Word
Gems
What is a
man but the sum of his thoughts?
Economics:
Milton
Friedman's
Free
To Choose
#9: The Cure for Inflation
Friedman: The Sierra Nevada's in California 10,000 feet above sea level, in the
winter temperatures drop to 40 below zero, in the summer the place bakes in the thin
mountain air. In this unlikely spot the town of Body sprang up. In its day Body was filled
with prostitutes, drunkards and gamblers part of a colorful history of the American West.
A century ago, this was a town of 10,000 people. What brought them here? Gold. If
this were real gold, people would be scrambling for it. The series of gold strikes
throughout the West brought people from all over the world, all kinds of people. They came
here for one purpose and one purpose only, to strike it rich, quick. But in the process,
they built towns, cities, in places where nobody would otherwise have dreamed of building
a city. Gold built these cities and when the gold was exhausted, the cities collapsed and
became ghost towns. Many of the people who came here ended up the way they began, broke
and unhappy. But a few struck it rich. For them, gold was real wealth. But was it for the
world as a whole. People couldn't eat the gold, they couldn't wear the gold, they couldn't
live in houses made of gold. Because there was more gold, they had to pay a little more
gold to buy goods and services. The prices of things in terms of gold went up.
At tremendous cost, at sacrifice of lives, people dug gold out of the bowels of
the earth. What happened to that gold? Eventually, at long last, it was transported to
distant places only to be buried again under the ground. This time in the vaults of banks
throughout the world. There is hardly anything that hasn't been used for money; rock salt
in Ethiopia, brass rings in West Africa, Calgary shells in Uganda, even a toy cannon.
Anything can be used as money. Crocodile money in Malaysia, absurd isn't it?
That beleaguered minority of the population that still smokes may recognize this
stuff as the raw material from which their cigarettes are made. But in the early days of
the colonies, long before the U.S. was established, this was money. It was the common
money of Virginia, Maryland and the Carolinas. It was used for all sorts of things. The
legislature voted that it could be used legally to pay taxes. It was used to buy food,
clothing and housing. Indeed, one of the most interesting sites was to see the husky young
fellows at that time, lug 100 pounds of it down to the docks to pay the costs of the
passage of the beauteous young ladies who had come over from England to be their brides.
Now you know how money is. There's a tendency for it to grow, for more and more of
it to be produced and that's what happened with this tobacco. As more tobacco was
produced, there was more money. And as always when there's more money, prices went up.
Inflation. Indeed, at the very end of the process, prices were 40 times as high in terms
of tobacco as they had been at the beginning of the process. And as always when inflation
occurs, people complained. And as always, the legislature tried to do something. And as
always, to very little avail. They prohibited certain classes of people from growing
tobacco. They tried to reduce the total amount of tobacco grown, they required people to
destroy part of their tobacco. But it did no good. Finally, many people took it into their
own hands and they went around destroying other people's tobacco fields. That was too
much. Then they passed a law making it a capital offense, punishable by death, to destroy
somebody else's tobacco. Grecian's Law, one of the oldest laws in economics, was well
illustrated. That law says that cheap money drives out dear money and so it was with
tobacco. Anybody who had a debt to pay, of course, tried to pay it in the worst quality of
tobacco he had. He saved the good tobacco to sell overseas for hard money. The result was
that bad money drove out good money.
Finally, almost a century after they had started using tobacco as money, they
established warehouses in which tobacco was deposited in barrels, certified by an
inspector according to his views as to it's quality and quantity. And they issued
warehouse certificates which people gave from one to another to pay for the bills that
they accumulated.
These pieces of green printed paper are today's counterparts of those tobacco
certificates. Except that they bear no relation to any commodity. In this program I want
to take you to Britain to see how inflation weakens the social fabric of society. Then to
Tokyo, where the Japanese have the courage to cure inflation. To Berlin, where there is a
lesson to be learned from the West Germans and how so called cures are often worse than
the disease. And to Washington where our government keeps these machines working overtime.
And I am going to show you how inflation can be cured.
The fact is that most people enjoy the early stages of the inflationary process.
Britain, in the swinging 60's, there was plenty of money around, business was brisk, jobs
were plentiful and prices had not yet taken off. Everybody seemed happy at first. But by
the early 70's, as the good times rolled along, prices started to rise more and more
rapidly. Soon, some of these people are going to lose their jobs. The party was coming to
an end.
The story is much the same in the U.S. Only the process started a little later.
We've had one inflationary party after another. Yet we still can't seem to avoid them. How
come?
Before every election our representatives would like to make us think we are
getting a tax break. When they are able to do it, while at the same time actually raising
our taxes because of a bit of magic they have in their kit bag. That magic is inflation.
They reduced the tax rates but the taxes we have to pay go up because we are automatically
shoved into higher brackets by the effective inflation. A neat trick. Taxation without
representation.
Bob Crawford: The more I work, it seems like the more they take off me. I know if
I work an extra day or two extra days, what they take in federal income tax alone is
almost doubled because apparently it puts you in a higher income tax bracket and it takes
more off you.
