Tape 62 - Monetary Figure Revisions, Spending

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Interviewer	Hello! This is Instructional Dynamics,	0:02
	inviting you to another of our biweekly interviews	0:04
	with Dr. Milton Friedman, professor of economics	0:07
	at the University of Chicago.	0:10
	We are taping this interview on Thursday, December 3rd.	0:12
	Professor Friedman, there has been a spate	0:16
	of monetary actions since our last tape.	0:18
	The monetary figures have been revised,	0:21
	the discount rate has been lowered,	0:23
	the treatment of eurodollars has been changed.	0:25
	Let's take up first the revision of the monetary series.	0:28
	Do the revisions effect your estimate of the outlook?	0:32
Milton	Yes, they do.	0:36
	The revisions themselves are interesting.	0:38
	This is the second year in a row	0:41
	in which the Fed has essentially done the same thing,	0:43
	and for essentially the same reason.	0:45
	A year ago, just about this time of the year,	0:48
	though I rather think it was a couple of months earlier,	0:52
	something like September,	0:55
	the Fed came out with a revision	0:56
	which sharply raised the rates of growth	0:59
	of the money supply for the earlier months of the year.	1:02
	That revision was occasioned by what they regarded as	1:08
	an understatement of the money supply	1:14
	as a result of operations in eurodollars.	1:16
	It wasn't the eurodollar figures	1:20
	themselves that were involved.	1:21
	But the figure that is published as the money supply	1:23
	is the total of currency deposits	1:26
	held by individuals, businesses,	1:29
	and government other than the federal government	1:32
	minus items in the process of collection.	1:34
	Items in the process of collection include, for example,	1:38
	a check which you receive today	1:41
	from someone else and deposit in your bank.	1:43
	Your bank will credit that to your account	1:46
	so your deposit is raised by it.	1:49
	On the other hand, it will take several days	1:51
	before the check gets back to the bank	1:53
	of the person who issued it,	1:54
	and is debited against his account.	1:56
	In the meantime, the argument goes,	1:58
	that sum of money is carried in both your account	2:00
	and his account, and thus, in order to avoid duplication,	2:03
	and this is the reason why the figures	2:07
	are calculated this way,	2:08
	those items in the process of collection	2:10
	are subtracted from gross or from total deposits.	2:12
	I may say as an aside, it's not entirely clear	2:18
	that that's even from a purely abstract,	2:21
	conceptual point of view the right thing to do.	2:24
	I doubt that there's a person listening to this tape	2:27
	who has not at some time or other	2:29
	written a check for which he did not at the time	2:31
	have the necessary amount of funds in the bank,	2:33
	knowing full well that by the time	2:38
	the check was presented for deposit at his bank	2:40
	he would have the funds to pay for it.	2:42
	That is to say, people do take account of the float,	2:45
	as these items in the process of collection are called,	2:48
	in calculating the money they have available.	2:50
	Of course, the banks always refer to this	2:55
	in the unattractive term of "kiting checks"	2:58
	or "playing the float", but there's no reason whatsoever	3:01
	why a prudent man should not allow	3:04
	for the time involved in these processes.	3:07
	At any rate, to go back to the figures,	3:09
	what they discovered a year ago	3:11
	when they came to revise their estimates	3:13
	was that the items in the process of collection	3:16
	had been artificially blown up	3:18
	by virtue of certain technical details	3:21
	involved in overnight loans by New York banks	3:25
	from London banks,	3:28
	and that these had generated an abnormally large volume	3:29
	of items in the process of collection,	3:32
	which on the one hand had the effect	3:34
	of making the reserve requirements	3:36
	in New York banks appear to be lower,	3:38
	and on the other hand, made the monetary figures	3:41
	understate the true value of the total amount of money	3:45
	available to people in the United States.	3:47
	I may say, one of the big New York banks	3:51
	was a pioneer in discovering this technique,	3:53
	and you have to give it some credit for being so clever.	3:56
	Well, now they've supposedly fixed that all up,	3:58
	and changed their reporting procedure,	4:01
	and changed the requirements on the New York banks	4:02
	in order to get rid of that.	4:05
	Here we are a year later, and now you have	4:07
	a further revision for essentially the same reason,	4:09
