Welcome to E Con Talk, part of the Library of Economics and Liberty. I'm your host, Russ Roberts of George Mason University. My guest today is Milton Friedman. Milton is a senior research fellow at Stanford University's Hoover Institution, the 1976 Nobel laureate in economics and a hero to millions in the United States and around the world for his insights and actions on behalf of economics and liberty. Milton I'd like our conversation to focus on the ideas contained in two of your books. A Monetary History of the United States 18 72 1960 a massive scholarly work and capitalism and freedom, A slim monograph on the principles of a free society. Let's begin with the Monetary History of United States, written with Anna Schwartz, published in 1963. It was an extraordinarily detailed and careful study of the role of money in the economy and among many important insights. It made the case that inflation is everywhere and always a monetary phenomenon. When that book was published, what was the reaction of the profession to its scholarship,

the profession on the whole appreciated scholarship, as I remember as best I can. They were three different reviews in three different professional journals, all of which were highly favorable, even though one of them at least, was written by her. But I think two out of the three were written by strong canyons.

And what was its impact in affecting? Ah, the way the profession, at least in the short run, looked at at the role of money. Uh,

I find that a very hard question to answer. Obviously, many things were going on in the world, was going on. Bretton Woods was on, uh, the sixties was a period, a pretty good prosperity. On the whole. During the fifties and the sixties, it looked as if the candy and interpretation was right. After all, during that period, we had relatively prosperous countries, relatively stable prices, relatively low interest rates, everything.

It was a golden ear, as it were, and everybody was what was said to be operating on candy in line. What really changed the public perception and also the professional perception was the experience of the seventies. During the 19 seventies, you had you had a combination that under Kenji and analysis could not exist. You let hi unemployed, high inflation and unemployment at the same time, Name stagflation. Uh, in that combination was really ruled out by the simple kind of candy in analysis that was involved. But it was that experience which, more than anything else, led to a basic change in public and intellectual attitudes toward

money. So the the scholars and the public had to try to puzzle out why this seeming impossibility was definitely occurring.

Well, they didn't. Yes, and no. Because of our book. Because Bob Lucas is work, we're not. We had predicted that this would happen and therefore there wasn't, as in Word was, it was like an experiment. And you wait and see what happens. And the predicted results happened.

There was something to hold onto intellectually toe. Explain the lens to look through to explain

what was going on. Sure, because, uh, this land had been provided in advance, and we had said what its consequences wouldn't bay. And we had predicted that you could happily high unemployment and high inflation at the same time.

I was an undergraduate and graduate in the seventies and my textbooks, it's the undergraduate level, not the gradual level, because I attended a small university in the Midwest. I think he used to have an affiliation with the University of Chicago. But as an undergraduate, Mike, my textbooks talked about all the different theories of inflation, cost, push, cost pole, the role of unions, the role of certain industrial concentration. And, of course, the possibility that building Friedman, this maverick thinker, was right. That money has something to do with it. It's my impression that's not true anymore, that the intellectual environment understands today that inflation is caused by a rapid growth in the money supply.

I think it does. I think that's clear. End the last 30 years last 20 years has done a great deal to rub that in, because every central bank has come to accept the view that it's responsible for inflation.

Let's talk about the central bank's, um, what role do you think the monetary history had and the related work around it, Of course, in influencing central bankers and focusing on the money supply and the role and its role infecting inflation,

I think it had a certain matter. Five. I think it had a great deal of it. I think what was most important there was a chapter in the monitor history that dealt with the Great Depression. Because, uh huh, the difficulty of having people to understand monetary theory is very simple, and that is that the central banks are good at press relations. Central banks hire people, and the central bank's employ a large fraction of all economists. So there is a bias to tell the case the story in a way that is favorable to the central banks. Uh, but the Great Depression was such a major event and such a disaster that there was no way in which you could talk it away. All those they tried to do so. If you read the annual reports of the Federal Reserve Board and Orange testimony before Congress, you will find it then, as latest 1933 the very depths of the Depression. It's talking about how much worse things would have been if they hadn't behaved so well.