Friedman: Bob Crawford lives with his wife and three children in a suburb of
Pittsburgh. They're a fairly average American family.
Mrs. Crawford: Don't slam the door Daphne. Okay. Alright. What are you doing?
Making your favorite dish.
Friedman: We went to the Crawford's home after he had spent a couple of days
working out his federal and state income taxes for the year. For our benefit, he tried to
estimate all the other taxes he had paid as well. In the end, though, he didn't discover
much that would surprise anybody.
Bob Crawford: Inflation is going up, everything is getting more expensive. No
matter what you do, as soon as you walk out of the house, everything went up. Your gas
bills keep going up, electric bills, your gasoline, you can name a thousand things that
are going up. Everything is going sky high. Your food. My wife goes to the grocery store.
We used to live on say, $60 or $50 every two weeks just for our basic food. Now it's $80
or $90 every two weeks. Things are just going out of sight as far as expense to live on.
Like I say it's getting tough. It seems like every month it gets worse and worse. And I
don't know where it's going to end. At the end of the day that I spend nearly $6,000 of my
earnings on taxes. That leaves me with a total of $12,000 to live on. It might seem like a
lot of money, but five, six years ago I was earning $12,000.
Friedman: How does taxation without representation really effect how much the
Crawford family has left to spend after it's paid its income taxes. Well in 1972 Bob
Crawford earned $12,000. Some of that income was not subject to income tax. After paying
income tax on the rest he had this much left to spend. Six years later he was earning
$18,000 a year. By 1978 the amount free from tax was larger. But he was now in a higher
tax bracket so his taxes went up by a larger percentage than his income. However, those
dollars weren't worth anything like as much. Even his wages, let alone his income after
taxes, hadn't kept up with inflation. His buying power was lower than before. That is
taxation without representation in practice.
Unnamed Individual: We have with us today you brothers that are sitting here today
that were with us on that committee and I'd like to tell you....
Friedman: There are many traditional scapegoats blamed for inflation. How often
have you heard inflation blamed on labor unions for pushing up wages. Workers, of course,
don't agree.
Unnamed Individual: But fellows this is not true. This is subterfuge. This is a
myth. Your wage rates are not creating inflation.
Friedman: And he's right. Higher wages are mostly a result of inflation rather
than a cause of it. Indeed, the impression that unions cause inflation arises partly
because union wages are slow to react to inflation and then there is pressure to catch up.
Worker: On a day to day basis, try to represent our own numbers. But that in fact
is not the case. Not only can we not play catch up, we can't even maintain a wage rate
commensurate with the cost of living that's gone up in this country.
Friedman: Another scapegoat for inflation is the cost of goods coming from abroad.
Inflation, we're told, is imported. Higher prices abroad driving up prices at home. It's
another way government can blame someone else for inflation. But this argument, too, is
wrong. The prices of imports and the countries from which they come are not in terms of
dollars, they are in terms of lira or yen or other foreign currencies. What happens to
their prices in dollars depends on exchange rates which in turn reflect inflation in the
United States.
Since 1973 some governments have had a field day blaming the Arabs for inflation.
But if high oil prices were the cause of inflation, how is it that inflation has been less
here in Germany, a country that must import every drop of oil and gas that it uses on the
roads and in industry, then for example it is in the U.S. which produces half of its own
oil. Japan has no oil of its own at all. Yet at the very time the Arabs were quadrupling
oil prices, the Japanese people were bringing inflation down from 30 to less than 5% a
year. The fallacy is to confuse particular prices like the price of oil, with prices in
general. Back at home, President Nixon understood this.
Nixon: "Now here's what I will not do. I will not take this nation down the
road of wage and price controls however politically expedient that may seem. The pros of
rationing may seem like an easy way out, but they are really an easy way in for more
trouble. To the explosion that follows when you try to clamp a lid on a rising head of
steam without turning down the fire under the pot, wage and price controls only postpone
the day of reckoning. And in so doing, they rob every American of a very important part of
his freedom.
Friedman: Now listen to this:
Nixon: "The time has come for decisive action. Action that will break the
vicious circle of spiraling prices and costs. I am today ordering a freeze on all prices
and wages throughout the United States for a period of 90 days. In addition, I call upon
corporations to extend the wage price freeze to all dividends."
Friedman: Many a political leader has been tempted to turn to wage and price
controls despite their repeated failure in practice. On this subject they never seem to
learn. But some lessons may be learned. That happened to British Prime Minister James
Callahan who finally discovered that a very different economic myth was wrong. He told the
Labor Party Conference about it in 1976.
James Callahan: "We used to think that you could use, spend your way out of a
recession and increase employment by cutting taxes and boosting government spending. I
tell you in all candor that option no longer exists. It only works on each occasion since
the war by injecting a bigger dose of inflation into the economy followed by a higher
level of unemployment as the next step. That's the history of the last 20 years."
Friedman: Well, it's one thing to say it. One reason why inflation does so much
harm is because it effects different groups differently. Some benefit and of course they
attribute that to their own cleverness. Some are hurt, but of course they attribute that
to the evil actions of other people. And the whole problem is made far worse by the false
cures which government adopts, particularly wage and price control.
