THE ECONOMY'S NEW CLOTHES: Milton Friedman on the New Economy

funding for this program is provided by the John M Olin Foundation and the star foundation No welcome to uncommon knowledge I'm Peter Robinson our show today the new economy consider this a prosperous America consumer confidence soaring the stock market setting one new record after another and the entire economy seeming to be driven by one new technology the automobile that's right I'm talking about the 1920s when if you were a baron of Wall Street there was a good chance you'd be driven around in a Lincoln Towncar like this one or if you were a more ordinary American that you'd drive yourself around in a Model T like this many of the nation's leading economists thought the boom would go on indefinitely failing to predict the crash of 1929 which of course led to the Great Depression now to today once again the nation is prosperous consumer confidence is soaring the stock market is setting one new record after another and the entire economy seems driven by one new technology the dot as in calm as in the Internet the question of course is how many parallels there are between today and the Roaring Twenties will our boom and as badly as that boom or are we in a genuinely new economy with changed economic rules with us to discuss the new economy one of the most important economists of the 20th century Nobel laureate Milton Friedman is the economic future that we see taking shape around us the new information economy so discontinuously with the past that it does indeed represent a new economy I think not if you go back to the 1920 when you had essentially the same phenomena what are the things that people say about the new economy now it's a big technological development right in the 1920s a big technological development was in automobiles and electricity in the middle of the 20s there were dozens of IPOs of automobile companies almost every year coming out there were hundreds of automobile companies started of which only a small number of course survived the second thing that people say is well now we have a good monetary policy we have don't have to worry about inflation the 1920s you had exactly the same argument because a Federal Reserve which have been established in 14 had started to learn how to run things and from 1923 to 1929 he did an extremely good job and prices were very stable from 1923 to 28 so there were five golden years I prices were very stable you people talk about the change in the industrial composition all the mergers and so on it was a big merger movement in the 1920 indeed that curving Fischer who was a greatest economist of the time gave a talk the night before bloody Thursday or whatever the day was in 29 in which he talked about all of these elements every single element in there you can find in the days in which he concluded in talking about how the stock market was in for a long good run he lost his shirt on it but he was a great economist and in a way I don't think he was wrong because you would not have had that the terrible debacle if the Federal Reserve hadn't behaved very badly and it never occurred to him that the Federal Reserve would behave that badly well look we better go into that for a moment so the Great Depression was the fault of the Fed that's right now the stock market I'm not saying that the stock market collapse was a fault of the fact right not that it was a genuine bubble the Fed may have contributed to it but it was primarily a genuine bubble all right and it was a bubble that was it was stimulated that boom the bull market of the 20s was stimulated by exactly the same kind of forces that have been stimulating our present bull market so there were real changes eazl development real changes in the economy that we're indeed impressive they were objectively taking place that wasn't nonsense but the bubble now you'd better actually define what you mean by a bubble I don't know that I want to talk about a bubble I want to talk about a bull market that gets very high and then is reversed and comes down again all right we've had three comparable bull markets in the sense of twenties we've had the 20s in the United States the 80s in Japan and the 90s in the United States and if you plot them one on top of another they almost coincide they have exactly the same pattern so if this is new some the 80s was new if that was new the 20s was new so we're inching our way toward the edge of the precipice no that's a different question all right what happens after there's no doubt such a bull market tends to overshoot by how much and when those are much more difficult question right and especially by how much because that partly depends on what happens after the bull market breaks in the United States in the three years after the bull market broke in 29 29 from 29 to 32 or 33 the Federal Reserve permitted over forced the stock of money to go down by 1/3 for every hundred dollars in existence and money I'm not talking about bank deposits and currency in your pocket for every hundred dollars in existence in 1929 there were only 67 dollars in 1933 and as a result when the day that collapse I think it was a decline of 80 percent the Great Depression was a long time ago haven't we learned a thing or two about managing the economy since between 1890 and 1945 the United States experienced seven contractions three of five percent two of 10 percent and one of almost 15 percent yet since 1945 we've experienced just one contraction of a mere 3% and today in the so-called new economy we find ourselves in the midst of an 18 year expansion that has been marred by only one mild recession so the business cycle is becoming less important no no I've always questioned whether there is such a thing really as a business cycle what you have is an economy which is subject to shocks from time to time right and a shock comes along which