The Region - Banking and Policy Issues Magazine - Interview with Milton Friedman
In his new book, Money Mischief, economist Milton Friedman compares inflation to
alcoholism; blames the rise of Chinese communism, in large part, on an inadequately
controlled money supply; defines and describes MV=PT in four brief paragraphs; tells how
three Scottish chemists ruined William Jennings Bryan's political career through their
pioneering work with gold; and relates many other anecdotes befitting the book's subtitle,
Episodes in Monetary History.
As the above examples illustrate, the Nobel prize winner is one of those rare academic
scholars who is also able to convey his message beyond the academy. His publishing career
includes many books that have been popularly successful, including Free to Choose, which
also spawned an extended television run and is now available in video.
Of all his contributions, one of Friedman's most important is his part in deepening the
understanding of the role of money in determining the course of events.
Region: Six Nobel laureates and 94 other economists recently called for increased federal
spending to spur economic growth, even though it would add to the budget deficit. Among
them are Arrow, Sharpe, Klein, Solow and Modigliani. Does this collective recommendation
of world-class economists make sense?
Friedman: I do not agree with the view of the 100 economists calling for increased
spending to spur economic growth. My disagreement is partly based on political
considerations, partly on economic considerations. From the political point of view,
increased spending may initially be designed to be temporary but few things become more
permanent than temporary spending. Hence, the economists are in fact calling for a still
higher level of government spending yet, in my view, reducing the scope of government is
our most important single objective.
On a technical level, I believe that there is no persuasive evidence that, given the
course of monetary policy and monetary aggregates, federal government deficits have any
stimulative effect. They have a stimulative effect only insofar as they are financed by a
more rapid increase in the quantity of money than would otherwise occur.
However, even if I shared the view of the economists who signed this statement that an
increase in budget deficits would be stimulative, it would be consistent with their
technical view to recommend a reduction in taxes as a way to achieve an increased budget
deficit. From their point of view, a reduction in taxes would have the same stimulative
effect as an increase in spending, yet it would avoid the long-term adverse effect of
increasing the role of government in the economy.
Region: In a Region interview with your friend and former colleague George Stigler, we
posed a question about the quality of the Fed's economic research efforts. Stigler said,
"I don't feel very confident commenting about that. I've been told by Milton Friedman
that one of the perversities of history is that when the quality of the Washington staff
is high, policy is pretty poor, and in the years when policy has been very good, the staff
has been low quality. Now if you want to explore that, you'll have to interview him."
Did George Stigler understand you correctly?
Friedman: I probably said some such thing in my discussions with George, but I've not made
a systematic study. I believe that it was based on one major phenomenon that stuck in my
mind. In my special field of interest of money, there is no doubt that a large fraction of
all of the economists who work more or less full time on monetary research are employed by
the Federal Reserve. Many of them have made important contributions to monetary analysis
and theory going back to the 1920s, when Winfield Reiffler, Walter Stewart and Emmanuel
Goldenweiser were all contributing to understanding monetary institutions. I have no doubt
that the Federal Reserve has made a positive contribution to monetary research, which I
suppose I ought to set off on the account as a credit against a terribly poor policy
performance. If I were to make up a balance sheet for the Federal Reserve, I could name
many credit items on the research side, very few on the policy side.
The interesting thing to me has always been that the most important contributions to
understanding of monetary theory and monetary institutions have not come from Washington
during the decades in which I've been active. The Federal Reserve Bank of St. Louis in the
1950s, '60s and '70s was by far and away the pre-eminent producer of significant monetary
research within the System. More recently, several other regional banks, including your
own, have joined them and have made important contributions. Certainly the Minneapolis
bank, with the contribution of its personnel to the development of rational expectations,
has been an important contributor to monetary theory. All of the regional banks publish
bulletins--required by law I guess. Some hardly ever publish material of general interest
to students of monetary theory and policy, but most do, even if only occasionally. It
would be invidious for me to mention names without a more careful study--though offhand, I
can recollect such articles in the bulletins of four regional banks other than St. Louis
Region: In your early writings, you argued that deposit insurance was a worthwhile
development. Here at the Minneapolis Federal Reserve we've taken the position that deposit
insurance, now at virtually 100 percent, has a perverse effect and should be reformed in a
way that would bring more market discipline. Where do you stand on the question of deposit
Friedman: Circumstances alter cases and I believe that both views are correct. Anna
Schwartz and I in our Monetary History were discussing the situation after the financial
collapse of the 1930s. We said then and believed then, and I still do, that the Federal
Reserve had failed to do what it was originally set up to do. It had permitted a collapse
of the monetary system, it had permitted perfectly sound banks to fail by the thousands
because of liquidity problems, although it had been set up in 1913 with the objective of
preventing that kind of a situation. And we argued in the book that since the Fed had
failed and showed no sign that it was not going to continue to fail in pursuing its
function, something else was needed to perform the function for which it had originally
been established and that the Federal Deposit Insurance Corporation would serve that
function. Interestingly enough, it did for some 40 years. From 1934 to the early '70s,
there were very few bank failures. And there were essentially no runs on banks because of
liquidity problems. So it did serve a useful function for 40 years.