	which this time raised the estimated money supply	4:13
	by seven billion dollars	4:16
	on a total of two hundred something billion dollars,	4:18
	so it's not a negligible sum, even roundedly.	4:22
	This time, the culprits seem to be	4:25
	not those same New York banks,	4:28
	but two little-known groups of institutions,	4:31
	one the so-called Edge Act, E-D-G-E Act.	4:36
	I spell that out because whenever I hear	4:41
	one of these monetary people talking about it,	4:43
	it sounds like Ajax, the cleaner,	4:45
	rather than Edge Act institutions, which are	4:47
	subsidiaries of American banks	4:53
	engaged in foreign activities.	4:55
	I don't know all the details, but under a special act,	4:57
	they have a wider range of possibilities than the banks do.	5:00
	And the second are the New York agencies of foreign banks.	5:05
	And it seems that these two groups of banks,	5:09
	in connection again with eurodollar transactions,	5:12
	have been creating a large volume	5:15
	of items in the process of collection	5:17
	that should not have been subtracted	5:19
	from the total deposits, but have been.	5:21
	From what I can discover, I think	5:26
	the revision is a correct revision,	5:28
	because I think, in fact, the earlier figures	5:30
	did understate the money supply,	5:32
	and did give us a misleading indication.	5:34
	I may say, I think it is something of a scandal	5:36
	that the Federal Reserve Board should, at this late date,	5:40
	be making revisions of this size	5:44
	in the basic monetary figures for which it is responsible.	5:46
	As I have probably mentioned repeatedly in the past,	5:51
	far more effort and energy has gone into the improvement	5:54
	of the Federal Reserve's indexes of industrial production,	5:57
	for which there is no particular reason	6:00
	why it should be constructing it,	6:01
	than have gone into the improvement of the	6:03
	purely statistical characteristics	6:05
	of their money supply series,	6:06
	which ought to be their prime task.	6:08
	But at any rate, whatever may be to blame in the past,	6:10
	the fact is that the statistical error	6:14
	in the computation of the figures	6:17
	has given a misleading impression	6:19
	of the character of monetary policy	6:21
	over the last seven or eight months.	6:22
	You will recall that in my earlier tape I indicated that	6:25
	starting from the base of in February, which seems to me	6:29
	to be appropriate base from which to start,	6:32
	the rate of growth of narrow money supply,	6:35
	currency, and demand deposits had been	6:37
	at the rate of about 4.6, 4.7 percent,	6:40
	taking into account the recent slowdown.	6:44
	On the new basis, that rate of growth	6:47
	is raised by a whole percentage point,	6:49
	and comes to 5.7 percent,	6:51
	and if one goes back before the last two months,	6:53
	when in the new series as in the old series,	6:56
	there was very little growth in the quantity of money,	6:58
	for reasons which I discussed in an earlier tape,	7:01
	you will find that the rate of growth	7:05
	of the new series is higher yet,	7:07
	somewhere in the neighborhood of	7:08
	six and a half to seven percent.	7:09
	The broader total, including time deposits,	7:11
	but excluding certificates of deposits,	7:14
	which I had been estimating as rising	7:16
	something like eight and a half to nine percent,	7:19
	now has to be set as rising perhaps nine to ten percent.	7:21
	As a result, it now appears that there is	7:25
	considerably more steam in the boiler	7:27
	than even I had been estimating.	7:29
	I had been assuming that there was	7:31
	sufficient steam in the boiler to turn the economy around	7:34
	and bring a mild recovery next year.	7:37
	On the basis of the new figures, I would now	7:39
	raise upward my estimate	7:45
	of a probable performance next year.	7:47
	I think now, on the basis of these figures,	7:52
	that after we have the unduly low figures	7:55
	for the fourth quarter of this year,	8:00
	because of the GM strike, and the unduly high figures	8:01
	for the first quarter of the next year	8:04
	because of the resumption of work at GM	8:06
	plus the stockpiling for the steel strike,	8:08
	we will see during the rest of the year	8:10
	a very substantial rise in dollar GNP,	8:12
	and also in physical output.	8:18
	I would not be at all surprised if,	8:20
	from the fourth quarter of this year,	8:22
	which is a rather depressed base,	8:24
	to the fourth quarter of next year,	8:26
	you'll hit a rate of GNP growth	8:28
	somewhere between eight and ten percent.	8:30
	This is not entirely an optimistic forecast,	8:34