The garbage collectors in London felt justifiably aggrieved because their wages
had not been permitted to keep pace with the cost of living. They struck, hurting not the
people who impose the controls, but their friends and neighbors who had to live with
mounting piles of rat infested garbage. Hospital attendants felt justifiably aggrieved
because their wages had not been permitted to keep up with the cost of living. They
struck, hurting not the people who impose the controls, but cancer patients who were
turned out of hospital beds. The attendants behaved as a group in a way they never would
have behaved as individuals. One group is set against another group. The social fabric of
society is torn apart inflicting scars that it will take decades to heal and all to no
avail because wage and price controls, far from being a cure for inflation, only make
inflation worse.
Within the memory of most of our political leaders, there's one vivid example of
how economic ruin can be magnified by controls. And the classic demonstration of what to
do when it happens.
Germany, 1945, a devastated country. A nation defeated in war. The new governing
body was the Allied Control Commission, representing the United States, Britain, France
and the Soviet Union. They imposed strict controls on practically every aspect of life
including wages and prices. Along with the effects of war, the results were tragic. The
basic economic order of the country began to collapse. Money lost its value. People
reverted to primitive barter where they used cameras, fountain pens, cigarettes, whiskey
as money. That was less than 40 years ago.
This is Germany as we know it today. Transformed into a place a lot of people
would like to live in. How did they achieve their miraculous recovery? What did they know
that we don't know?
Early one Sunday morning, it was June 20, 1948, the German Minister of Economics,
Ludwig Earhardt, a professional economist, simultaneously introduced a new currency,
today's Deutsche Mark, and in one fell swoop, abolished almost all controls on prices and
wages. Why did he do it on a Sunday morning? It wasn't as you might suppose because the
Stock Markets were closed on that day, it was, as he loved to confess, because the offices
of the American, the British, and the French occupation authorities were closed that day.
He was sure that if he had done it when they open they would have countermanded the order.
It worked like a charm. Within days, the shops were full of goods. Within months, the
German economy was humming along at full steam. Economists weren't surprised at the
results, after all, that's what a price system is for. But to the rest of the world it
seemed an economic miracle that a defeated and devastated country could in little more
than a decade become the strongest economy on the continent of Europe.
In a sense this city, West Berlin, is something of a unique economic test tube.
Set as it is deep in Communist East Germany. Two fundamentally different economic systems
collide here in Europe. Ours and theirs, separated by political philosophies, definitions
of freedom and a steel and concrete wall.
To digress from inflation, economic freedom does not stand alone. It is part of a
wider order. I wanted to show you how much difference it makes by letting you see how the
people live on the other side of that Berlin Wall. But the East German authorities
wouldn't let us. The people over there speak the same language as the people over here.
They have the same culture. They have the same for bearers. They are the same people. Yet
you don't need me to tell you how differently they live. There is one simple explanation.
The political system over there cannot tolerate economic freedom. The political system
over here could not exist without it.
But political freedom cannot be preserved unless inflation is kept in bounds.
That's the responsibility of government which has a monopoly over places like this. The
reason we have inflation in the United States or for that matter anywhere in the world is
because these pieces of paper and the accompanying book entry or their counterparts in
other nations are growing more rapidly than the quantity of goods and services produced.
The truth is inflation is made in one place and in one place only. Here in Washington.
This is the only place were there are presses like this that turn out these pieces of
paper we call money. This is the place where the power resides to determine how rapidly
the amount of money shall increase.
What happened to all that noise? That's what would happen to inflation if we stop
letting the amount of money grow so rapidly. This is not a new idea. It's not a new cure.
It's not a new problem. It's happened over and over again in history. Sometimes inflation
has been cured this way on purpose. Sometimes it's happened by accident. During the Civil
War the North, late in the Civil War, overran the place in the South where the printing
presses were sitting up, where the pieces of paper were being turned out. Prior to that
point, the South had a very rapid inflation. If my memory serves me right, something like
4% a month. It took the Confederacy something over two weeks to find a new place where
they could set up their printing presses and start them going again. During that two week
period, inflation came to a halt. After the two week period, when the presses started
running again, inflation started up again. It's that clear, that straightforward. More
recently, there's another dramatic example of the only effective way to deal with rampant
inflation.
In 1973, Japanese housewives going to market were faced with an unpleasant fact.
The cash in their purses seemed to be losing its value. Prices were starting to sore as
the awful story of inflation began to unfold once again. The Japanese government knew what
to do. What's more, they were prepared to do it. When it was all over, economists were
able to record precisely what had happened. In 1971 the quantity of money started to grow
more rapidly. As always happens, inflation wasn't affected for a time. But by late 1972 it
started to respond. In early 73 the government reacted. It started to cut monetary growth.
But inflation continued to soar for a time. The delayed reaction made 1973 a very tough
year of recession. Inflation tumbled only when the government demonstrated its
determination to keep monetary growth in check. It took five years to squeeze inflation
out of the system. Japan attained relative stability. Unfortunately, there's no way to
avoid the difficult road the Japanese had to follow before they could have both low
inflation and a healthy economy. First they had to live through a recession until slow
monetary growth had its delayed effect on inflation.