In my opinion, what destroyed the usefulness of deposit insurance was the inflation of the
1970s for which the Federal Reserve has to bear major responsibility. That inflation had
the effect of destroying the net worth of financial enterprises, particularly the savings
and loan institutions, which were borrowing short and lending long. They had mortgages and
the like outstanding at fixed relatively low rates of interest. When the cumulative
inflation of the 1970s inevitably led to a rise in the interest rates they had to pay, the
result was to wipe out the net worth of the proprietors of those enterprises. Once the net
worth of the enterprises was destroyed, deposit insurance did have a very perverse
influence. In order for deposit insurance to work, there has to be some private personal
incentive for safe banking. That incentive was provided by the net worth of the
proprietors of financial institutions. Eliminate that net worth and deposit insurance
created a win-win position for proprietors of those enterprises to engage in risky
Region: In your new book, Money Mischief, you discuss monetary union. What are
your thoughts on Europe's plan for one currency?
Friedman: I believe it will not come to an achievement in my lifetime. It may in yours,
but I'm not sure that's true either.
Region: Why is that?
Friedman: Because I do not believe that at the moment, a single European currency is
either feasible or desirable. Let me restate that. It would be highly desirable if Europe
could have a common money, a single unified money, just as it's desirable for the United
States that we have a single unified currency. But in order for that to be possible or
desirable, you have to have a unified currency over an area in which people and goods move
relatively freely, and in which there is enough homogeneity of interest so that severe
political strains are not raised by divergent developments in different parts of the area.
Let me illustrate. In the United States, right now you have much more severe economic
problems in New England, in the Northeast in general, than you have elsewhere. If the
Northeast were a separate country with a different language from the rest of the country,
with a supposedly national government, it would be very tempted to resort to devaluation.
What prevents it from doing that now is that we are a nation with one language, one
political structure, a recognition that one region or another may have difficulties
relative to other regions. Some years ago it was the South that had this problem.
Now come to Europe. Will there be as much tolerance for that kind of an adjustment as
between France, on the one hand let's say, Germany, Italy, Spain, Sweden, and so forth?
I'm very dubious that those preconditions for a successful unified currency exist on the
European continent. That's looking at the ultimate.
Now consider the process you have to go through to get to a unified currency. In order to
have a truly unified currency, not a collection of separate national currencies joined by
temporarily fixed exchange rates like the European Monetary System or the International
Monetary Fund was in its earlier days - in order to have a truly unified currency, you
either need to have no central bank, as with a commodity currency like a gold standard for
example, or you need to have at most one true central bank: one authority that can issue
money. In the United States that authority is the Federal Open Market Committee of the
Federal Reserve System. It's one. The Federal Reserve Bank of Minneapolis issues currency
notes on which the bank's name appears, but you can't decide how much to issue. That
decision is made in Washington by the Federal Open Market Committee.
In order to have a comparable situation in Europe, you have to eliminate the Bank of
France, the Bank of Italy, the Deutsche Bundesbank, the Bank of England and so forth. You
have to have one true central bank with full authority. The plans that are being made call
for such a central bank, but it's a long cry from calling for it and having it. After all,
the Treaty of Rome, which I believe was signed in 1957, called for eliminating all customs
and tariff barriers among the Common Market nations. They still have not all been
eliminated some 35 years later. So to call for something is one thing, to do it is a very
different thing. And even the central bank that's called for is going to be run by
essentially a committee of representatives from France, from Germany, from England, and so
on. I cannot see that kind of institution as having the same ability to withstand
political pressures internally in these various areas that the Federal Reserve's Federal
Open Market Committee has.
