 Okay, it looks like about 10-15, so I'm going to go on the basis of start my lecture and they will come, we'll see, okay? I want to start by saying that I have a lot of good things to say about Milton Friedman, okay? But not today. And the reason is we're dealing with money and macro and not with microeconomics and market theory generally. But I will say this much, I mean if you look at Friedman on issues like rent control or issues like minimum wage, issues like international trade and so on, he's an inspiration. And he's a good debater and kudos to Friedman on all those things. The only thing I can't forgive him about, you might know that Friedman was spearheaded. He spearheaded the move to end the military draft and he succeeded. And what I can't forgive him for is he didn't do it quite quick enough to save me. I spent four years in the military, okay? Now, today is Hayek and Friedman head-to-head, but as you'll see pretty quickly, Keynes is right in the middle of it. He's right in the middle of everything and so can't keep him out here. But in bringing in Keynes, we'll get a better idea about Friedman and his differences with Hayek. Here we go. Start with the level of aggregation, which is something I deal with very quickly on a summary basis. But it's something I want to draw your attention to early on in this lecture. And I start with an overstatement. It's not my overstatement, it comes from Axel Landhoof, who's a Swedish economist but Austrian sympathizer to a large degree. Your aggregation scheme is your theory. When you pick up a macro textbook, it's almost like some throat clearing remarks about, okay, look, we've got income, we've got consumption, we've got investment, we've got government spending. So now we're ready to go. Let's get some theory working here for us, okay? And yet what you want to realize is that by specifying that as your aggregation scheme, those are the four aggregates you're going to pay attention to, that means that you've already decided that there's nothing going on within any one of those aggregates that have any claim on our attention. And of course there's that investment aggregate sitting there that will be graft against this, that and the other thing, but never explored in its interior, okay? And of course the Austrians were saying, no, no, you've got to look at the structure of capital, the structure of investments, all right? So it's a good place to start. Now I'm going to look at the three of them, Keynes, Friedman, and Hayek. I think we can do it fairly quickly. They're rising at a high level of aggregation. Keynes believed that market economies performed perversely. I had that written before as Keynes argued. He didn't really argue, he just believed it. They behaved perversely, especially the market mechanisms that bring saving and investment in line with one another. Seeing unemployment and resource idleness as the norm, that's because he was looking at the wind during the 30s, the Great Depression was on. Keynes called for counter-cyclical fiscal and monetary policies and ultimately for a socialization of investment. That's in quotes, that socialization of investments. That's in his swan song chapter 24 of the general theory. His fiscal and monetary policies were aimed at just propping up capitalism long enough to usher in some more reasonable form of economics, namely socialism. That's Keynes' high level of aggregation. But if we look at Friedman, he's got a higher level of aggregation. Friedman, his monetarism was based on a still higher level of aggregation. The equation of exchange, MV equal PQ. More about that later, how many of y'all already know what MV equal PQ mean? Quite a few will get to it that don't. Q is total output, everything. That's consumption and investment. In other words, his level of aggregation doesn't even allow a distinction between consumption and investment, although he would admit that investment tends to be a little more erratic than consumption. So it puts in eclipse the issues of the allocation of resources between current consumption and investment for the future. And certainly puts into eclipse any kind of ongoings within the investment sector. But seeing no problems with him emerging from the market itself. In other words, he's a market guy. He thinks Adam Smith's invisible hand works quite well. Thank you very much. So Friedman focused on the relationship between government-controlled money supply, that's the M up there, and overall price level, that's the P. So his whole focus was simply on that relationship between the money supply and the price level. Now here's Hayek. Capital-based macro is distinguished by its propitious disaggregations. Look that up in Webster if you don't know what. It just means well-chosen, okay? Which brings into view both the problem of intertemporal resource allocation and the potential for a market solution. Hayek showed that a coordination of saving and investment decisions could be achieved by market-governed movements in the interest rate. He also recognized that this aspect of the market economy is especially vulnerable to the manipulation of interest rates by the central bank. Boy, that's, I mean, he's set the stage now on how to go about analyzing this. You can't handle that with monetarism. You can't handle that with Keynesianism because of your level of aggregation. So again, how methods shape substance. And I'll look at methods, and once again I'm going to start with Keynes, and you'll see why quickly enough. This is from a 1988 book by Alan Melcher, who himself is a monetarist. And look what he says, and think about this. Keynes was a type of