	because any rate of increase of the nominal GNP of that kind	8:37
	certainly threatens a reawakening of inflationary pressures	8:40
	at an earlier date than I had been fearing.	8:44
	I'd like to add one more thing	8:47
	about the recent monetary movements.	8:48
	You will recall that in my last tape	8:51
	I referred to the paradox that while in its August meeting,	8:54
	the Open Market Committee had voted	8:59
	that the desk in New York should resolve any doubts	9:02
	on the side of a more rapid, rather than a less rapid	9:05
	expansion of the monetary aggregates.	9:08
	In fact, the opposite happened.	9:09
	In fact, the quantity of money	9:11
	under the old measurement, the old statistics,	9:13
	showed zero rate of increase for the next couple of months.	9:15
	Under the new statistics, it shows	9:18
	a minor rate of increase for the first of those months--	9:20
	well, a fairly sizable rate of increase	9:23
	for the first of those months,	9:24
	and a very minor rate of increase	9:25
	for the second of the months, about plus one percent	9:27
	instead of minus one percent per year.	9:29
	Now, this episode apparently caught Washington by surprise,	9:33
	and all of a sudden, toward the middle of November,	9:37
	you suddenly got everybody in Washington	9:41
	waking up to the fact.	9:42
	You have the Council of Economic Advisors	9:44
	suddenly getting exercise, the Treasury getting exercise,	9:46
	and the Federal Reserve Board itself getting exercise,	9:48
	and it's perfectly obvious that,	9:51
	from what happened then is that	9:52
	the Fed got hold of the people at the desk	9:53
	and asked why in the world they had been behaving	9:57
	as they had, why they hadn't been following the rules,	9:59
	and this, unless I am greatly mistaken,	10:02
	was what triggered that extraordinary	10:04
	rally in the price of long-term government bonds	10:09
	that occurred just about a week ago.	10:12
	It was one of the sharpest, quickest,	10:14
	most striking rallies on record,	10:16
	and I believe, as I say, what triggered it	10:17
	is that, under the lash from Washington,	10:20
	the New York desk started going in and buying securities.	10:22
	I may say, this is entirely my conjecture.	10:24
	I have no inside information that leads to that.	10:27
	I have no direct evidence, but it seems like	10:30
	very much the most plausible explanation	10:32
	of that little flurry in the bond market.	10:35
Interviewer	You say that spending	10:38
	is going to increase fairly sharply,	10:39
	but the outlook for capital spending is weak,	10:41
	and consumption shows no sign of loosening up,	10:44
	so where is the spending going to come from?	10:47
Milton	Well, that's a question I hear all the time,	10:50
	and certainly, what is said about	10:53
	the specific sectors is correct.	10:56
	Capital spending does look kind of dull,	10:59
	the rate of use of capital facilities	11:02
	is very much lower than it has been for a long time.	11:05
	You have indeed, in a certain sense,	11:10
	far more unemployment of capital than you have of men.	11:12
	Similarly, consumers have been saving	11:17
	an abnormally high proportion of their income,	11:20
	and if they are listening to all the rhetoric	11:22
	that is filling the air, they must be	11:26
	operating on a very different conception than mine.	11:29
	They must be operating on the belief	11:32
	that the economy is really in a deep depression,	11:33
	or that's perhaps an exaggeration,	11:36
	but at least it's in a serious recession	11:38
	and is going to get worse.	11:40
	I have before me, as it happens,	11:41
	the monthly investment letter by Hayden, Stone,	11:45
	which is written by L. Stone of the firm,	11:48
	and that letter, which on many items	11:53
	often makes a great deal of sense,	11:58
	has been persistently bearish on the economy as a whole,	12:00
	has been viewing with gloom and doom,	12:04
	and indeed, in this issue it says--	12:07
	and this is the December letter--	12:09
	it says that, and I quote,	12:13
	"Unfortunately, the pace of the decline	12:18
	seems to be accelerating."	12:21
	This is really an example of what I often talk about	12:22
	about the kind of hysteria that emanates from Wall Street	12:25
	that has no fundamental basis in fact.	12:27
	But insofar as the public hears all this kind of talk,	12:30
	one may well ask, why should the public	12:33
	reduce the volume of its savings?	12:35
	Why should it increase the volume of its spending?	12:37
	True, residential construction is rising,	12:40
	but that alone is hardly enough to support	12:42
