From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm.

Transcription

1 What Price Inflation? Finance and Accounting 38, part 7 (1958): Presented at a session of the Division of Finance and Accounting, 38 th Annual Meeting of the American Petroleum Institute, Chicago, 11 November There is a growing expectation in this country that we shall experience inflation over the coming years. This belief, which has become much more widespread during the past several years, is now so prevalent as to be reflected in many different directions, not the least of which is the stock market. Of course, I would be of most value to the group here if I could set forth in detail the exact process whereby this inflation either will or will not come about and, in particular, predict its course in the next 6, 9, or 12 months. However, I shall refrain from trying to do so because the one thing that we really know about predictions, based on a mass of evidence, is that no one can make such predictions at all accurately. How to Predict Successfully I want to qualify that statement a little by enumerating for you the only three ways I know in which one can make this kind of short-run prediction successfully. The first is a method which was followed by a Southern doctor who claimed that he could always tell in advance what the sex of a child was going to be. About the third month of pregnancy he would proceed to announce that it was going to be a boy but then he would say, You know, people always forget what you tell them, and then he would take out a small black book and write in it girl. Well, if it was a boy, everyone remembered what he had told them but if it was a girl, he had the evidence to prove that he had been right in his prediction. The second method of being sure to make correct predictions is a method which I remembered being followed by Leon Henderson during the thirties. In the fall of 1934 he predicted that there was going to be a depression the next year but there was not; in the fall of 1

2 1935 he predicted the same thing and there was not. Then, in 1936, he predicted the same thing and he was a made-man because there was one. The third method is a bit more sophisticated and is revealed by an experience that I had with a friend as we were driving down the West Side Highway in New York on our way to dinner at Luchow s. We were having an argument about who was going to pay for dinner. Finally he said, I ll tell you what you take half of the letters in the alphabet and I ll take the other half and if the first word that the waiter speaks begins with a letter in your half then you pay for it otherwise I do. I said that I would have nothing to do with this. A few moments later he said, Well, I ll give you two-thirds of the alphabet and I ll take the other third. However, I still did not agree. Then, as we were walking into Luchow s, past the bar on our way to the back, he said, I ll give you all the letters of the alphabet with the exception of one, the letter Y, and, as the waiter came up he turned to him and said, Do you serve beer here? Sources of Inflation Aside from this slight venture into the problem of how to predict, for the purposes of this talk, I am going to put aside the question whether and when there is or is not going to be inflation. Instead, I propose to consider a number of different problems: 1. Whence arises the danger of inflation? 2. Why is it that there is a real possibility of inflation over the long period? 3. What are the likely consequences of inflation what price shall we pay if we do have inflation? If we review our history, we find many examples of inflation in the various countries of the world. Most of these inflationary periods have occurred as the result of attempts by governments to spend more funds than they were currently receiving. That is to say, they have occurred because of the pressures of budget needs of governmental authorities. These, in turn, 2

3 have arisen because of war or the preparation for war. In an attempt to meet these needs, countries have imposed a tax, as it were, in the form of inflation. They have printed money or created deposits to finance expenditures and, in this way, have produced price rises. This has been the principal source of inflation in the past. The fear of a similar development is one of the main reasons why it is now believed that there is great danger of inflation. This belief arises out of the view that the United States government has committed itself to extremely large expenditures. Furthermore, our attitude toward social policies and welfare measures is such as to lead to still larger expenditures, and that financing these expenditures is going to lead to inflation. I do not believe that this is the chief danger at the present time. It is clear that it is a danger, for there is much pressure for added governmental expenditures of all kinds and these could result in inflationary pressure if financed through the printing press. However in this respect, our postwar record is extraordinarily and surprisingly good. One of the most amazing facts of the postwar period has been the willingness of the people to tax themselves to support very large expenditures. Do not misunderstand me, I am not saying that large expenditures are a good thing. On the contrary, I believe that our government budgets are, have been, and are likely to be much too high and that it would be highly desirable to reduce them. However, given that we have had such budgets, it has been a good thing that the country has been willing to have tax levels maintained at extremely high levels, and at levels so that by and large we have not had budget deficits during the postwar period which would in themselves require printing of money on a large scale. This trend may not continue and it may be that as sentiments change the majority of the people will insist on expenditures without being willing to pay the corresponding taxes. If this should happen, then the danger of inflation would pose as a serious threat. However, most certainly on the record, one cannot say that this is the case today. 3

