Friedman said that the fiscal spending increases proposed by Bush were unwise because U.S. unemployment was still low and fiscal stimulus does not work, as Japan has shown. The Sept. 11 attack on the United States should not mean that the United States ends up with "a larger federal government," Friedman said.
Friedman was also critical of Greenspan's monetary policy, which he described as "without precedent." Greenspan had begun boosting the money supply, Friedman said, before there was clear evidence of a decline in the economy. The Fed's reaction to a slowdown that Friedman characterized as still quite mild was "extremely pre-emptive (and) extremely aggressive."
In Friedman's view, Greenspan would have done better to have contained monetary growth to a more reasonable level. But Friedman reasoned that Greenspan's reaction had been so aggressive because "there is a real concern ... that the first decade of the 21st century does not duplicate the 1930s."
More positively, Friedman saw a possibility that the U.S. economy could recover early next year and that the U.S. stock market might now be undervalued. He felt too that monetary policy had improved in Japan, which might now break out from its slump.
Q (Ian Campbell): I wanted to ask you your view of the U.S. economy at the moment. When we last spoke at the end of April you felt that Alan Greenspan, however much you respected him, was "overdoing it" with respect to interest rate cuts. Now the interest rate is down to 2.5 percent, and we've also got George Bush with his fiscal stimulus. Is this the right way to go about things?
A (Milton Friedman): I think not. I think so far as the fiscal stimulus is concerned, it is not the right thing to do, for a number of reasons. Of course, we have to distinguish between fiscal stimulus in the form of government spending and fiscal stimulus in the form of tax breaks.
In the first place let me speak of increased fiscal spending. It seems to me there're several reasons why it's a bad idea. In the first place, this has so far been a relatively mild recession. Even today, the unemployment rate is still 4.9 percent; that is a number that, in the past, has more often been associated with prosperity than with depression. So it's relatively mild, it's about the same length as it's usually been. Undoubtedly Sept. 11 will make it deeper and longer, and so we will have a real recession. But with the amount of monetary stimulus you have, there is no reason why the economy should not turn around sometime next year, first or second quarter perhaps.
In the second place so-called stimulus is not stimulus; it doesn't work. Empirically that's certainly been demonstrated by the experience of Japan. But it's also been true for the United States and elsewhere, wherever monetary policy has gone one way and fiscal policy the other, monetary policy has dominated, not fiscal policy. And right now monetary policy is extremely pre-emptive, extremely aggressive and there is nothing to be gained by having government spend more money. I think we don't really want the legacy of Sept. 11 to be a larger federal government
Q: What about the tax cuts? Are you opposed to them?
A: I am always in favor of tax cuts, for any reason, as a way to keep the government smaller. However, they will not give you any fiscal stimulus, any more than increased spending, and that for two reasons. One, which applies equally to spending, is the time lag involved. What typically happens is that by the time the spending becomes effective you're already in the expansion phase, you've passed the recession. And that's especially true now when you're starting moving towards fiscal stimulus nine months into the recession. And the second reason is that if you make tax cuts, that's alright, that means private people spend more, but government either redeems fewer bonds or borrows in order to finance it, and either of those just offsets the private spending. So that in my opinion you can't depend on either spending increases or tax reduction as a reliable way to stimulate an economy in a recession.
Q: How about monetary policy? You felt in April that Alan Greenspan might be "overdoing it," that monetary growth was too high.
A: The monetary policy Greenspan is following I think really has no precedent. Ordinarily, historically, the Fed has not been pre-emptive. It has been post-active. That is to say, it has started to move toward easing after there is clear evidence that the economy is in a decline.
Greenspan acted pre-emptively in January 2001. Before there was any clear evidence that the economy was in a decline he cut sharply the Fed Funds Rate and started increasing the money supply more rapidly. Now, I have a great deal of sympathy with what he did because I have no doubt that what he had in mind and what really frightened him was the similarity with the 1920s in the United States and the 1980s in Japan, which, like the 1990s in the United States, were both periods of very rapid economic expansion thanks to technological development, with a booming, excessively bullish stock market. And what followed was a disaster in the United States and terrible trouble in Japan. And I'm sure that Greenspan said to himself we're facing the same situation and I'm not going to let that happen to us.
Q: At the moment we have both fiscal and monetary policy making every effort to keep Americans spending. But don't they actually need to change their behavior and spend less? Isn't the huge current account deficit a sign of that?
A: What's looming over all of us is the very high rate of both consumer and corporate indebtedness. As you know, consumer credit is at an all-time high and one part of consumer assets, the stock market, has gone way down so the net debt position of the consumer has gotten a lot worse. And the same thing is true of corporates. The corporate balance sheet is similarly out of whack. And at the moment banks seem to be doing very little corporate lending. So you can view what's being done as an attempt to liquefy the economy.