	the kind of a spending boom that I see in advance.	12:45
	So I can well understand people saying to me,	12:48
	"Well, you're talking about a great increase in spending,	12:51
	where is it going to be?"	12:53
	and my answer is that I don't know where it's going to be.	12:55
	All I know is that if you pour money in at the top,	12:57
	it's got to come out somewhere.	13:00
	The interesting thing is that just where it	13:02
	comes out varies from time to time.	13:03
	Let's suppose this time, for example,	13:06
	you say to me it's not going to	13:07
	come out in capital spendings.	13:08
	Suppose you say it's not going to come out in consumption.	13:09
	Well then, the people who get the money	13:12
	are going to do something with it.	13:13
	They're going to try to buy securities,	13:14
	and in that case, what will happen is	13:16
	any large increase in the volume of money	13:18
	will show up in much lower interest rates	13:20
	than you or I are now forecasting,	13:23
	and when those interest rates get down there,	13:25
	some people are going to be encouraged	13:27
	to make some capital investments	13:29
	that they otherwise would not.	13:30
	Some consumers are going to be encouraged	13:32
	to borrow for purposes that they now are not contemplating.	13:34
	Housing will go up much faster than it otherwise would.	13:37
	So the answer to that question is that,	13:40
	given that water is pouring in at the top,	13:42
	if one channel is dammed up, it'll come out another channel.	13:47
	A couple of weeks ago, I was at a meeting	13:51
	of economic experts, which illustrates this point very well.	13:54
	As you may know, there are various kinds of	13:59
	econometric models of the economy.	14:01
	There are a whole spate of very large-scale	14:03
	econometric models: the Federal Reserve-MIT model,	14:06
	the Brookings model, Wharton School model,	14:10
	Office of Business Economics, and so on.	14:18
	Now, each of these models consists of	14:19
	a very large number of equations,	14:21
	and they are typically constructed in the same way.	14:23
	You try to estimate what's going to	14:25
	happen to capital investment.	14:27
	You have another equation to estimate	14:30
	what's going to happen to consumption,	14:32
	still another to estimate what's	14:33
	going to happen to housing, and so on.	14:34
	That is to say, you estimate by separate equations	14:36
	all the different bits and pieces,	14:38
	mostly in real terms, and in terms of physical output,	14:40
	then add all that up, make another estimate somewhere else	14:44
	of what's going to happen to prices,	14:47
	multiply the two together,	14:49
	and that's your estimate of nominal GNP.	14:50
	On the other hand, alongside of these large-scale,	14:53
	technically enormously impressive and complex models,	14:58
	their tens of equations and tens of variables,	15:01
	there is a dinky, one-horse, one-equation little model	15:04
	that has been constructed by the Federal Reserve Bank	15:07
	of St. Louis on monetarist principles.	15:10
	Now, the important point at the moment	15:12
	is not that it's on monetarist principles.	15:13
	The important point is that it proceeds	15:15
	in exactly the opposite direction.	15:17
	It says what is determined in the first instance	15:19
	is what's going to happen to total spending.	15:22
	And as that St. Louis model develops,	15:24
	and as it has already developed	15:26
	to some extent, it will go from the top down.	15:27
	It next goes and says, given that we know	15:30
	what's going to happen to total spending,	15:32
	let's try to forecast how that will	15:33
	break down between prices and output.	15:35
	As they further expand it, they will say,	15:37
	let's try to forecast how that total output	15:39
	will be divided between different lines.	15:42
	But the crucial difference between these two sets	15:44
	is that the one builds up and the other starts down.	15:46
	Now, the thing that fascinated me about this meeting	15:49
	was that it involved a comparison	15:52
	to the predictive accuracy of these models,	15:53
	on the average, over about the past ten years,	15:55
	and it was just no contest.	15:58
	This dinky little one-horse St. Louis model	16:00
	had, on the average, roughly half as large	16:03
	an error of forecast, of prediction,	16:05
	as these great, big, lumbering hulks of models.	16:08
	Now the reason, I believe, is not	16:13
	because one is large and one is small,	16:14
	but because I do believe that the principle,	16:16
	that the thing that you have to start from the top down	16:19
	is much more sound than the principle	16:22