4 The danger of inflation, under present circumstances, arises, I believe, from a rather different source. It arises not from the steady year-to-year pressure for higher government expenditures but from the fear of deflation and the commitment to governmental action to maintain employment at a high level. The situation in this respect is one that we are accustomed to in many other instances. If you are walking down the street and are afraid that you are going to stumble over a stone, then you are more likely to hit your head on a branch. On the other hand, if you are walking down the street and you are worried about hitting your head on a branch, you are more likely to stumble over a stone. In the late twenties and early thirties the major fear in the minds of most people, most policy makers and the like, was the fear of inflation. We had been through a period of some thirty years in which the main price trends had been upward, interrupted only by the postwar price decline in Because the concern was about inflation, unintentionally, we were led to follow policies which had as one of their consequences the most extreme deflation in recent history one must go back to the late 1830 s and early 1840 s to find a comparable contraction. That experience, in its turn, instilled in the nation an extraordinary concern about the possibilities of deflation and unemployment and made it rather unconcerned about the possibilities of inflation. Despite the recent rise in talk about inflation, I think the fundamental situation has not changed. The fact that dominates men s minds is to avoid large-scale unemployment. As you all know, and here I need only refer to recent history, the very slightest wiggle in the curve of economic activity, the slightest tendency for unemployment to develop leads to an exaggerated concern about the state of the world and to an almost panic attempt to stimulate policies which, it is hoped, will offset it. Certainly the attitude toward these slight wiggles in the business curve is that of the anxious mother worried about her delicate infant who is likely to come down with a cold at 4

5 any moment. It is another instance of walking down the street and worrying about the branch rather than the stone. Minor recessions and wiggles are bound to occur. No human activity that we know of proceeds at a completely uninterrupted pace and for centuries of economic history there have been recessions and contractions from time to time. When one does occur, the general attitude I have described leads to fear that it will develop into a major contraction. Because of this attitude, each time there is a minor decline, there is a great tendency to overreact to it. The tendency is to undertake a wide variety of governmental measures to ease money, reduce taxes, increase government expenditures, foster housing, and so on. Measures of this sort act only with a substantial lag. We may move today but the effect of what we do today will not be felt for months or even years. If the Federal Reserve System eases credit today, it will be anywhere between 6 and 24 months before its major effect on economic activity will be realized. If the government engages in deficit spending, the same thing is true. Any measures which we take will only have their effect after a lag of time. However, if the recession turns out, as it has in each of the postwar episodes, to be relatively mild and business turns around within something like 8, 9, or 12 months, we are left with a legacy of measures taken during the recession whose effect is to give a stimulus toward inflation in the subsequent years. It is this reaction pattern, rather than the simple pressure of large-scale government budgets, which offers the chief danger of inflation in the coming years. This is a rather new pattern. To the best of my knowledge, it was never a source of inflation before World War II. It is quite natural, therefore, that we look for more traditional sources of inflation rather than this one. Recent Experience 5

6 It seems to me that we are extremely fortunate to have escaped thus far with as little inflation as we have had in view of this general attitude. The reasons we have avoided pitfalls are largely accidental. In the recession, we escaped from this pattern because of errors of forecast. As you will remember, people thought, at that time, that the problem was inflationary until the recession was half over. In fact, by the time the administration could react, the recession had started to lift. Then, as you know, came the Korean war and we had an inflation which could be attributed to the policy in connection with this war rather than reaction to recession. In the recession, the administration on the advice of the Council of Economic Advisors took an extremely strong stand against overdoing the reaction to it, despite the opposite views of a majority of professional opinion, both in the economic and political circles. Even so, we did have an overreaction and measures were taken which left the legacy of the mild price rise during mild by past standards but not mild in terms of the attitudes of people to it. We have just come through an episode in which we have again overreacted. The recession of was widely thought to herald a major contraction. As you all know, it is now estimated that the trough was reached in April of the past year but it is clear that the measures taken to offset the decline, including an extremely easy-money policy for a while and a large deficit on public account, have left a legacy of inflationary pressure for this coming year. It may be that there will not be a large price rise at this time. In fact, there is some evidence that there will not be. The Federal Reserve Board in particular believes that the major mistake it made during the expansion of was to continue the easy-money policy for too long a period, especially during There is some evidence that it may take a different course of action this time. It has already tightened up considerably and this may mean that the overreaction may not have serious inflationary effects this time. 6