It's 25% unemployment might have been 30 30 or 40. Very depressing, actually. But because

of that, but because of that, because the evidence was so clear in that case, and there are lots of me lots of other people have done, and I we're not the only ones who did it, because the evidence was so clear you had a decline in the quantity money by 1/3 from 29 2 33 And that coincided with a decline in the economy by half or so. When you have 25% of the working force unemployed, you can't just talk it away.

But at the time at the time, everyone afterward, the main lesson that people drew from that was that capitalism is broken.

Absolutely. The blessing people through was it. It was a fault of business. It was a market failure. But I think that reason they drew that lesson was because of the way in which the self interest of the monetary authorities let him to promote it.

And you could tell us in the self interest of FDR in and paint himself as a savior. Despite the with the recession, somebody

ate. But that would have been the same for them. Even if they had recognized the cause, only they would've concentrated more on doing on abolishing the Fed or on reformulated the Fed. But the reason why the public and the intellectuals at large held to that perception because that was what they were being told by the authorities.

And so it justified a great deal of government intervention in the economy at the time. Oh, it certainly did. And you're suggesting that the monetary history was the beginning of a revision toward, ah, different perspective?

Well, I don't know. On the ideological views side, uh, it's probable there there were other things that were row Hayek's Road to Serfdom, which was sure published in 1945. Ah made the ideological case, but I think them and but I think the monetary history. I don't know what role it played in the public at large, but in terms of the monetary authorities in terms of money, there's no doubt that it played

in that chapter on the Great Depression. Must have alarmed them greatly about their potential for doing harm. Exactly. Ah, and at that time in the sixties, there was a lot of debate about what the role the central bank should be. And because inflation was relatively low, there was much less attention. Pay played to that rule pay to that role and other issues of full employment, et cetera.

And as of the sixties, Doc and the interview was dominant for sure, so that they're the central banks did not have any, uh, here and there they were. There were things like Federal, Your Bank of ST Louis, uh, which was which was arguing against the Federal Reserve policy and which was arguing that they should pay more attention to the quantity of money. But they were Mavericks. They were considered as Mavericks, but so far is a bulk of the population, the bulk of the profession, the bulk of the people hired by the monetary authorities. They all work agents.

And that, of course, is no longer true. But focusing on the central bank roll going back again to the seventies, when I was in school and shortly after your book came out, there was the focus was on the money supply, the quantity of money, counting it, controlling it through open market operations. Something changed in the last 25 years ago. 30 years. That's not what Alan Greenspan or Ben Bernanke talk about. They talk about other things, and they play with that short term interest rate, not the so called stock of money that you focused on so in.

And that's what they talk about, But that's not what I d'oh. What do they dio? They move the They use the short term interest rate as a way of controlling the quantity of money. If you look at the statistics, the the rate of change of the quantity of money from months and months quarter to quarter year to year has never been so, so low as it has been over the last 20 years. I don't believe there's another 20 year period in the history of the country in which you find so steady array growth in the quantity of money, and it's okay that can't all be an accident. That's because they use the short the short term interfere. After all, how do they look at it in a cinema? Simplest possible way. The Fed says the short term interest rate should be 4.5%. How do they keep it there by buying and selling securities on the open market? Now you're Mr Bernanke. You're Mr Greenspan you're watching.

And with the current ah short term interest rate, you'll find that the quantity of money is starting to creep up more rapidly than you really want. Well, then you will tend to be favorable toe raising to a higher rate of energy at that higher rate of interest, the demand for money is less. Ah, and so the supply of money under that phenomenon, instead of having to sell uh, government bonds to keep it there, they have to buy government bonds to keep it there or vice versa. Maybe I'm getting and make them. But in any event, that's the short term. Military is a tool with which you can control the quantity of money,

but they don't talk about

that way. No, they don't talk. Why do you think that is? I don't know. I've always been puzzled by why they insist on using the interest rate, Think about

one day money and then they talk about how you know the economy is growing too well. That must be it. We have to be careful. That could be inflationary. We have to hold it back, which a logic. I've never fully understood

that if you if you really carried out the logical concerning the quantity of money you deprive the veteran reserve or anything to d'oh, it's supposed a Federal Reserve said he was going to increase going to your money by 4% a year, year after year, week after week, month after month. That would be a purely mechanical project. You could you could you could program a computer