theorist who developed his theory after he had developed a sense of relative magnitudes and of the size and frequency of changes in these magnitudes. He looked at what was moving around. Well, income's moving around. Consumption's moving around. Investment really moving around. It's flopping around, okay? I want to consider those. He concentrated on those magnitudes that changed most, assuming that the others remain fixed for the relevant periods. And when I look at things that don't flop around, Keynesian theory is essentially a theory of things that flop around a lot, okay? And I depicted this as what I call a variation sieve, sort of a metaphorical variation sieve. In other words, collect all of the data that you have on all of the magnitudes that you can think of, and then find whatever the sigma is, what's the extent of variation of those, and then you pour them through this sieve and all the things that don't seem to vary much, they fall through the sieve. The things that vary a lot stay in the sieve. So now you've got a sieve full of aggregates that flop around a lot, and those become your building blocks for macroeconomics. Now, you want to think about that. Is that a good strategy for setting out your macroeconomics? All right. That's Keynes. Well, you couldn't expect much more from Keynes. But look what Friedman says. He says, I believe that Keynesian theory is the right kind of theory in its simplicity, its concentration on a few key variables. What does key mean? Flopping around. Key magnitudes and potential fruitfulness. My potential fruitfulness means you can use your econometric skills to analyze these things. Because any of you have taken any econometrics or statistics or whatever, you know that if you have an independent variable that doesn't change, there's no sense in putting it in. It's not going to explain any of the dependent variable. How could it? It doesn't change. It changes just a little bit. It's still going to be swamped by things that change a lot. Okay? So here they're using their econometric techniques as a criteria for trying to figure out what's actually relevant to do. The implication here is that big effects have big causes. See, ultimately you want to find the cause of this, the cause of that, and so on, but they seem to think that there's a relationship between the size of the effect and the size of the cause. In fact, more than that, Friedman is on record in an IEA pamphlet a number of years ago where he says that we're able to assume, we have a right to assume that big causes come from big effects. That sort of boilerplate to the whole enterprise. Well, of course, that's not true. Now, some big causes have big effects. Some big effects have big causes. Mount Vesuvius and Pompeii come to mind. Big cause, big effect. Okay? But a careless smoker starting a forest fire. Little cause, big effect. Okay? And according to the Austrians, what seems to be a mild change in the interest rate can have a cumulative effect that eventually makes a boom unsustainable. So that's part of the methodology of both Keynes and Friedman about big causes and big effects. Elsewhere, Friedman has actually said, this is a quote from a New York Times article, about 68 I think it was, we're all Keynesians now. This is Friedman. We're all Keynesians now. Now he was misinterpreted. He didn't mean to say that we're all in favor of active fiscal policy, discretionary, monetary policy, policies about budget deficits and so on. We're not trying to manipulate those things. We're not all trying to manipulate those things. How are we all Keynesians now? Well, he clarified it in a later piece. He says, no, no, no. What I meant was we all used the Keynesian language and apparatus and we could include aggregation scheme. Okay? Except actually Friedman has won up on Keynes by having a higher level of aggregation. That's what he meant. Well, okay, fine, he meant that. But if he meant that, then he really shouldn't have said all unless he was just forgetting about the Austrians because they don't do that. All right? That's the distinction. They have a much more disaggregated system. Yeah, Time Magazine 1968. There you go. Now, look at what Hayek says. He's not saying big cause, big effect. I mean, big cause, big effect are the things that the local news commentator can pick up. Okay? Anybody can pick that up. It takes some skill to look for other things. The role of the economist Hayek points out this is in pure theory of capital is precisely to identify the features of the market process that are apt to be hidden from the untrained eye. In other words, the untrained eye, even the eye of the entrepreneur, is not likely to monitor fairly mild changes in the interest rate that nonetheless have cumulative effects and eventually over a period of time, the length of the boom that it's generating will reveal its unsustainability and cause a collapse. Exactly what he had in mind. For Hayek, then, the cause and effect relationship between central bank policy during the boom and the subsequent economic downturn have a first-order claim on our attention. Let's figure out why this growing economy all of a sudden went bust. Was it growing too fast? If so, why? Was there something wrong with interest rates? If so, what was the policy that gave rise to that? He's looking at the boom. His whole theory focuses on the boom to figure out why a bust turns out in some circumstances to be inevitable. So it has a first-order claim on our attention despite the more salient movements in macro-magnitudes that characterize the post-crisis spiraling of economy and the deep depression. So you see this