7 Whether or not we have a major price rise in the next year or so remains to be seen. During the next ten years it is quite possible that we will experience a major price rise, which again may be attributed to overreaction on the part of the governmental and monetary authorities to the contractions or the recessions that will punctuate the period. What will be the consequences of such inflation if it does occur? Inflation and the Quantity of Money The major point that I would like to emphasize here is that the price which we shall pay for any inflation will be a consequence mainly of the kinds of cures that we are moved to adopt for the inflation rather than of the direct effect of the inflation itself. Inflation invariably reflects an increase in the quantity of money at a more rapid pace than any accompanying increase in output. Technically, inflation is the easiest thing in the world to stop. All one has to do is to see that the quantity of money does not rise. The difficult problem is the political aspect, that is to achieve a real will and desire on the part of the people to stop the inflation. Of course, people talk about not liking inflation but that is only half the story. What everyone dislikes is inflation in the prices of things that he purchases. He is delighted to have inflation in the prices of the items that he sells. Although it is easy to stop general inflation, it is rather difficult to see to it that the prices of things everyone buys go down, while the prices of things that everyone sells go up. The difficult and complex problem in the analysis of inflationary episodes is to explain the initial source and cause of the expansion of the supply of money. Whatever the source, inflation cannot occur without a substantial increase in the quantity of money. The only effective cure is the adoption of measures which will keep the quantity of money from increasing faster than output. 7

8 Under present circumstances, the quantity of money is likely to rise faster than output in the coming decades for the reasons given herein, and it is almost certain that other alleged cures will be tried. The search for other cures is partly a question of shifting the blame. Federal officials and members of the Reserve Board alike naturally are unwilling to accept responsibility for pay inflation which occurs. Accordingly, they insist that the government alone cannot prevent inflation monetary policies and fiscal measures are not, they say, sufficient. This, of course, as a technical matter, is simply wrong. The only way to stop inflation is to keep the stock of money from rising. The fundamental responsibility for maintaining a reasonably stable level of prices and preventing inflation is governmental. Governmental authorities have all the tools and all the power necessary to achieve this objective. For obvious reasons, however, they may not want to use this power. They would prefer to give the economy a very strong boost when there is the slightest danger of contraction and unemployment. On the other hand they would also like this boost to be effective only when it is really needed. Since there is no way of knowing in advance when a boost is really needed, our policy inevitably introduces an inflationary push in the vain hope that somehow or other something else can be brought in to stop the inflationary effects when they are not needed. Inflation and Wage and Price Controls In speech after speech, statement after statement, one finds the assertion that government cannot, by itself, stop inflation through monetary and fiscal policies. This is followed by an appeal to business and labor to exercise a measure of social responsibility in the prices that they charge and in the wages that they demand. Only if we can get the voluntary cooperation from both business and labor groups in holding down prices and wages, can we succeed in preventing inflation. In addition to the desire to shift the responsibility for controlling inflation, there are a number of other factors which will encourage the belief that monetary and fiscal measures 8

9 cannot do the job alone. The very circumstances under which inflation is likely to occur will give credence to the belief that monetary and fiscal policies have limited efficacy. The argument will be that contractions occurred despite the application of monetary and fiscal policy, and that such measures by themselves had proved inadequate. The difficulty in trying to adjust anything perfectly is that there is a lag in reaction what you do now may not take effect until a year from now. It is this time lag which makes the problem complex and makes it difficult to see that monetary and fiscal policy is really effective. For example, in the 1956 episode it appeared that monetary policies were not very effective. The Federal Reserve Board had tightened credit considerably but prices continued to rise. Of course, it might have been the measures taken in which were responsible for or which helped to bring about the recession in But this is a bit more complicated and difficult to see. Conversely, it is argued that, in the spring of 1958, the Federal Reserve Board had a very easy-money policy and we still had a recession coupled with a large measure of unemployment. The fact that perhaps those same easy-money policies were partly responsible for the rapid recovery in the fall of 1958 or early 1959 is difficult to see. Another factor which tends to lead to the use of measures other than monetary and fiscal policy is the attitude of a large part of the public toward monetary policy in particular and the price system in general. There are many people in this country, including those in positions of power, who believe that there is nothing self-adjusting or correcting in a free market or freeenterprise system and that we require governmental intervention to keep it going along the right lines. This desire for controls on other grounds will add to the tendency to try to stop inflation by doing something about prices and wages. Already, we have seen this movement started. The pleas on the part of our President and the Secretary of the Treasury as well as, at an earlier date, President Truman for voluntary cooperation on the part of business and labor to 9