knocks the economy down and then it recovers but the idea that those are at regular intervals of a regular-size I think that is not supported by could we get by the I mean I have no doubt whatsoever mm-hmm that to a large extent past recessions were produced by mistaken monetary management that they were not natural in the economy they did not have to occur but you had a situation in which the monetary authorities this is particularly after the Federal Reserve was established followed a policy of tending the sort of a stop-go policy they were late in reacting to changes in the economy and when they acted they acted too strongly and even the Fed has learned from experience and I believe that the performance of the Fed under mr. Greenspan has been a better than under Ender any prior Chairman so the Fed you may know personally I'm in favor of abolishing them yes I know I know I'm a rather subdued I would rather substitute a computer for the business cycle is one of those phrases that is almost in Kant Ettore people say it over and over again and so I assume there must be a business cycle now I hear you saying you're not sure that such a thing even exists if you want to see a real cycle think of a seasonal cycle right you can that's a event it's warm in the summer it's cold in the winter you grow food in the summer you don't grow it in the winter radicular you have a real clarity predictor that would be a real honest-to-god cycle all right now the image of the business cycle that people have had is that there are there are reactions in the economy of a similar kind which tend to run with reasonably regular frequency now for one time to give an example one favored favorite theory at a time was a so-called sunspot theory if this there are spots on the Sun which have a physical cycle yeah ten years cycle roughly and that doesn't affect the fertility of crops in the in on the earth it affects a growing condition and Stanley Jevons in the econ English economist in the nineteenth century had correlated the movements in agricultural output with the movements in the Sun and argued that that was a cause of a the cycle that would be a real honest-to-god cycle right and people have been searching for some other mechanism but what I think is really going on is a very different thing I think that you have a reaction mechanism in the economy the image I've always had is think of a piece of wood look up here with an elastic band glued on the bottom of it all right and every now and then something comes along that plucks it down right for example you get the shock of the oil embargos and that is actually about the 70s in a century that knocks it down and that creates a recession and then there is a reaction mechanism within the economy which you can understand that it takes time for what happens then to have its full effect some things react immediately some things react later and that reaction mechanism means then we'll take a reasonably predictable amount of time for the economy to react back to their run get back up to that board up there which defines its long term pad path right and similarly there might be something that pulls it up all of a sudden you've got a war in which in order to finance it they print a lot of money that causes inflation that produces a temporary boom and then you react down to it so the image I have is of a of an economy which is subject to shocks from time to time and which reacts to those chunks in a rather predictable manner with a predictable reaction mechanism in it now we've been very fortunate since assessee the 70s you had a serious recession right as a result as I believe of the shock of the oil embargo now right now we've been very fortunate that we haven't had any the one major shock we had in the period since then was the agent crisis yes was a collapse of the Asian countries but that agent crisis was both favorable and unfavorable for us he was unfavorable in the sense of of the financial disturbances it dissolved but it was favorable in that it meant lower commodity prices suddenly Korean cars become PKS factures right and also because it cause people all over the world to be concerned about the safety of their assets it was favorable to our financial markets it produced an inflow of foreign funds to the safety of the American rice rice so at because it had these opposite effects it did not produce a serious recession in the United States so our the high growth rates of the past few years sustainable it used to be a rule of thumb that the economy would grow at about 2.5 3% 3% a year with a good year now listen to these growth rates 1996 3.7 percent 97 4.5% 98 4.3 percent 99 4.1 percent question about the so-called new economy have we achieved a new permanently higher growth rate five years is not a very long base if you are not impressed or permanently higher you undoubtedly have had rapid rate to growth and I think there's no doubt that they derived from these technological developments and in computers and any information industry and but that's a process of getting up to a new higher level and once you get there you won't grow any faster than you ever did before it's not a see there's a big difference between a permanently higher growth rate mmm-hmm like this right you're changing the whole the Slowhand line changing where that board is right see the board was there and now you've had developments which enabled you from the same resources to get a larger output right so you're having a board shift from here it's up here Ryan in the process of the shift you'll have a rapid growth for a few years until you get there and then the growth rate will slow down so you need to say up there you'd expect it to settle back down to 2.5 percent 3 percent in that well all we know is that for the last one hundred hundred and fifty years it's been of the order of two two and a half percent