Region: The New School of Classical Economics (among others, Sargent, Wallace, Prescott,
Lucas) argues that the best way to study economics is within the general equilibrium
models. They stress the importance of the institution's arrangements: the rules of the
game. What is your view on this approach?
Friedman: I believe that the approach has much to offer us, but I also believe that its
proponents, like all proponents of fresh approaches, tend to carry a good thing too far. I
would say it has had too much influence up to date. It has made a real contribution, but
it is by no means the only, or necessarily even the most useful, approach.
Region: If you were advising the Federal Reserve, what would you say are the unsolved
economic problems of the day?
Friedman: One unsolved economic problem of the day is how to get rid of the Federal
Reserve. The most unresolved problem of the day is precisely the problem that concerned
the founders of this nation: how to limit the scope and power of government. Tyranny,
restrictions on human freedom, come primarily from governmental institutions that we
ourselves set up.
Abraham Lincoln talked about a government of the people, by the people, for the people.
Today, we have a government of the people, by the bureaucrats, for the bureaucrats,
including in the bureaucrats the elected members of Congress because that has become a
And so undoubtedly the most urgent problem today is how to find some mechanism for
restructuring our political system so as to limit the extent to which it can control our
individual lives. You know, people have the image, have the idea, that somehow "we
the people" are speaking through the government. That is nonsense. You cannot tell me
that the consumers of the United States would have approved a policy which in fact led to
everyone paying about $2,000 or more a year per automobile purchased. Yet that was the
effect of the policy of imposing so-called voluntary import quotas on Japanese cars.
Nobody will tell me that the people of this country really favor paying two or three times
the world price for sugar. Nobody will tell me that the people of this country believe it
is desirable to spend money to provide water to farmers at less than cost in order to
enable them to produce crops which the government buys up in part at more than the world
price and then has to dispose as surpluses. You cannot explain those activities of
government, and there are hundreds more, as reflecting the will of "we the
people." They reflect a system in which concentrated vested interests have been able
to obtain great power and impose costs on a diffused consumer interest.
Region: On a recent McNeil/Lehrer interview, you made the point that ironically we urge
emerging eastern European countries to privatize, yet here in the United States we tend to
move in the opposite direction: toward a more socialized state, and you gave health care
as an example.
Friedman: Direct government spending in the United States amounts to about 42 percent of
the national income. I'm putting it a little elliptically. Government spending equals a
sum which equals 42 percent of the national income. In addition, there is much spending,
which is classified as private spending, effectively mandated by the government. It would
make no difference whatsoever in your life if the antipollution equipment you have on your
car were provided to you without charge by the government but you had to pay a tax equal
to the amount that you spent on those. You wouldn't know the difference. And yet if that
were done, it would be counted as government spending.
Numerous other private expenditures are mandated by the government in a host of different
ways. The cost of farm subsidies is included in the 42 percent, but the higher prices you
pay for agricultural products because of the farm policy are not included in recorded
government expenditures. Yet they are in effect mandated by the government and represent
command over resources subject to government control and direction. Similarly, building
codes impose costs that you might not privately want to engage in, wage and hour laws--and
on and on. So I believe that easily more than 50 percent of the productive resources
available in the nation are allocated by governments--federal, state and local. How those
productive resources are used is determined not by the private interests of the
individuals who dispose of them but by governmental mandates.
Of course, some of that is desirable. I'm not in favor of no government. You do need a
government. But by doing so many things that the government has no business doing, it
cannot do those things which it alone can do well. There's no other institution in my
opinion that can provide us with protection of our life and liberty. However, the
government performs that basic function poorly today, precisely because it is devoting too
much of its efforts and spending too much of our income on things which are harmful. So I
have no doubt that that's the major single problem we face.
Region: In Minnesota, the state government handed a massive support package to an airline
to encourage it to build a facility in the state and promise not to leave. What are your
thoughts on such state development packages?
Friedman: I believe they're terrible. If you read the Constitution, it specifies that
there shall be no tariffs or restrictions or hindrances to trade among the states. Just as
we speak of non-tariff restrictions on international trade, I regard the kind of thing
you're talking about as non-tariff restrictions on internal trade. I'm not a lawyer, but I
would like to believe that a strict interpretation of the Constitution would render such
actions by individual states illegal.
Region: Going back to your new book, Money Mischief, you predict in the epilogue that
"the world will see more episodes both of high inflation and full-fledged
hyperinflation within the next decade." What leads you to that conclusion?