10 keep prices down will be followed by legislative action with a compulsory element if it does not succeed. Because such voluntary pleas can hardly succeed, the next step is likely to be some sort of governmental control of prices or of wages or both. Steps in this direction are already visible. A bill was introduced in the latest Congress instructing the Council of Economic Advisors to follow wage and price movements in particular industries and report to the Congress each year as to whether the price rises and the wage rises were justified. As you know, there have been congressional hearings pertaining to particular price changes. If any substantial inflationary pressure arises, I believe an attempt will be made to check it by measures directed at controlling particular prices and wages rather than by general monetary and fiscal measures alone. To me, this cure seems to be worse than the disease and it is this point that I would like to emphasize here. Open Vs. Suppressed Inflation Open inflation, that is price rises without any control of particular prices or wages, presents serious social problems. But there is ample evidence that a free-enterprise system can take the economic effects in its stride. On the other hand, in an inflation suppressed by direct price and wage controls there is a far more serious economic problem. Surveying the history of the world, at different times and in different places, one finds many cases of inflations that have proceeded at a rate of from 5 to 20 per cent a year, and more, without the free-enterprise system being very much disturbed. Obviously, some people gain and others are harmed. Many social problems arise and these problems, in turn, raise political problems. However, the mechanical operation of the productive apparatus can adjust without too great difficulty. Perhaps the most striking evidence along this line is the contrast between what happened in Germany after World War I and what happened in Germany after World War II. The kind of inflation that occurred in Germany immediately after World War I is designated as hyper- 10

11 inflation. A student of mine wrote a dissertation on hyper-inflation and defined it as an episode in which prices rise at more than 50 per cent a month. The German inflation fits this definition for a time, prices were doubling and tripling every day. As you will remember, people were getting paid three times a day so that they could spend their money before it declined in value. This was a kind of inflation which is not in prospect when we think of inflation in the United States. It is the kind of inflation which occurs only under the circumstances of war. The inflation in World War I was extraordinary and yet, except for the last five or six months of the period, production and output in Germany did not decline during the course of the inflation. Indeed, partly as a result of inflation, Germany was practically the only country in the Western world that did not experience a serious contraction in Much of this activity was devoted to producing the wrong kinds of things and the social effects of this inflation were such that they undoubtedly paved the way in many respects for the Nazi regime which followed some ten years later. The point I wish to emphasize, so far as the technical efficiency of Germany is concerned, is that although the German economy was affected it was not destroyed. On the other hand, after World War II Germany was again faced with the problem of inflation. The inflationary pressure was astronomically smaller than in the first World War. The stock of money in Germany at the end of the war was something like four times what it had been at the outset. In order to have eliminated inflationary pressures, prices would have had to rise after World War II approximately four- or five-fold, whereas to describe the price rise in World War I you would have to use powers of ten. The crucial difference was that after World War II prices were not permitted to rise freely. There was suppressed inflation. There was a wide range of price controls of rationing and other factors pertaining thereto. Production in Germany after World War II was cut in half. The free-enterprise system was almost inoperative. People were driven to the widespread use of barter to effect 11

12 exchanges, not because prices had risen but because the price system was not allowed to function, because the manifestations of inflation were suppressed. The lesson taught by these two periods of inflation is the important difference between open inflation on the one hand and suppressed inflation on the other. It is the suppressed inflation that creates the more serious problem for an operative free-enterprise market system. I want to avoid any misunderstanding. I am not saying that inflation is a good thing. I am saying that if you are going to have inflation, then let it run its course openly. Trying to suppress it by holding down particular prices and wages not only does not cure it but brings far worse consequences than letting the inflation run its course. Another very clear example is the contrast between Britain and France immediately after World War II. I remember being in both countries a couple of years after the war. The conclusion which we reached then was that Britain was being strangled by the law abiding character of its population and France was being saved by the black market. This was another illustration of the same thing. In both countries, governments were trying to hold down prices and wages. In Britain there was a large measure of obedience to the price and wage controls, so the country was hamstrung. In France there was little attention paid to the controls and, essentially, there was a free market. Hence France, though obviously it had been affected at least as much by the war damage, was operating at a fairly respectable level. The effects of suppressed inflation are identical, whether price and wage control is voluntary or is enforced by legal enactment. The crucial point is that if prices are not allowed to move so as to reconcile the desires of the buyers on the one hand and the sellers on the other, so as to clear the market, then either the market will not be cleared or something else must come in and do it. You have either a price system which will ration available supplies among the people who want to purchase them or you will have to have something else to do it. If you have something else to do it, then it is clear what it is going to be. It will be some 12