all right now let me ask you this why that sounds like a rule of the universe 100 100 to 100 years all kinds of different economic regimes the agrarian regime and then we go through the Industrial Revolution and now you're suggesting into this new information Asian economy and it's still 2.5 percent a year I don't know it's 2.5 percent a year but that average is an average of a lot of different numbers alright then these four and a half percent numbers go into it the zero numbers for a while go into it right so there's variability which is just a pure statistical artifact assistant a fact that on the average it's been around to two and a half percent and so unless you tell me something that will make it very different see don't misunderstand me the benefits from the technological change are permanent you have the whole level of the economy is higher than it otherwise would be right that's going to stay there right I don't mean there will be some dips and so on but it'll stay there but the effect on the rate of growth is temporary now related to this question of whether we've achieved a higher rate of productivity is have we achieved a new lower rate of unemployment what the average level of unemployment is that you can maintain what I defined as a natural rate of unemployment depends on the circumstances of the period if you have a world in which you have very strong trade unions lots of wage rigidities and fixed rates you have high rates of unemployment as in Germany or in Europe in general today where rates of unemployment are Tet they've just come down into ten percent in Germany right and that's a result of having a very rigid wage system the word wage it's very hard to fire anybody so people don't want to hire anybody right and in which wages are fixed by union agreements and so on on the other hand if you have a more flexible economy with and unions have become much less important the United States right then the natural rate of unemployment is on the average is going to be lower we have a much more fluid wage and labor market we do and what's more you'll have all sorts of developments in the way of part-time employment temporary employment agencies and information is more readily available easier to find out what jobs there are where they hear the net is directly absolutely at play I think the Internet is as I say the Internet has been a major factor I think it will have tremendous effect but but on the level of where we'll be not on the permanent rate of growth right okay now we come to the information economy has driven the stock market to one new high after another has the bull market gone too far now this is Milton Friedman in 1998 quote I have believed for some time now that the stock market was in a bubble when you uttered those words the Dow was at about 6500 yeah it was wrong no I was wrong at that time but if you wait and it long enough you'll be right right look well do so what do you believe about the markets today the equity markets today in the United States I think that they are in a but they're now you resist using the term bubble I mean why is that you don't like that term well because it's very hard to do you know you only recognize a bubble after the event not before all right and we'll find out later whether it's a bubble what do people mean when they say bull that what they mean by a bubble they mean that the levels of the stock market prices cannot be justified by the likely real earnings of the companies whose stocks are being valued the rise in the market averages has been produced by a very small number of companies the telecoms and the internet sighs right it's a two-tier market and the high tech market is in a bubble you won't call the new economy market and the old economy if you want to call it the new economy market I don't mind all right the newer economy market but right the market when we know what we're talking about we're talking about as you say the high tech in the telecom telecom okay now 1920 excuse me 1929 the bubble burst equity markets in this country collapsed 80% No hold on go slowly all right in 1929 when it burst they did not collapse 80 percent it was 80 percent over the course of the next three years over the in fact by early 1930 the market was almost back it had almost recovered from the collapse an actual so let me rephrase it then from peak to trough recognising that some years elapsed but from peak to trough it fell the equity market fell eighty percent in reason I think I emphasize it right is because I believe if the Federal Reserve had followed correct policy right the market the bottom of the market would have come in 30 or 31 rather than in 33 and would have been nothing like 80 percent below yeah well your anticipating my question so from 29 to 33 we drop 80% in Japan when the bubble bursts they drop about half the equity market drops about half right now the bubble bursts sometimes here in the United Way's will have to see what the Federal Reserve does afterwards what should it do what it should do note to Alan Greenspan well Alan Greenspan doesn't need a note he understands Monetary Affairs every bit as much as I do but and what I will tell you what he will do all right that's a good knot what he should do mark but what he will do no to invest is exactly what he did in 1988 87 when you had the stock market decline right the big decline right about 25% in a couple days that's right he poured in money he had the Federal Reserve to follow a very easy money policy and that's what he will do again if the market tanks not indefinitely but for a time to give it some cushion the Fed knows now we know now what to do in the case of a serious fall well when I say we know what to do I don't mean to suggest it's an easy and obvious thing how much how rapidly when do you overdo it do you move the economy and do you see you have to be careful you