Friedman: What leads me to that conclusion is the enormous changes that have occurred in
the economic structures of countries around the world. Obviously, part of it was inspired
by the Eastern European countries in which I doubt very much that all of them will get
through without going through episodes of hyperinflation. They seem to be on the verge of
it in Russia right now. Similarly, Latin America has been a great breeder of such
episodes, and while some countries in Latin America, like Mexico and Chile and maybe
Argentina, at the moment are following better economic policies, that's by no means true
of all of them.
Region: As a founding member of the Mont Pelerin Society, what would you say was the
organization's original purpose and how has it evolved over the last four decades? (The
Mont Pelerin Society is an international organization of free-market economists and
scholars from colleges, universities and businesses; formed in 1947 by--among
others--Friedrich Hayek, George Stigler and Friedman.)
Friedman: There's no doubt what its original purpose was. Its original purpose was to
promote a classical, liberal philosophy, that is, a free economy, a free society,
socially, civilly and in human rights.
I believe that it has made an important contribution to that purpose. It has made that
contribution not by propaganda but by offering a place where people of like mind could get
together, discuss their problems, and resolve difficulties they had about both philosophy
It is hard at this distance to recall what the intellectual climate of opinion was
immediately after World War II, in the 1940s and throughout the '50s. It was a climate in
which those of us who believed in free markets and in a socially and politically free
society were a tiny, very much beleaguered minority. Collectivism--economic, social,
political--was very much in the ascendancy. During World War II, governments everywhere
had largely assumed control of the economy. And it was simply almost taken for granted
that they would have to continue to do so in the postwar period. The origin of the meeting
really goes back to Friedrich Hayek's book The Road to Serfdom, which was regarded at the
time as a strange, minority point of view. In that kind of an intellectual environment,
the opportunity to meet a group of people year after year--able people, intellectuals for
the most part, though also people who were involved in the political, social, financial
business world--on an occasion where you didn't have to be looking to see if somebody was
trying to stab you in the back, in which you could feel free to express your doubts and
disillusionments and the like made a very real contribution.
Region: And the Mont Pelerin Society of the 1990s, has it been...
Friedman: The world has changed, the intellectual climate has changed. The ideas of a very
small beleaguered minority in the '50s have become much more widely accepted, although
they're still far from being fully embedded in actual public policy. But at the moment the
Mont Pelerin Society has a renewed function: to provide a similar opportunity for
education, discussion, illumination to people from the former Communist world.
Region: I attended a Mont Pelerin Society meeting in Montana last year and they were
expressing concern about radical environmentalism and the role of government and were
proposing some thoughts along the line of free market environmentalism.
Friedman: That is a continuation of its traditional function. But you should also note
that last year there was a regional meeting held at Prague which was pursuing what I've
now described as its new role.
As an amusing footnote, one of the major benefits that I personally derived from the first
meeting of the Mont Pelerin Society in 1947 was meeting Karl Popper and having an
opportunity for some long discussions with him, not on economic policy at all, but on
methodology in the social sciences and in the physical sciences. That conversation played
a not negligible role in a later essay of mine, "The Methodology of Positive
Economics," which has probably led to more pages of subsequent print by others than
anything else I've written. It just shows how nature and science works in wondrous ways.
Region: We understand that most often you sport an Adam Smith necktie. What is the origin
of that fine tradition?
Friedman: As I understand it the first Adam Smith necktie was produced at the suggestion
of Ralph Harris when he was teaching at St. Andrews University in Scotland near Adam
Smith's birthplace. It then caught on and Adam Smith neckties were produced by various
groups in Britain, including the Institute of Economic Affairs which Ralph Harris later
joined and of which he became director, now retired. In the United States, Don Lipsett
started producing and distributing Adam Smith neckties. More recently, the Fraser
Institute in Canada has also done so. So much for production.
I cannot say how the practice grew of wearing the tie, except that somehow or other it
became a mark of political ideology. To tell an amusing incident, when I did our TV
program "Free to Choose," I wore an Adam Smith necktie whenever I wore a
necktie. The summer after it had been shown on TV, I received a letter from
representatives of a group of teachers who had been using the program in their summer
course. They sent me a necktie, saying they had discovered in watching the program that I
apparently had only one necktie and they thought I ought to have another.
Region: Thank you Mr. Friedman.
-- by David Levy, Vice President of The Federsal Reserve Bank of Minneapolis