13 governmental measures that will tend to ration goods and services among purchasers, or in other ways seek to direct and control in detail the operation of the economic system. Doctrine of Social Responsibility I cannot refrain from a brief digression at this point on the doctrine of social responsibility of businessmen. There is talk about the responsibility of businessmen and of labor unions to control their prices and wages, partly because this doctrine and this notion is used as a means of passing the buck by responsible governmental authorities and partly because it is so widely accepted by the businessmen themselves. There is scarcely a meeting of prominent businessmen at which some businessman does not get up and say that business has a social responsibility that goes beyond the responsibility to make profits for its stockholders and to use its resources as efficiently as it can. In its pricing, and its wage policy, it must take account of the social consequences of its actions. Now, I submit to you that this doctrine is fundamentally subversive of the foundations of the free-enterprise system. In a free-enterprise system, business has one and only one social responsibility and that is to make as much money as it can while adhering to the rules of the game and, by the rules of the game, I mean adhering to free and open competition. So long as it adheres to free and open competition, the only effective social responsibility of business is to make as much money as it can. The justification for this responsibility from a social point of view is that if each individual enterprise separately seeks to make as much money as it can, it will, as if moved by an invisible hand, also serve the social interest. This is the fundamental justification of the free-enterprise system and of private property. I say business not businessmen because, obviously, businessmen are also citizens in the community and, as citizens, they have social responsibilities in their individual capacities to participate in government and to promote what they regard as the interests of the community at large. But if, in their capacity as businessmen, in their capacity as people who are running 13

14 business enterprises, they have some social responsibility other than using their property as effectively as possible or making as much profit as they can, then they are, in effect, civil servants and there is no justification in a democratic society for their being self-selected. If businessmen are to conduct their business affairs in accordance with the criteria of social responsibility rather than the proper care of property and resources that they are in charge of; if they are to serve not the interests directly of the stockholders and the owners of the enterprise, but some broader social interest, then it will be intolerable that they be selfselected and it will not be for long that they will be allowed to determine what these other social interests are. Men who are in charge of business presumably have some special competence to run those businesses but they have no special competence to know what the relevant criteria of social responsibility are over and beyond running their business as profitably as they can. If they should set their prices, not with a view to what is in the best interest of their own company, but with a view to the contribution it makes toward preventing inflation, how are they to know what are the right prices to set? How are they to know how much weight they should give to these other factors? That is not something for them to determine and there can be little question where it will be determined. Necessarily and correctly, if that were the correct doctrine, it would be determined in the halls of government. If businessmen are civil servants then they had better be selected by the population at large in a democratic fashion and be subject to democratic control. This is why it seems to me that the doctrine of social responsibility to which businessmen are lending lip service is basically antithetical to the kind of system in which they fundamentally believe. The widespread acceptance of a doctrine so subversive to a free-enterprise system is testimony to the fact that none of us are immune from the intellectual air we breathe. The acceptance of this doctrine on the part of the business community is simply another aspect of the general intellectual trend toward collectivism. 14

15 Consequences of Suppressed Inflation This is something of a digression, though not entirely unrelated to my main theme that the basic danger to our economic and social system from inflation is that we will seek to counter it by measures of the kind that I have been describing first, voluntary wage and price controls and, if these are not successful, then legally imposed and enforced controls. Now, suppose this comes about and the wage and price controls are effective in the sense of preventing wages and prices paid from exceeding legal maxima. What would be the consequences? I need hardly remind you of the immediate consequences because you have seen in practice what the effects are widespread shortages will occur whenever prices are fixed at too low a level, just as in our farm program surpluses are created by prices fixed at too high a level. In the presence of shortages, there will have to be some mechanism for distributing those goods in short supply among the people who want them. This mechanism will have to be some kind of rationing. If shortages occur in only a few isolated cases, the rationing might be left to private favoritism, as in the case of gray markets in steel, when private enterprises were essentially in a position to ration steel, or again, in the case of automobiles just after World War II. However, if the shortages are widespread, then inevitably there will be a clamor for explicit rationing by government. Even though we had a government that did not want to undertake explicit rationing, it will inevitably be driven into measures of this kind if it ever takes the step of fixing wages and prices at levels that are below those that would otherwise prevail. I myself am an optimist and so I am inclined to believe that there is very little possibility that we shall drift into a collectivist society in the coming years. However, if we do so, then it seems to me that the route that I have been describing is by all odds the most likely. We shall do so not by intention or design but by default. We shall do so by adopting an alleged cure for inflation which is worse than the disease. 15