don't want to green restart the bubble right right so this is not as this is not like having a computer all set up to do it but all you have to do is push the button this is complicated tricky business Michael my computer setup instead of the Fed would be for the long-term purpose and would eliminate all of this fine-tuning would have none of this right which simply have the quantity of money go up regularly day by day week by week even in the event of a market fall off even you would make no adjustment no adjustment because adjustment there are times when the adjustment is desired and good but if you look over the record of the Federal Reserve it's old history it's done harm more often than it's done good there are only a few periods 23 to 28 as it happens is one of them right and the recent few years are it's another right but there if you tally the number of years in which they behave in a way that I would score as excellent in a way I would score is terrible the terrible years greatly outnumber the excellent year now the price you pay for a big depression like 29 to 33 it had not been redeemed by softening the effect of the 87 stock market collapse I see now final question our Alan Greenspan and the Federal Reserve doing the job they ought to do given that we are in about at least one tier of the equity market is in a bubble in your judgment Alan Greenspan is the man you'd like to have in charge of all the lovers well that's likely to do as good as anybody let me make it clear it's not Alan Greenspan's business he's not the Federal Reserve Board business to try to control the stock market prices they're bizzle so he was engaging in a no-no when a couple years ago he said that equity markets showed quote irrational exuberance he should not have said that oh absolutely that was a mistake all right the business of the Fed is to keep prices stable general prices not stock market prices but the prices you pay for bread and for milk and for cars and for coats and fur hats and shoes the average of all prices the general price level that's its business and it's one and only business and it has no business trying to affect the stock market all right now if you but but in order to prevent inflation in order to keep stable prices given that it has the power and the duty it will have to react to changes in the stock market well I shouldn't try to determine what the stock market is the consensus among traders and investors and business journalists right now is that the Fed is raising interest rates and that Alan Greenspan of with with a purpose in mind and that Alan Greenspan is doing everything but wiggle his ears to signal to the markets that he is serious that he believes the market equity markets are overvalued and he wants to cool this thing off and bring it down do you believe that's a correct reading of his actions no I don't you don't I think that that's an understandable reading of his actions but I don't think it's a correct because what he has been stressing is not the market but he has been stressing is what he believes isn't that the demand for output is increasing faster than attainable rate and which it can be increased right that's the point he's stressing and party demand is the capital gain right part of the game demand is arising out of the capital gains so the equity markets play a role there play a role in adding to the demand for goods and services and his concern is that unless if that continues it will produce higher prices over the whole range of goods and services and there are some evidence that there is a little pickup of inflation I think he is correct to be worried about that I think that if you look at what's been happening to total monetary growth it's been too high to be sustainable over a long period and it's appropriate for them to try to bring it down let me ask you a last question than on this on this new economy is it a characteristic of this new emerging economy that the Fed is losing a certain element of control here's what I mean that interest rates grow up and what we've seen in the markets in the last couple of weeks is that the Dow goes down and the Nasdaq takes off because investors calculate that the older industries represented in the Dow will be affected by increases in interest rates but the high tech industries which are not as reliant on Bank money won't be so we shift capital from a place where the Fed does seem to have control to the Nasdaq the new stocks where it doesn't have control and Alan Greenspan is a frustrated in a sad man the Federal Reserve has never had control of the stock market but it has as much control over the economy as a whole over the monetary growth of the economy as a whole has it ever had there's nothing in this new economy that in any way at all reduces the hours of the Fed now of course when I say that it's I think that the market enormous ly overestimate the powers of the Fed that they attribute to Greenspan a capacity to fine-tune anything in the world that he does not have and that that's a source of danger because what affects price level is partly what people expect the price level debase right price expectations and at the moment there is so much confidence in Greenspan's handling of the unit I only leave it tonight that people are forming price expectations that it is how very hard to see as realistic Milton Friedman thank you very much what a relief Milton Friedman believes the equity markets are overvalued but that when the markets come to their senses the Federal Reserve will behave better today than it did in 1929 in other words the dot-com economy will not go the way of the Model T I'm Peter Robinson thanks for joining us

Channel: Hoover Institution

Views: 140,385

Keywords: HooverInstitutionUK, economy, internet, technology, boom, 1920s

Id: zt_tKi89T-M

Length: 26min 25sec (1585 seconds)

Published: Sun Apr 22 2012