Inflation is just like alcoholism. In both cases when you start drinking or when
you start printing too much money, the good effects come first. The bad effects only come
later.
That's why in both cases there is a strong temptation to overdo it. To drink too
much and to print too much money. When it comes to the cure, it's the other way around.
When you stop drinking or when you stop printing money, the bad effects come first and the
good effects only come later. That's why it's so hard to persist with the cure. In the
United States, four times in the 20 years after 1957, we undertook the cure. But each time
we lacked the will to continue. As a result, we had all the bad effects and none of the
good effects. Japan on the other hand, by sticking to a policy of slowing down the
printing presses for five years, was by 1978 able to reap all the benefits, low inflation
and a recovering economy. But there is nothing special about Japan. Every country that has
had the courage to persist in a policy of slow monetary growth has been able to cure
inflation and at the same time achieve a healthy economy.
DISCUSSION
Participants: Robert McKenzie, Moderator; Milton Friedman; Congressman Clarence J.
Brown; William M. Martin, Chairman of Federal Reserve 1951_1970; Beryl W. Sprinkel,
Executive Vice President, Harris Bank, Chicago; Otmar Emminger, President, Ieutsche
Bundesbank, Frankfurt West Germany
MCKENZIE: And here at the Harper Library of the University of Chicago, our
distinguished guests have their own ideas, too. So, lets join them now.
BROWN: If you could control the money supply, you can certainly cut back or
control the rate of inflation. I'd have to say that that prescription is a little bit
easier to write than it is to fill. I think there are some other ways to do it and I would
relate the money supply __ I think inflation is a measure of the relationship between
money and the goods and services that money is meant to cover. And so if you can stimulate
the goods, the production of goods and services, it's helpful. It's a little tougher to
control the money supply, although I think it can be done, than just saying that you
should control it, because we've got the growth of credit cards, which is a form of money;
created, in effect, by the free enterprise system. It isn't all just printed in
Washington, but that may sound too defensive. I think he was right in saying that the
inflation is Washington based.
MCKENZIE: Mr. Martin, nobody has been in the firing line longer than you, 17 years
head of the Fed. Could you briefly comment on that and we'll go around the group.
MARTIN: I want to say 19 years.
(Laughter)
MARTIN: I wouldn't be out here if it weren't for Milton Friedman, today. He came
down and gave us advice from time to time.
FRIEDMAN: You've never taken it.
(Laughter)
MCKENZIE: He's going to do some interviewing later, I warn you.
MARTIN: And I'm rather glad we didn't take it __
(Laughter)
MARTIN: __ all the time.
SPRINKEL: In your 19 years as Chairman of the Federal Reserve, Bill, the average
growth in the money supply was 3.1 percent per year. The inflation rate was 2.2 percent.
Since you left, the money supply has exactly doubled. The inflation rate is average over 7
percent, and, of course, in recent times the money supply has been growing in double-digit
territory as has our inflation rate.
EMMINGER: May I, first of all, confirm two facts which have been so vividly
brought out in the film of Professor Friedman; namely, that at the basis of the relatively
good performance of Western Germany were really two events. One, the establishment of a
new sound money which we try to preserve sound afterwards. And, secondly, the jump
overnight into a free market economy without any controls over prices and wages. These are
the two fundamental facts. We have tried to preserve monetary stability by just trying to
follow this prescription of Professor Friedman; namely, monetary discipline. Keeping
monetary growth relatively moderate. I must, however, warn you it's not so easy as it
looks. If you just say, governments have to have the courage to persist in that course.
FRIEDMAN: Nobody does disagree with the proposition that excessive growth in money
supply is an essential element in the inflationary process and that the real problem is
not what to do, but how to have the courage and the will to do it. And I want to go and
start, if I may, on that subject; because I think that's what we ought to explore. Why is
it we haven't had the courage and don't, and under what circumstances will we? And I want
to start with Bill Martin because his experience is a very interesting experience. His 19
years was divided into different periods. In the first period, that average that Beryl
Sprinkel spoke about, averaged two very different periods. An early period of very slow
growth and slow inflation; a later period of what at the time was regarded as creeping
inflation __ now we'd be delighted to get back to it. People don't remember that at the
time that Mr. Nixon introduced price and wage controls in 1971 to control an outrageous
inflation, the rate of inflation was four-and-a-half percent per year. Today we'd regard
that as a major achievement; but the part of the period when you were Chairman, was a
period when the inflation rate was starting to creep up and money growth rate was also
creeping up. Now if I go from your period, you were eloquent in your statements to the
public, to the press, to everyone, about the evils of inflation, and about the
determination on the Federal Reserve not to be the architect of inflation. Your successor,
Arthur Burns, was just as eloquent. Made exactly the same kinds of statements as
effectively, and again over and over again said the Federal Reserve will not be the
architect of inflation. His successor, Mr. G. William Miller, made the same speeches, and
the same statements, and the same protestations. His successor, Paul Volcker, he is making
the same statements. Now my question to you is: Why is it that there has been such a
striking difference between the excellent pronouncements of all Chairmen of the Fed,
therefore it's not personal on you. You have a lot of company, unfortunately for the
country. Why is it that there has been such a wide diversion between the excellent
pronouncements on the one hand and what I regard as a very poor performance on the other?