16 Alternative Course of Action What are the alternatives? Are there any ways in which we can avoid or reduce the danger of the kind of outcome that I have described? It is not clear to me that there is any very good way of doing so. What we need is some restraint not voluntary wage and price restraint, but restraint on the part of the public at large and of political groups in particular from trying to have the government do too much and in the process doing less. That is to say, we need a greater tolerance for minor fluctuations in economic activity, a willingness to accept a slight decline in economic activity without undertaking every measure that we can think of to offset it. We need a willingness to stay back and hold off a little and see how things will go. No human activity or economic system can proceed at an absolutely perfect and even pace. You can have perfect security at a perfectly even pace in only two places that I know of one is in prison and the other in the graveyard. In any other place (or activity) there are always some unexpected things that happen. This is particularly true in a free society, in which our aim is to try to have an economic system which adapts itself to the wants and desires and preferences of the people. It is inevitable that there will be fluctuations. It is highly desirable that these should not degenerate into major fluctuations such as we experienced during the thirties or during major inflations. The problem is to see to it that governmental activity does not introduce disturbances which are themselves a source of trouble. If we look at the actual record of governmental activity, far from it being true that governmental actions have tended to offset private tendencies toward instability, the facts are the reverse. By and large the most unstable component in our society has been government. Even in the past ten years, which was a period of relative success, if we had had less of an attempt to counter-cyclical change, there would have been less cyclical change to counter. This is certainly true if one takes the long view. There can be little doubt that the major difficulty from 1929 to 1932 was a consequence of inappropriate governmental action. We 16

17 might have had a recession but it would have been a relatively mild one. Certainly, it would not have been a major depression if it had not been for the policies followed by governmental authorities, in particular, by the Federal Reserve System in its monetary actions. The same thing is true of every other major movement we have had the large postwar inflation after World War I, from 1919 to 1920, and the major contraction from 1920 to In the postwar period which followed World War II, our record is considerably better. We have had a more even movement and much more stable economy; nevertheless, if one traces governmental actions in detail, they show up as a source of instability rather than of stability. We need a greater degree of tolerance for minor fluctuations in economic activity, not because the fluctuations are a good thing but because the attempt to even them out is in fact likely to have the opposite result, to make them still wider to introduce additional sources of uncertainty. How can we get a greater degree of tolerance? How can we get a system in which governmental measures would be less of a source of instability themselves? I think myself that the major need in this area is the need for having governmental policy determined by some rule fixed in advance, insofar as possible, after looking at the whole range of likely possibilities in the future rather than having it determined from day to day by discretionary decisions and policies of individuals who are subject to the climate of opinion in which they move and from day-to-day pressures. I have elsewhere described the kind of rules we might adopt. Limitations of time prevent my going into these details now, so I had better leave my position here in the general form in which I have put it. What we need is the acceptance of some kind of self-denying ordinance or rule for economic policy and, in particular, for monetary policy, which will have the effect of deciding in advance the policy that is going to be followed rather than trying, day by day, to adjust it. 17

18 The task of looking into the future is not one in which anyone has a very good record, so I want to close by emphasizing that what I have been trying to do is not to forecast what is actually going to happen, not to say that we are going to have a price rise of 3, or 5, or 7 per cent next year or the year after, or even to say that there is going to be a continuous price rise, but to suggest to you some of the possible sources of the danger of inflation and, more importantly, the consequences of inflation if it should occur. The most likely source of inflation is a tendency to overreact to recessions. The major danger is that we shall try to cure inflation by measures which are in reality worse than the disease. DISCUSSION QUESTION: If we accept the premise that an objective control is impossible, that is, some subjective factors will creep into any sort of control which might be used, would you consider it better to do away with all controls or would you try to work in controls which would involve some subjective factor? MR. FRIEDMAN: I am not sure that I clearly understand your position. When you say controls, are you speaking of price and wage controls? QUESTION: I am referring to the Federal Reserve restrictions. MR. FRIEDMAN: So far as the Federal Reserve Board is concerned, there is no possibility of not having any controls; we must have some kind of monetary authority. We could eliminate monetary authority only if we were willing to adopt a completely automatic gold standard. If we could set up an honest to goodness gold standard, it would be a good thing; however, no one seems to be interested in such a system. I believe most people are interested in an arrangement whereby we would have the pretense of a gold standard while, in fact, it would be a managed standard. 18