Q: There are numerous signs of excess in the U.S. economy. One is the very low personal savings rate, only 1 percent of gross domestic product last year; another is the all-time record trade and current account deficits; another is very high levels of debt; another, that has perhaps corrected to some extent, a stock market that soared to a level of around 180 percent of GDP which, prior to 1995, had never exceeded GDP, or had done so only on one occasion for one quarter.
All these things, to my mind, are signs of excess is the U.S. economy. Isn't what's needed a shock? Isn't it necessary for corporations to borrow less, for U.S. consumers to spend less and save more, and wouldn't it be better if the United States got on with this process, rather than having the government doing everything possible to stop Americans changing their behavior?
A: What is also true is that what may be the right thing for the individual to do may not be the right thing for the community as a whole to do. It's very desirable for you to save more and to cut down your debt but in the process of doing you'll put somebody else more heavily in debt and put somebody else in a bad position. What's good for you may not be good for the economy. It's part of the general proposition that almost always what's true for the individual is the opposite of what's true for the country as a whole. If you go out to buy strawberries you can buy as many as you want. But the community as a whole has a fixed amount of a strawberries. The quantity is fixed for the country, the price is variable. The same is true in this case. You don't want to get a downward spiral in which people are feeding off one another's attempts to put their balance sheets in order.
But there's no doubt whatsoever that you do need a change in behavior, that you do need a higher level of personal savings. But that higher level of personal savings will do good only if it's matched by a corresponding level of investment.
Q: Isn't there a danger that by cutting taxes further and also increasing government spending that George Bush drives up long-term interest rates, which would delay a recovery? And a danger too that in pumping so much money into the economy, Greenspan sends the dollar falling very precipitously and that this creates an inflationary problem?
A: There is an inflationary danger, absolutely. But it's not clear that the dollar shouldn't decline. I think the dollar is overvalued. And the dollar is going to have to decline as part of the process of working off the foreign deficit. So I'm not sure it's a bad idea for the dollar to devalue. But so far as the long-term interest rate is concerned, there is a world capital market, the United States is a small part of that world capital market, and nobody has ever been able to establish empirically any significant relationship between the U.S. fiscal position and the long-term interest rate.
Q: If you were managing U.S. monetary policy now, would you have cut rates to 2.5 percent or would you have paid more attention to monetary growth and perhaps allowed the slowdown to take place?
A: If I had been managing monetary policy, and thank God I have not, I would not have been using the interest rate as the operating instrument, I would have been using monetary growth as the operating instrument and I would have held monetary growth at a lower level than it's been.
The answer to your question then is yes in the sense that undoubtedly my preference would have been for a less vigorous policy than Alan's. But that doesn't mean I would have been right. I'm not prepared to judge Greenspan's policy a failure. It's one without precedent, one that reflects a very real basis of concern. There is a real concern. We really don't understand why but we do have a problem, making sure that the first decade of the 21st century does not duplicate the 1930s.
Q: Have Greenspan's rate cuts done any good?
A: Who knows? It's too early to tell. Again, I'm inclined to look at what their effect has been on monetary growth and to ask whether 10 percent monetary growth does any good. But there's no doubt that one of the effects of Sept. 11 will be to increase the demand for cash balances.
Q: As you know, my view has been that a great deal of what has happened in the United States in recent years has been driven by inflation in the stock market and in asset prices generally. My feeling has been that the United States needs to get prices and relationships in the economy back into line and that the best way to do that would probably be to keep monetary policy more neutral and certainly avoid eroding a fiscal surplus that was created by this wealth effect.
A: I have no doubt of the need to erode the fiscal surplus, that the Bush tax cut if anything was too small and too postponed. But I agree fundamentally with your general position. But I say to you that you and I need to have a question mark in our minds about the special character of this period just because of the reaction to the collapse of the stock market. Probably the stock market overdid it on the way up; it's very likely overdoing it on the way down.
Q: Well, even now, if you look at the historical relationships, such as price/earnings relationships, the U.S. stock market is still very highly valued.
A: Well, I don't believe that's true. There are various ways of looking at it. Some of them suggest what you say; others do not. It's not clear to me that the stock market is at the moment overvalued. If anything, I think it may be undervalued.
Q: One of the big problems for the United States is that it has been very much the single motor in the world economy. Japan has been struggling to avoid recession for a decade, and Europe is less than dynamic. How do you see Europe and Japan coming along now?
A: Well, I think the Japanese central bank has finally started to do the right thing, not in quantitatively sufficient magnitude, but moving in the right direction, getting away with this obsession with sitting tight on zero interest rates, and buying long-term government securities and increasing high-powered money. It's been doing so a little bit more and more.
I think Japan may well be about ready to break out of where it is; it may well be the motor for the next year or two, if you need a motor. I don't really know that you need a motor. There's no reason why the different economies of the world can't have different cyclical patterns, as they often have in the past.
So far as the European economy as concerned, I know too little about it to have any judgment one way or the other. Britain seems to be doing OK. And the euro is going to get its real test as the local monies disappear.
Q: Yes, I think also that the test for the euro will come over time if different economies are performing quite differently.
A: I agree with that very much.
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