subtle thing. You actually don't see it. You have to tease it out of the history of the 1920s. You understand that there was something funny going on with interest rates during the 1920s, more so near the end of the 1920s in the middle, but you sort of tease that out of your historical understanding and you know and you find out why that then gives you a downturn. Now, it's only after the downturn starts that Friedman gets interested because it's only after the downturn starts that you see this flopping around. You see this huge drop in investment expenditure, a huge drop in consumption, a huge drop in income. And the Friedmanites will say, oh, that's what we've got to focus on are we have to make our theory out of these huge drops and see how they correlate and so on and never mind what happened before. Friedman regard the 1920s as the heyday of the Federal Reserve and see anything wrong going on there. Okay. This is something Hayek said during his Nobel lecture. There may well exist better scientific evidence that has empirically demonstrated regularities among magnitudes that flop around a lot. For a false theory which will be accepted because it is more scientific than for a valid theory which is rejected because there's no significant quantity of evidence for it. That last part of the sentence may be an overstatement. I mean there is historical evidence that makes us think that the interest rates are too low during the 30s or during the 20s. Now, I've already suggested, but I'll do this in a more deliberate way, about the difference in focus. Keynes attributed the downturn to psychological factors. So when he talks about the downturn, he's not really talking about economics, he's talking about psychology, he's talking about animal spirits. So that's what he's looking at to justify, to realize, okay, that's why we had a downturn. I suggest that a more typical and often predominant explanation of the crisis is a sudden collapse in the marginal efficiency of capital. The EMEC here is just entrepreneurial expectations of the profitability of continuing to invest. They get cold feet, okay? They lose the fire in the belly, lose their will, and it's contagious. They all pull back and the economy goes south. So that's his idea is why we got the boom in it in the bust going on. Keynes' main focus is on the dynamics of the subsequent downward spiral and on policies aimed at reversing the spiral's direction. So he's looking at the window in 1930s and he sees the economy spiral downward. And he's trying to think up policies and make them spiral back upwards, okay? Independent of just why they started the spiral, but if you really want to know why they started the spiral, psychology, animal spirits, and so on, okay? That's Keynes. Friedman, he's just dismissive about the issue. And I've learned I've picked these expressions out of the literature of monetarism. Dismissive about the whole issue of the cause of the initial downturn, referring to it as, and this is only a partial list, ordinary run-of-the-mill routine garden variety of recession. What does that mean? I mean, shouldn't the economists be able to explain the economics of a recession? Why is there a recession? No, that's just an ordinary garden variety run-of-the-mill recession. That's not what we're interested in. Of course, we're not interested in it because we don't have the data. We don't have a set of data that will allow us to investigate this econometrically, empirically. And so instead, we look at the post-recession dive into deep depression. And he makes that distinction. There's the recession, and then there's the spiraling into deep depression. And it's the spiraling into deep depression that he wants to analyze. So he's really pretty consistent with Keynes here, except he doesn't mention animal spirits. So his focus is on the policy blunders that occurred on the heels of the downturn and on the correlation between the decrease in the money supply and the decrease in GDP. That's the cue, output. Real output is GDP, real GDP. That's the cue when in V will be Q. Now, there are lots of other things going on too that cause the spiraling, but this was a biggie, the contraction of the money supply. And this is not exactly a paraphrase, but it's in the spirit and in the tone that Milton Friedman uses, especially in lecturing, the correlation between movements in the money supply and movements in the total output leaves no doubt about the central issue. In other words, those things go down together. And I've heard one commentator say that Friedman speaks in a tone as if he's talking to a group of students that were made to stay in after class because of not getting things straight. So that's the tone that he uses. Hayek's focus is on policy-affected aspects of the boom and their implications for the boom's unsustainability. Well, our sustainability here doesn't have any. Post-bus reallocation of labor and capital takes time, y'all, but the particular dimensions of it, such as the Great Depression and its length and depth, are to be explained largely in terms of the policy perversities that hamper the recovery. In other words, yeah, yeah, Hayek knows the Depression was deep and it was bad, but it was bad because of all the policies of Hoover and Roosevelt, policies of crop destruction to try to get the prices of the crop up. They destroyed cotton, they destroyed pigs, they destroyed corn, okay? They try to get the price of pigs up. That doesn't give you a recovery. Hoover imposed a tariff, a smooth, holy tariff. That doesn't help. Roosevelt had price fixing. Office of Price Administration, that crop prices up kept prices