19 Short of the establishment of a completely automatic gold standard, which is hardly feasible politically, we must have some kind of monetary authority, something like our present Federal Reserve System. But that system need not operate in an unpredictable and erratic fashion; it can be bound by requirements imposed on it. That is why I spoke in terms of rules. To illustrate my point more explicitly, I believe the best policy we could follow at the present time would be to instruct the Federal Reserve Board that it has one job and one job only; namely, to see that the money supply or the stock of money in the United States rises by a fixed percentage annually. What should this percentage be? It should be in the range between 3 and 5 per cent. This is the percentage increase required to maintain stable prices, given our potentialities for increased production and population. It does not make much difference what number you pick within this range. The important fact is that it be a specific number which would restrict the Federal Reserve Board. This seems to be a very simple-minded policy; indeed, much too simple-minded to be taken seriously. Surely almost anyone could improve upon it. Why not, it will be said, follow a more sophisticated policy: when there is inflationary pressure, increase the money supply at somewhat less than the specified percentage; when there is deflationary pressure, at somewhat more than the specified percentage. The answer is given by our own experience. The Federal Reserve has tried for over 40 years to do better than the simple rule I suggested; it has tried to follow the more sophisticated policy. Yet, in fact, the results have been very much worse rather than better than those that would have been produced by the simple rule. The Federal Reserve Board, during these 40 years, has been under the direction of a most capable group of people. I do not believe that one could hope to get a higher standard of ability, knowledge, or a more public-spirited group of people than those who have been associated with the Federal Reserve System. Therefore, I do not attribute their failure to do better than the simple rule to defects of personality or of 19

20 individuals. Although, of course, things might have been different if different persons had been in charge. I would say that the fact that the Federal Reserve System has done a great deal worse than the simple rule rather suggests that it is not so easy to do better, that possibly it is rather a complicated matter to do better. I believe there are two reasons why it is such a complicated matter to do better. The first has to do with the existence of lags in response. If monetary policy were like a water tap, so that the moment you turned off the tap the water stopped and the moment you turned it on the water started, matters would be easy. If increasing or decreasing the current rate of growth of the stock of money had an immediate effect, all one would have to do would be to experiment, and little harm could come from mistakes. If it turned out that the tap was turned on a little too strongly, one could then turn it down a little and have an immediate correction. However, suppose that when you turn the tap on, the water will start flowing only some six months to a year from now, and when you turn it off, it may be six months to a year before it stops flowing. The problem would clearly be much more difficult. It would be a long time before mistakes could be discovered and then corrected, and, in the meantime, much harm could be done. But this is precisely the case with monetary policy. The actions taken to control the stock of money today have their influence on economic activity a substantial time later. The lag, so far as our studies go, is something on the order of 12 to 16 months, on the average. However, this average is very misleading. In some instances the lag may be three months, and in other instances it may be two years. It is this lag which makes it very difficult to control monetary changes in a highly sophisticated way. The second factor which makes it difficult to do better than the kind of simple policy I suggested is the continuous political pressure to which the monetary authorities are subjected. If they have a fixed rule, they have at least something to stick to. On the other hand, if they do not, it is very hard to avoid the kind of pressures to which they are subject, even though they 20

21 know that they should be doing something other than what they are doing. This surely is one factor which explains why, on the average, the Federal Reserve has done just the opposite of what the sophisticated policy would call for; namely, it has tended to increase the money stock at more than the usual rate when there was inflationary pressure and at less than the usual rate when there was deflationary pressure. QUESTION: Do you think business corporations should give money to universities? MR. FRIEDMAN: I can answer that question very easily: No. Of course, I have a personal vested interest in having money given to universities but I believe that one s conclusions should be based on other considerations. If I were a director or a stockholder of a corporation, I might want to give money through the corporation because present tax laws would enable me to give more money at less cost to me as an individual. Under present arrangements, the government allows a deduction from corporate income for contributions. Thus, by giving through the corporation, I may be able to give two dollars for every one dollar which I could otherwise give. Under present tax laws, I can therefore understand why stockholders would want to give money to universities through corporations. However, I do not think these tax laws are right. I see no justification for the exemption of corporate contributions from the corporate tax. This is another aspect of the social responsibility doctrine. Our community consists of people; they are the stockholders who own the corporation and who should be the recipients of income from the corporation. These people should be giving away their own money, not have other people do it for them. I would prefer to see the universities appeal to the individuals in their private capacity. I find it difficult to see any justification for corporate gifts to universities. QUESTION: In terms of the basic ideas which you have indicated, I think that you have a very sympathetic audience; however, the election just a few weeks ago presented a few questions as to whether the kinds of policies you favor are politically feasible or whether we 21