	that you go up the other way,	16:23
	that the total quantity of money in the economy	16:25
	plus other variables do determine	16:27
	how much, in total, people are going to spend.	16:29
	The particular forms which that spending take	16:32
	will vary from time to time, and therefore,	16:34
	you can less accurately predict the breakdown	16:37
	than you can predict the total.	16:39
	Now, this lesson is already being learned	16:42
	by some of the big model builders.	16:44
	One of the non-monetarist model builders,	16:46
	Professor Fair of Princeton University,	16:48
	who I believe is an MIT student,	16:52
	has been constructing his model,	16:55
	and, learning from the St. Louis example,	16:57
	has been building it from the top down,	17:02
	although he doesn't happen to have a monetarist approach.	17:03
	At any rate, I cite these models,	17:06
	and further the support of the view I have that	17:08
	we can say more about what total spending is going to be	17:11
	than what form it's going to take, and that when I say	17:14
	I don't have the slightest idea which of these channels	17:17
	the spending is going to break out on,	17:19
	that doesn't lessen my confidence	17:21
	in the belief that we are very likely headed	17:23
	for a substantially increased rate of spending.	17:25
Interviewer	What effect do you think the	17:28
	discount rate change will have?	17:30
Milton	Well, I don't think that will have	17:32
	very much effect on anything that is,	17:32
	as I mentioned, on the earlier discount rate change,	17:34
	that's coming after the market and not before it.	17:37
	Short-term rates in the market	17:39
	have been going down drastically.	17:41
	Bill rates and short-term rates are below the discount rate.	17:43
	The problem will arise only when	17:47
	the market rates start coming up	17:49
	and start hitting that discount rate,	17:51
	which may happen sooner than I	17:52
	have heretofore been expecting.	17:54
	If I am right about the greater amount	17:55
	of steam in the economy, it also means that	17:57
	the decline in short-term rates will come to an end	17:59
	sooner than I had been expecting them to.	18:02
Interviewer	What about the treatment of eurodollars?	18:05
-	Well again, that isn't really related	18:07
	to the point I made earlier.	18:10
	It's an attempt to help the balance of payments look better.	18:11
	This is one of the curious things.	18:19
	You would think that it would be in our interest	18:21
	to discourage banks from borrowing abroad,	18:23
	but the effect of these regulations	18:26
	is to encourage them to keep on borrowing abroad	18:27
	in order not to make the balance	18:30
	of payments figures look too bad.	18:32
	On the whole, I don't see much virtue in these changes,	18:35
	but I do not believe they will have any great importance	18:39
	so far as the economy is concerned.	18:42
Interviewer	Professor Friedman, what effect do you think	18:44
	these changes will have on future monetary policy?	18:46
Milton	Well, the revision of the figures	18:50
	will take some of the heat off that has been on	18:52
	the Federal Reserve Board to expand still more rapidly,	18:54
	because it's now clear that they have been expanding	18:56
	more rapidly than people have thought.	18:58
	So I think, on balance, the effect of these revisions	19:01
	will be to increase the probability	19:05
	that over the next six or eight months,	19:07
	the Federal Reserve Board will	19:09
	go back to its earlier target of about	19:10
	a five percent per year rate of increase in M1.	19:13
Interviewer	Thank you very much, Professor Friedman.	19:16
	Remember, subscribers, if you have	19:18
	any questions or comments for topics	19:20
	you would like to hear discussed in this series,	19:22
	please send them to Instructional Dynamics Incorporated,	19:24
	166 East Superior Street,	19:27
	Chicago, Illinois, 60611.	19:29
	Doctor Friedman will be visiting	19:33
	with you again in two weeks.	19:34

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Title:

Tape 62 - Monetary Figure Revisions, Spending

Date:

1970

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Friedman, Milton, 1912-2006

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Paul A. Samuelson papers, 1933-2010 and undated

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Paul A. Samuelson papers, 1933-2010

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Economics Cassette Series: Milton Friedman

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Tape 62 - Monetary Figure Revisions, Spending

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