MARTIN: Because monetary policy is not the only element. Fiscal policy is equally
important.
FRIEDMAN: You're shifting the buck to the Treasury.
MARTIN: Yes.
FRIEDMAN: To the Congress. We'll get to Mr. Brown, don't worry.
MARTIN: Yeah, that's right.
(Laughter)
MARTIN: The relationship of fiscal policy to monetary policy is one of the
important things.
MCKENZIE: Would you remind us, the general audience, when you say "fiscal
policy", what you mean in distinction to "monetary policy"?
MARTIN: Well, taxation.
MCKENZIE: Yeah.
MARTIN: The raising revenue.
FRIEDMAN: And spending.
MARTIN: And spending.
FRIEDMAN: And deficits.
MARTIN: And deficits, yes, exactly. And I think that you have to realize that when
I've talked for a long time about the independence of the Federal Reserve. That's
independence within the government, not independence of the government. And I've worked
consistently with the Treasury to try to see that the government is financed. Now this
gets back to spending. The government says they're gonna spend a certain amount, and then
it turns out they don't spend that amount. It doubles.
FRIEDMAN: The job of the Federal Reserve is not to run government spending; it's
not to run government taxation. The job of the Federal Reserve is to control the money
supply and I believe, frankly, I have always believed as you know, that these are excuses
and not reasons for the performance.
MARTIN: Well that's where you and I differ, because I think we would be
irresponsible if we didn't take into account the needs and what the government is saying
and doing. I think if we just went on our own, irresponsibly, I say it on this, because I
was in the Treasury before I came to this __
FRIEDMAN: I know. I know.
MARTIN: __ go to the Fed; and I know the other side of the picture. I think we'd
be rightly condemned by the American people and by the electorate.
FRIEDMAN: Every central bank in this world, including the German Central Bank,
including the Federal Reserve System, has the technical capacity to make the money supply
do over a period of two or three or four months, not daily, but over a period, has the
technical capacity to control it.
(Several people talking at once.)
FRIEDMAN: I cannot explain the kind of excessive money creation that has occurred,
in terms of the technical incapacity of the Federal Reserve System or of the German
Central Bank, or of the Bank of England, or any other central bank in the world.
EMMINGER: I wouldn't say technically we are incapable of doing that, although we
have never succeeded in controlling the money supply month that way. But I would say we
can, technically, control it half yearly, from one half-year period to the next and that
would be sufficient __
FRIEDMAN: That would be sufficient.
EMMINGER: __ for controlling inflation. But however I __
VOICE OFF SCREEN: It doesn't move.
FRIEDMAN: I'm an economic scientist, and I'm trying to observe phenomena, and I
observe that every Federal Reserve Chairman says one thing and does another. I don't mean
he does, the system does.
MCKENZIE: Yeah. How different is your setup in Germany? You've heard this problem
of governments getting committed to spending and the Fed having, one way or the other, to
accommodate itself to it. Now what's your position on this very interesting problem?
EMMINGER: We are very independent of the government, from the government, but, on
the other hand, we are an advisor of the government. Also on the budget deficits and they
would not easily go before Parliament with a deficit which much of it is openly criticized
and disapproved by the same bank. Why because we have a tradition in our country that we
can also publicly criticize the government on his account. And second, as if happened in
our case too, the government goes beyond what is tolerable for the sake of moral
equilibrium. We have let it come through in the capital markets. That is to say they have
enough interest rates that has drawn public criticism and that has had some effect on
their attitude.
FRIEDMAN: I think that is a very important point that Dr. Emminger just made
because there is not a one-to-one relationship between government deficits and what
happens to the money supply at all. The pressure on the Federal Reserve comes indirectly.
It comes because large government deficits, if they are financed in the general capital
market, will drive up interest rates and then we have the right patents in Congress and
their successors pressuring the Federal Reserve to enter in and finance the deficit by
printing money as a way of supposedly holding down interest rates. Now before I turn to
Mr. Brown and ask him that, I just want to make one point which is very important. The
Federal Reserve's activities in trying to hold down interest rates have put us in a
position where we have the highest interest rates in history. It's another example of how,
of the difference between the announced intentions of a policy, and the actual results.
But now I want to come to Clarence Brown and ask him, shift the buck to him, and put him
on the hot seat for a bit. The government spending has been going up rapidly, Republican
administration or Democratic administration. This is a nonpartisan issue, it doesn't
matter. Government deficits have been going up rapidly. Republican administration or
Democratic administration. Why is it that here again you have the difference between
pronouncements and performance? There is no Congressman, no Senator, who will come out and
say, "I am in favor of inflation." There is not a single one who will say,
"I am in favor of big deficits." They'll all say we want to balance the budget,
we want to hold down spending, we want an economical government. How do you explain the
difference between performance and talk on the side of Congress?