to do that like an index mutual fund takes away the fun of being a fun man. Dr. So you're suggesting part of the reason is perhaps

that's part of the reason. But the main reason I think it's different. It's that the association, the central bank, regarded associates with banks in regard itself a sort of a mentor of the banking system and to the individual bank. It isn't doesn't believe it's creates a quantity of money that doesn't make any sense to them what they deal with our industry and therefore it's natural. And so many of the central bankers are themselves from the banking industry, their bankers, and so it's natural for them to think in terms of interest rates. And moreover, when they think in terms of interest rates, where then there got all kinds of industries, short term interest rates, long term interest rates, all kinds of excuses for ah, uh, exercising power or thinking they're exercising, taking credit for exercise. I've always been in favor of abolishing the Federal Reserve and substituting a machine program that would keep the quantity of money going up at a steady rate.

And they have go make your earlier comment. Over the last 20 years or so, they've approximated that

come closer to approximating an absolutely.

And I would argue, and I assume you would as well that the relative stability of the U. S. Economy over the last 20 years is a reflection of that steady growth in the money supply.

I think there's no

doubt at all the non erratic pat

that 20 year is a golden period. It's a period in which you had declining inflation but fairly steady raid studying level. You had only three recessions, all of them brief, all of mild. I don't believe you can find another 20 year period in American history, but it's interesting to note that so far as the international acceptance of monetary control is concerned, it was. It was started by the back of New Zealand, not by the Federal Reserve Bank. It was, uh, sometime in the 19 eighties, when New Zealand essentially came close to privatizing its its central bank. Uh uh Ah Set up a situation in which the governor of the Central Bank of New Zealand had a contract with the government in which he agreed to keep the, uh, the, uh, rationality inflation within a certain bounds 03% or 02%. And if he did not do so, he was He could

be fired, not decapitated, merely fired, merely fired. But it still concentrated his mind's

official yah and, uh, Don Brash, who was appointed as the first governor of the Central Bank of New Zealand. He's a very a. He's now the leader of the opposition in the in the New Zealand Parliament. But at the time he came from the he came from business. He was a businessman and he was He is an extraordinarily able, ineffective fella. And he took this job on at the time when New Zealand at a very high inflation rate, and he succeeded in living up to his contract and that really set the pattern. It was a New Zealand experience. I'm sure it had more to do with other kinds of central banks around the world adopting inflation targeting in the United States experience because

it was so dramatically effective in his A a. It

was the first time that anybody had explicitly adopted an inflation talk so that that was something that everybody observed. And second lay. It was so dramatically affected

going back to this issue of the money supply and the lack of talk about it in concentration. It is it or is it not more difficulty to measure the money supply today than it was 30 30 40 years ago? No credit. Other things,

you know, it's always been difficult to measure. The money has always been an argument. Whether, as you know it started out, was just coinage. Gold and silver coins, 100% quality, that is 100% wait and die. The story is told over and over again. And that's correct that the Golden dealers in Gold discovered that they were holding deposits for people and nothing they very rarely came to take it out, and so they could issue promises to pay. That exceeded the amount of gold I had. And that was the beginning of the fractional reserve banking has been, and that's the way in which the banking system operates today and in fact, in which the country operates, Uh,

we have paper money, but there's it used to say on it it doesn't anymore. Used to say on the U. S. Government promises to pay so $10 But they hadn't. When you went to get the $10 you got 10 $1 bills. And if you broke down the $1 bills you would get, you could get us far as having all copper.

Lucky. So, are you optimistic about the, um the role of central bank will continue to play in that inflation and price level story. We say we've had a golden era of 2025 years of stable prices, steady growth with only minor by historical standards, minor recessions. Are you optimistic about the next 25 years? 20 years.

