary explosion, | 22:24 | |
with rates of growth decidedly higher | 22:26 | |
than the Fed has set as its objective. | 22:28 | |
That's why I continue to believe, | 22:32 | |
as I did I may say when I wrote that column | 22:35 | |
in February that you referred to, | 22:37 | |
that the real danger, not for 1976, but for 1977 and 78, | 22:38 | |
is accelerated inflation | 22:44 | |
rather than a relapse into another recession. | 22:45 | |
- | Doctor Friedman, we have a letter | 22:49 |
we encourage our subscribers to write in | 22:50 | |
to suggest questions and subjects, | 22:52 | |
and it seems like we have trouble getting to them. | 22:54 | |
But here's one which from Gary Glynn | 22:57 | |
of Brooklyn, New York which reads as follows: | 23:01 | |
Dear Doctor Friedman, would you please comment | 23:04 | |
on Professor Friedrich Hayek's theory | 23:06 | |
that general economic stimulus has resulted in a | 23:08 | |
misallocation of labor and capital, | 23:10 | |
leading to the necessity of our either | 23:13 | |
having to have accelerating inflation | 23:16 | |
followed by severe unemployment later, | 23:18 | |
or bad unemployment now. | 23:20 | |
Specifically in his recent occasional paper | 23:23 | |
published by the Institute of Economic Affairs, | 23:25 | |
he says that you have not properly accounted | 23:27 | |
for this microeconomic phenomenon | 23:29 | |
in your policy recommendation of steady, | 23:32 | |
moderate money supply growth. | 23:34 | |
- | Well on the whole, I share very much | 23:37 |
Professor Hayek's view about the problems | 23:41 | |
for the immediate future, | 23:44 | |
but I believe the difference between his views and mine | 23:47 | |
are while real, can readily be exaggerated. | 23:51 | |
There is no doubt, that not general economic... | 23:58 | |
Well, let me go back. | 24:01 | |
I think the fundamental point of difference | 24:02 | |
is that what I stress is the importance of monetary growth | 24:05 | |
in excess of the amount people anticipate. | 24:09 | |
It is my argument that if you had money growing at any rate | 24:13 | |
and everybody anticipated it, | 24:17 | |
if money were growing at 10 or 15% per year, | 24:20 | |
and everybody expected that, | 24:23 | |
then prices would be rising | 24:25 | |
perhaps at 10% a year or 12% per year. | 24:26 | |
Everybody would expect that. | 24:28 | |
All interest rates would be | 24:30 | |
10 or 12 percentage points higher. | 24:31 | |
Everybody would adjust to that. | 24:33 | |
You would have a waste in changing price tickets | 24:37 | |
and the like, but there would not be in that case | 24:39 | |
any major misallocation of labor and capital. | 24:41 | |
On the other hand, when monetary growth | 24:44 | |
is different from what people expect, | 24:47 | |
when it's faster than people anticipate | 24:49 | |
or slower than people anticipate, | 24:51 | |
then you do have the misallocation of labor and capital | 24:53 | |
that Professor Hayek is talking about. | 24:56 | |
He stresses the absolute rate of growth | 25:00 | |
while I stress the difference between the rate of growth | 25:02 | |
and the rate anticipated, | 25:05 | |
and that's what leads to our different conclusions. | 25:07 | |
Now under the present circumstances where we are now, | 25:09 | |
it follows from what I've been saying | 25:12 | |
that once people have been adjusted to an inflation, | 25:13 | |
you cannot get to a lower level of inflation, | 25:16 | |
without unemployment in the process | 25:19 | |
or without misallocation in the process. | 25:22 | |
Similarly, if you accelerate inflation, | 25:24 | |
you can maintain employment, | 25:27 | |
but only by encouraging a further misallocation | 25:29 | |
of labor and capital as he says. | 25:32 | |
Thus, I do not believe that my policy recommendation | 25:34 | |
of steady moderate monetary money supply growth | 25:37 | |
is really fundamentally inconsistent | 25:40 | |
with his predictions about what has happened | 25:43 | |
from a policy which differs in respect | 25:46 | |
of being unsteady and immoderate. | 25:49 | |
- | Thank you very much Professor Friedman. | 25:52 |
If you subscribers would like to pose questions | 25:53 | |
for Doctor Friedman to answer | 25:56 | |
or subjects for him to discuss on future tapes, | 25:57 | |
please write your suggestions | 26:01 | |
to Instructional Dynamics Incorporated, | 26:02 | |
450, that's 4-5-0 East Superior Street, Chicago 60611. | 26:05 | |
We'll be visiting with Doctor Friedman again | 26:13 | |
a couple of weeks hence. | 26:15 |
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