BROWN: Well, first I think we have to make one point. I'm not so much with the
government as I am against it.
FRIEDMAN: I understand.
BROWN: As you know, I'm a minority member of Congress.
FRIEDMAN: Again, I'm not __ I'm not directing this at you personally.
BROWN: I understand, of course; and while the administrations, as you've
mentioned, Republican and Democratic administrations, have both been responsible for
increases in spending, at least in terms of their recommendations. It is the Congress and
only the Congress that appropriates the funds and determines what the taxes are. The
President has no authority to do that and so one must lay it at the feet of the U.S.
Congress. Now, I guess we'd have to concede that it's a little bit more fun to give away
things than it is to withhold them. And this is the reason that the Congress responds to a
general public that says, "I want you to cut everybody else's program but the one in
which I am most particularly interested. Save money, but incidentally, my wife is taking
care of the orphanages and so lets try to help the orphanages," or whatever it is.
Let me try to make a point, if I can, however, on what I think is a new spirit moving
within the Congress and that is that inflation, as a national affliction, is beginning to
have an impact on the political psychology of many Americans. Now the Germans, the
Japanese and others have had this terrific postwar inflation. The Germans have been
through it twice, after World War I and World War II, and it's a part of their national
psyche. But we are affected in this country by the depression. Our whole tax structure is
built on the depression. The idea of the tax structure in the past has been to get the
money out of the mattress where it went after the banks failed in this country and jobs
were lost, and out of the woodshed or the tin box in the back yard, get it out of there
and put it into circulation. Get it moving, get things going. And one of the ways to do
that was to encourage inflation. Because if you held on to it, the money would depreciate;
and the other way was to tax it away from people and let the government spend it. Now
there's a reaction to that and people are beginning to say, "Wait just a minute.
We're not afflicted as much as we were by depression. We're now afflicted by inflation,
and we'd like for you to get it under control." Now you can do that in another way
and that without reducing the money supply radically. I think the Joint Economic Committee
has recommended that we do it gradually. But the way that you can do it is to reduce taxes
and the impact of government, that is the weight of government and increase private
savings so that the private savings can finance some of the debt that you have.
FRIEDMAN: There is no way you can do it without reducing, in my opinion, the rate
of monetary growth. And I, recognizing the facts, even though they ought not to be that
way, I wonder whether you can reduce the rate of monetary growth unless Congress actually
does reduce government spending as well as government taxes.
BROWN: The problem is that every time we use demand management, we get into a kind
of an iron maiden kind of situation. We twist this way and one of the spikes grabs us
here, so we twist that way and a spike over here gets us. And every recession has had
higher basic unemployment rates than the previous recession in the last several years and
every inflation has had higher inflation. We've got to get that tilt out of the society.
MCKENZIE: Wouldn't it be fair to say, though, that a fundamental difference is the
Germans are more deeply fearful of a return to inflation, having had the horrifying
experience between the wars, especially. We tend to be more afraid of recession turning
into depression.
EMMINGER: I think there is something in it and in particular in Germany the
government would have to fear very much in their electoral prospects if they went into
such an election period with a high inflation rate. But there is another important
difference.
MARTIN: We fear unemployment more than inflation it seems.
EMMINGER: You fear unemployment, but unemployment is feared with us, too, but
inflation is just as much feared. But there is another difference; namely, once you have
got into that escalating inflation, every time the base, the plateau is higher, it's
extremely difficult to get out of it. You must avoid getting into that, now that's very
cheap advice from me because you are now.
(Laughing)
EMMINGER: But we had, for the last fifteen, twenty years, always studied foreign
experiences, and told ourselves we never must get into this vicious circle. Once you are
in, it takes a long time to get out of it. That is what I am preaching now, that we should
avoid at all costs to get again into this vicious circle as we had it already in '73_'74.
It took us, also, four years to get out of it, although we were only at eight percent
inflation. Four years to get down to three percent. So you __
MCKENZIE: Those were __ yes.
EMMINGER: You have, I think, the question of whether you can do if in a gradualist
way over many, many years, or whether you don't need a sort of shock treatment.
SPRINKEL: The film said it took the Japanese _ what _ four years?
FRIEDMAN: Five years.
SPRINKEL: Five years. But one of my greatest concerns is that we haven't suffered
enough yet. Most of the nations that have finally got their inflations __
BROWN: Bad election speech.
SPRINKEL: __ well, I'm not running for office, Clarence.
(Laughter)
SPRINKEL: Most countries that finally got their inflation under control had 20, 30
percent or worse inflation. Germany had much worse and the public supports them. We live
in a Democracy, and we're getting constituencies that gain from inflation. You look at
people that own real estate, they've done very well.
MCKENZIE: Yes.
SPRINKEL: And how can we get there without going through even more pain, and I
doubt that we will.
FRIEDMAN: If you ask who are the constituencies that have benefited most from
inflation there are no doubt, it is the homeowners.
SPRINKEL: Yes.