I have great difficulty not being optimistic about it. All the evidence would look that seemed to be optimistic. On the other hand, I can't hold back a doubt governments want to spend money, and sooner or later governments are gonna wanna spend money without taxing it. And the only way to do that is to print money is to create inflation. Inflation is a form of taxation. How long will government be able to resist temptation and particularly as people become adjusted to being in a world of stable inflation, there will be bigger suckers, as it were, it will be easier to get a lot of out of it. Everybody anticipated inflation you couldn't get any were born for

it. But once you get, you can. Once you get people lulled into the expectation of a lack of it, there's the potential to exploit it. Uh, let me ask the question in a different way. Ah, lot of people credit Alan Greenspan with the expansion and success they give pole broke or some credit is wealthy early part of the spirit that we're talking about, but they make it sound like the key to success in monetary policy is you just got to get the right person in the job when Ben Bernanke or whoever is following him comes in. There's this absurd ah, microscopic examination of his the aura and vapors around such a person, and you're suggesting

that really is How is it that how is it the New Zealand can do it? How is it Australia can do it? How is it that Great Britain condone it? These are all countries which followed. Does it? Which do? Dylan started it. But then Australia, you know, in the Great Britain also adopted inflation

targeting. Well, they just happen to find the right guy

in each other's light at all. They won't look absolutely the great difficulty. I've always felt that the big defect politically of the Federal Reserve is precisely, and so much depends on UN elected representative. It's ah, the central bank has treated as if it were the Supreme Court. And so they know that if if that's why during the Depression there was no effective control on the central bank, there were members of Congress who knew what to d'oh. And you were trying to get the Fed to do it. But they could. They had no no way to do so.

There's no incentive directly. There was an indirect and Sam, of course, which was humiliation and stigma, of course, has endured. Of course, they had no no idea of the time how bad that would turn out. Those decisions would look in retrospect, but you're suggesting that if the disadvantage of the current system is a lack of accountability. But the alternative The elected system has the problem that you mentioned earlier of the temptation to exploit the ability to create money to increase

revenue. But that's why what you want to d'oh. Is it possible to have a mechanical system? That was, if there was any virtue to the gold standard, it was that virtue.

Maybe

you could create the same thing. Now my favorite reportable really is a little bit more sophisticated than the state, straight or less sophisticated. If you want to look at in a straight increasing the quantity of money, I would if I had my choice, freeze the amount of high power money, not an equation.

I've heard money

being a high powered money Isn't currency currency plus bank reserves. Okay, I would freeze that and holding constant and have it as sort of a natural constant like gravity or something. Okay, now you you would think that that's a bad idea because there would be no provision for expansion. However, in addition, the high powered money is a small fraction of total money, and the ratio of total money the high part money has been going up over time so the the economy would create more money. And that would be a roughly, uh, on the average you would have. Ah, pretty stable money growth and a pretty stable monetary system.

What you think the odds are of that happening? 00? Well, it's a small number zero wish they were a little more optimistic.

Uh, no, I don't think it'll happen unless there is another catastrophe like the Great Depression and unless under those circumstances, you might have it. But other than that is not gonna happen. And I think the real danger of this breaking down isn't there no danger of it's breaking down into a great Depression. The real danger is that will break up into an inflation. When I see in the papers in the Federal Reserve report that the inflation anticipation for 10 20 years is of the order of 2% a year, I find it very hard to believe it. Sooner or later, the government's going to get out of hand.

But But this current run is a lovely illustration of your your ideal, which would be a non discretionary mechanistic rule which people on average, find very unappealing. The average person plans Very unappealing. Discretion always seems to be better than the rule, because we could always issue Britain mimic the rule if that was what was called for. But the discretion gives us the opportunity to improve on the rule. And what you've argued, which is fascinating, is that with that discretion, which is not ideal in your world, yet with that discretion they have followed the rule is so far they've given the impression to the world that they're wise and careful engineers at the helm of the monetary system. And yet they have acted as robots and try. And what a wonderful example of, ah, lack of damage done by that that discretion so far. But I understand your pessimism.

That's the end of part one of my conversation with Milton Friedman. Please visit e con talk dot org to discuss this podcast with other listeners, find links related to this podcast and find other episodes of E con talk. This is your host, Russ Roberts, inviting you to join us for the next episode of E Con Talk. When Milton Friedman and I discussed the ideas in his landmark book Capitalism and Freedom,