22 simply have to adjust ourselves to a desire on the part of the people of the country as a whole to have a government dominated economically or whatever you may want to call it. I wonder if you would like to comment on that situation? MR. FRIEDMAN: On the matter of political feasibility, there is a great deal in what you say. One way of interpreting the election is to say that it proves people, on the whole, want more government intervention rather than less. This fact raises the possibility that we will get an increasing degree of government intervention and so on. I am no political analyst and have no comments to make in connection with the details of that election. Nevertheless, I would like to make some general remarks which I believe are relevant: first, the people and particularly economists have an extraordinarily bad record in predicting what is going to be politically feasible; and second, it is necessary to look beneath the results of election campaigns to the more basic underlying intellectual trend. One of the most important books that deals with the subject of intellectual trends is A. V. Dicey s Law and Public Opinion. This book is a series of lectures, originally given at Harvard University toward the end of the past century and published in a revised edition about It discusses the relationship between the course of law and public opinion. It is about as relevant as to what is going on today as it was to the period in which it was written. The main theme of the book is that the notion that legislation does not reflect public opinion is wrong, but that what is true is that there is a long lag between tides in opinion and tides in legislation. Legislation tends to reflect intellectual opinion of about two decades ago. What happens is that a change in the climate of public opinion always starts with the relatively young in intellectual circles. These ideas gradually seep through and become dominant in the legislatures after a long lag. The people now voting generally reflect the opinions of approximately 20 years ago. Thus, the real question about the future of a free society and degree of governmental intervention is perhaps to be found not by looking at what happens in the field of legislation right now but by studying what is happening in the world of ideas. Although one cannot be optimistic, there is much more cause for optimism in the latter. 22

23 There can be no doubt that there has been an extraordinary shift in basic intellectual opinion in the past 20 or 30 years. In the period immediately after World War II, it appeared as if the predictions of F. A. Hayek s The Road to Serfdom were going to be realized in the course of a few years. Today, there is almost nowhere in intellectual circles the kind of thinking that was so prevalent a decade or so ago. Another feature that I believe is important is that intellectual opinion in the United States tends to be the intellectual opinion in Britain with a lag of approximately two decades. In Britain, and several other countries, there has been a strong movement away from a belief in centralized planning without, however, any revival of a belief in the virtues of a freeenterprise system. I would describe the situation as an intellectual vacuum. There has been a loss of faith in the old gods of centralized planning and control without a restoration of the earlier gods of the free-enterprise system. That is why you find in British circles so much emphasis on the twentieth-century, white-man s burden the problem of developing the underdeveloped countries in the world. The new belief is, We have done all we can in Britain and so it is time to go elsewhere. Again, the intellectual vacuum of ideas is also one reason for a religious revival in Britain among the university groups and academic groups. There is no longer the complete faith that formerly existed that government could do it better. I believe that what is true in Britain is also true in most European countries, in other parts of the world, and even in American intellectual circles. Returning to the immediate election results, I would like to emphasize that a real believer in freedom and free enterprise can be nonpartisan. Since the thirties, the Democratic party has believed in free trade abroad but has been opposed to free enterprise at home. The Republican party has been in favor of free enterprise at home and opposed to free enterprise abroad. 23

24 If one really believes in the free-enterprise system which means that he believes in free trade and does not believe in farm price supports or centralized planning then it is very difficult to be partisan. Another point in this connection is, of course, that the parties are necessarily parties of expediency and, as such, have to appeal to a wide range of the population. If one party gets too far afield, then it is to the advantage of the other party to come closer to center. I am sure that we have all seen this development in both parties. QUESTION: Do you think it is wise for the big corporation to take an active part in partisan politics? MR. FRIEDMAN: No. Businessmen as individuals, as citizens, by all means have a responsibility to the community, and it seems to me highly desirable that businessmen should exercise this specific responsibility in their personal and private capacity. On the other hand, it seems to me most undesirable that a company in its corporate capacity should engage directly in politics or political activity, whether of a partisan or a nonpartisan nature. The question here is: How to right an evil? We have a situation in which labor unions have immunities that businesses do not have. Activities that would be illegal for corporations are legal for labor unions. Labor unions are permitted to use union funds to support political campaigns, particularly in local elections, in a way which would be illegal for businesses. The only solution to this inequality is to extend the law equally to both parties; that is, to extend the law so as to make it illegal for labor unions to engage in political activity which corporations are not permitted to engage in. I do not believe that the right solution to this problem is for business to think that it can fight fire with fire by engaging, as corporations, in partisan politics. My own feeling is that this is wrong in principle. The role of corporations is as intermediaries between individuals. They are not citizens in their own right. They are only a means whereby individual citizens in the community can better effectuate their ends. The citizens are stockholders, workers, 24