FRIEDMAN: But it's also the __ it's also the Congressmen who have been able to
vote higher spending without having to vote higher taxes. They have in fact __
BROWN: That's right.
FRIEDMAN: __ Congress has in fact voted for inflation. But you have never had a
Congressman on record to that effect. It's the government civil servants who have their
own salaries are indexed and tied to inflation. They have a retirement benefit, a
retirement pension that's tied to inflation. They qualify, a large fraction of them, for
Social Security as well, which is tied to inflation. So that the beneficial __
BROWN: Labor contracts that are indexed and many pricing things that are tied to
it.
FRIEDMAN: But the one thing that isn't tied to inflation and here I want to come
back and ask why Congress has been so __ so bad in this area, is our taxes. It has been
impossible to get Congress to index the tax system so that you don't have the present
effect where every one percent increase in inflation pushes people up into higher brackets
and forces them to pay higher taxes.
BROWN: Well, as you know, I'm an advocate of that.
FRIEDMAN: I know you are.
MCKENZIE: Some countries do that, of course.
FRIEDMAN: Oh, of course.
MCKENZIE: Canada does that. Indexes the __
BROWN: And I went up to Canada on a little weekend seminar program on indexing and
came back an advocate of indexing because I found out that the people who are delighted
with indexing are the taxpayers.
FRIEDMAN: Absolutely.
BROWN: Because as the inflation rate goes up their tax level either maintains at
the same level or goes down. The people who are least __ well, the people who are very
unhappy with it are the people who have to plan government spending because it is reducing
the amount of money that the government has rather than watching it go up by ten or twelve
billion. You get a little dividend to spend in this country, the bureaucrats do every
year, but the politicians are unhappy with it too, as Dr. Friedman points out because, you
see, politicians don't get to vote a tax reduction, it happens automatically.
MCKENZIE: Yeah.
BROWN: And so you can't go back and in a praiseworthy way tell your constituents
that I am for you, I voted a tax reduction. And I think we ought to be able to index the
tax system so that tax reduction is automatic, rather than have what we've had in the
past, and that is an automatic increase in the taxes. And the politicians say, "Well,
we're sorry about inflation, but __".
FRIEDMAN: You're right and I want to __ I want to go and make a very different
point. I sit here and berate you and you as government officials, and so on, but I
understand very well that the real culprits are not the politicians, are not the central
bankers, but it's I and my fellow citizens. I always say to people when I talk about this,
"If you want to know who's responsible for inflation, look in the mirror." It's
not because of the way you spend you money. Inflation doesn't arise because you got
consumers who are spendthrifts; they've always been spendthrifts. It doesn't arise because
you've got businessmen who are greedy. They've always been greedy. Inflation arises
because we as citizens have been asking you as politicians to perform an impossible task.
We've been asking you to spend somebody else's money on us, but not to spend our money on
anybody else.
BROWN: You don't want us to cut back those dollars for education, right?
FRIEDMAN: Right. And, therefore, __ well, no, I do.
MCKENZIE: We've already had a program on that.
FRIEDMAN: We've already had a program on that and there's no viewer of these
programs who will be in any doubt about my position on that. But the public at large has
not and this is where we come to the political will that Dr. Emminger quite properly
talked about. It is __ everybody talks against inflation, but what he means is that he
wants the prices of the things he sells to go up and the prices of the things he buys to
go down. But, sooner or later, we come to the point where it will be politically
profitable to end inflation. This is the point that __
SPRINKEL: Yes.
FRIEDMAN: __ I think you were making.
SPRINKEL: The suffering idea.
FRIEDMAN: Where do you think the __ you know, what do you think the rate of
inflation has to be and judged by the experience of other countries before we will be in
that position and when do you think that will happen?
SPRINKEL: Well, the evidence says it's got to be over 20 percent. Now you would
think we could learn from others rather than have to repeat mistakes.
FRIEDMAN: Apparently nobody can learn from history.
SPRINKEL: But at the present time we're going toward higher and not lower
inflation.
MCKENZIE: You said earlier, if you want to see who causes inflation look in the
mirror.
FRIEDMAN: Right.
MCKENZIE: Now, for everybody watching and taking part in this, there must be some
moral to that. What does need __ what has to be the change of attitude of the man in the
mirror you're looking at before we can effectively implement what you call a tough policy
that takes courage?
FRIEDMAN: I think that the man in the mirror has to come to recognize that
inflation is the most destructive disease known to modern society. There is nothing which
will destroy a society so thoroughly and so fully as letting inflation run riot. He must
come to recognize that he doesn't have any good choices. That there are no easy answers.
That once you get in this situation where the economy is sick of this insidious disease,
there's gonna be no miracle drug which will enable them to be well tomorrow. That the only
choices he has, do I go through a tough period for four or five years of relatively high
unemployment, relatively low growth or do I try to push it off by taking some more of the
hair of the dog that bit me and get around it now at the cost of still higher
unemployment, as Clarence Brown said, later on. The only choice this country faces, is
whether we have temporary unemployment for a short period, as a side effect of curling
inflation or whether we go into a period of still higher unemployment later on and have it
to do all over again. That's the only choice we face. And when the public at large
recognizes that, they will then elect people to Congress, and a President to office who is
committed to less government spending and to less government printing of money and until
that happens we will not cure inflation.
BROWN: But, Dr. Friedman, let me __
(Applause)
BROWN: Let me differ with you to this extent. I think it is important that at the
time you are trying to get inflation out of the economy that you also give the man in the
street, the common man, the opportunity to have a little bit more of his own resources to
spend. And if you can reduce his taxes at that time and then reduce government in that
process, you give him his money to spend rather than having to yield up all that money to
government. If you cut his taxes in a way to encourage it, to putting that money into
savings, you can encourage the additional savings in a private sense to finance the debt
that you have to carry, and you can also encourage the stimulation of growth in the
society, that is the investment into the capital improvements of modernization of plant,
make the U.S. more competitive with other countries. And we can try to do it without as
much painful unemployment as we can get by with. Don't you think that has some merit?
FRIEDMAN: The only way __ I am all in favor, as you know, of cutting government
spending. I am all in favor of getting rid of the counterproductive government regulation
that reduces productivity and disrupts investment. But __
BROWN: And we do that, we can cut taxes some, can we not?
FRIEDMAN: We should __ taxes __ but you are introducing a confusion that has
confused the American people. And that is the confusion between spending and taxes. The
real tax on the American people is not what you label taxes. It's total spending. If
Congress spends fifty billion dollars more than it takes in, if government spends fifty
billion dollars, who do you suppose pays that fifty billion dollars?
BROWN: Of course, of course.
FRIEDMAN: The Arab Sheiks aren't paying it. Santa Claus isn't paying it. The Tooth
Fairy isn't paying it. You and I as taxpayers are paying it indirectly through hidden
taxation.
MCKENZIE: Your view __
FRIEDMAN: And therefore the crucial thing is to cut down total government spending
from the point of view of inflation. From the point of view of productivity, some of the
other measures you were talking about are far more important.
BROWN: But if you concede that inflation and taxes are both part and parcel of the
same thing, and if you cut spending __
FRIEDMAN: They're not part and parcel of the same thing.
BROWN: If you cut spending you __ well, but, you take the money from them in one
way or another. The average citizen.
FRIEDMAN: Absolutely.
BROWN: To finance the growth of government.
FRIEDMAN: That's right.
BROWN: So if you cut back the size of government, you can cut both their inflation
and their taxes.
FRIEDMAN: That's right.
BROWN: If you __
FRIEDMAN: I am all in favor of that.
BROWN: All right.
FRIEDMAN: All I am saying is don't kid yourself into thinking that there is some
painless way to do it. There just is not.
BROWN: One other way is productivity. If you can __ if you can increase
production, then the impact of inflation is less because you have more goods chasing __
FRIEDMAN: Absolutely, but you have to have a sense of proportion. From the point
of view of the real income of the American people, nothing is more important than
increasing productivity. But from the point of view of inflation, it's a bit actor. It
would be a miracle if we could raise our productivity from three to five percent a year,
that would reduce inflation by two percent.
BROWN: No question, it won't happen overnight, but it's part of the __ it's part
of a long range squeezing out of inflation.
FRIEDMAN: There is only one way to ease the __ in my opinion there is only one way
to ease the pains of curing inflation and that way is not available. That way is to make
it credible to the American people that you are really going to follow the policy you say
you're going to follow. Unfortunately I don't see any way we can do that.
(Several people talking at once.)
EMMINGER: Professor Friedman, that's exactly the point which I wanted to
illustrate by our own experience. We also had to squeeze out inflation and there was a
painful time of one-and-a-half years, but after that we had a continuous lowering of the
inflation rate with a slow upward movement in the economy since 1975. Year by year
inflation went down and we had a moderate growth rate which has led us now to full
employment.
FRIEDMAN: That's what __
EMMINGER: So you can shorten this period by just this credibility and by a
consensus you must have, also with the trade unions, with the whole population that they
acknowledge that policy and also play their part in it. Then the pains will be much less.
SPRINKEL: You see in our case, expectations are that inflation's going to get
worse because it always has. This means we must disappoint in a very painful way those
expectations and it's likely to take longer, at least the first time around. Now our real
problem has not been that we haven't tried. We have tried and brought inflation down. Our
real problem was, we didn't stick to it. And then you have it all to do over.
BROWN: Well I would __ I would concede that psychology plays a great, perhaps even
the major part, but I do believe that if you have private savings stimulated by your tax
system, rather than discouraged by your tax system, you can finance some of that public
debt by private savings rather than by inflation and the result will be to ease to some
degree the paint of that heavy unemployment that you seem to suggest is the only way to
deal with the problem.
FRIEDMAN: The talk is fine, but the problem is that it's used to evade the key
issue: How do you make it credible to the public that you are really going to stick to a
policy? Four times we've tried it and four times we've stopped before we've run the
course.
(Several people talking at once.)
MCKENZIE: There we leave the matter for tonight, and next week's concluding
program in this series is not to be missed.
(Applause)
From Harper Library, goodbye.
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