from adjusting to the fallen money supply, okay? Make work projects on and on and on, cartelizing industry, so they could behave collectively as a big monopoly. All of these things took their toll in the Great Depression. Hayek knew that, okay? But it wasn't part of his business cycle theory, because his business cycle theory was aimed at showing why there was a downturn in the first place, why the growth during the 20s wasn't healthy growth. It was unsustainable growth, all right? Many of people have rejected the Austrian theory on the grounds that the misallocation of capital, well, okay, maybe there was some misallocation of capital, but it just wasn't enough to explain how that depression was so deep and why it was so long. Well, no, it doesn't explain that one, intended to explain that, nobody ever thought it would explain that, okay? But people like Gottfried Hobbler made that argument, Lionel Robbins and so on, both of whom at one time were sort of tuned in to the Austrian theory of the business cycle. Query here, I don't know why it's in orange, we put queries in orange. Can we justifiably say the bigger the boom, the bigger the bust? And you do read that, it's in Rothbard, it's in other places, but if you read Rothbard carefully, when he explains why that is true, the bigger the boom, the bigger the bust, he's talking about a bust to reallocate the misallocation that went on during the boom, okay? He talked about the necessary reallocation, meaning made necessary by the money caused misallocation during the boom, that's what he means when he says the bigger the bust, the more you misallocate, the longer it's going to take to reallocate. Yeah, he didn't mean that somehow the boom in the 20s was so big that it took all of 10 years to fix and a recession that involved 20-odd percent unemployment. He didn't mean that, okay, because those were caused by all that other nonsense going on during the 30s. Okay, so for Friedman, the full analysis of a business cycle consists almost wholly of an empirical accounting of the depression's depth and length, especially the depth in terms of the collapse in the money supply. For Hayek, Austrian theory is fundamentally a theory of the unsustainable boom and the subsequent reallocations of misallocated resources, accounting for the actual depth and length of the depression that ensues, requires an economic and historical account of each particular episode, all right? Now, I'll put this up here just to drive a point home. Case of the cabbage-eating Mississippi monster. I will say. Suppose that in late October of 1929, a thousand-pound monster descended on Mississippi soil, okay? You spent the next three and a half years eating all the cabbages and quite a few rabbits between Tupelo and Pascagoula. By early March of 1933, the monster weighed 4,000 pounds, 30 to 1,000, okay? Two investigators are sent to Mississippi to get a handle on the situation. One's from Vienna and one is from Chicago. You know, I googled on images, I googled Mississippi monster, and that's what I got, you know? I haven't looked into it. So the B&E's investigator asked, where in the world did this hideous thing come from? This is from Vienna. They proceed with the investigation. It turns out on further investigation that the monster was an unattended consequence of some ill-conceived government-sponsored bionics project, okay? Well, but then, case closed, you know, we figured it out. Now, here's the Chicago economist. The Chicagoan shows up, shows the Austrian aside, you know, this is part of the temperament, too. Not necessarily a freedman, but of other monsters. Never mind how the thing got here, the real question is, how did it grow from 1,000 pounds to 4,000 pounds? How did an ordinary run-of-the-mill garden-variety monster quadruple in weight in 40 months, okay? Chicago's answer, of course, is it was all those cabbages. They couldn't get good data on the rabbits. You see that problem, too. What can you do? Correlation between cabbage consumption and weight gain at the Mississippi Monitor leaves no doubt about the central issue. That would be the monitors, okay? Query. Do we suspect that the data availability is what led the Chicagoan to his conclusion and that the lack of hard data pertaining to the monster's origin caused him to be dismissive of questions about where the thing came from, okay? So these and other related suspicions are what underlie the message in Hayek's Nobel address, the pretense of knowledge. That's the title of his Nobel address. I don't think he mentioned Mississippi monsters, buddy. He might as well, and he should have, okay? Okay, now let's look at freedman's monetarism and you're still here. You're not going to see a lot of graphical analysis like I did with the Austrians or like you could do for the Keynesians because the monitors pretty much hang their hat on that one relationship. There was a point, 1970, where freedmen set out to exposit monetarist ideas in terms of the Keynesian framework. And it wasn't just the Keynesian cross that was a step above that, called ISLM analysis, where you take into account interest rates and other things. And he laid it out in two successive articles. I think there are two parts of one article over a couple of journal issues. And so he's showing how you could use the Keynesian apparatus to show what the monitor's conclusions are. That was in 1970. In 1999, though, in the New York Times article, he identified that exercise and his involvement in it, and he was the author, as the worst mistake he'd ever made to try to explain monetarism in terms of Keynesian analytical apparatus. It just didn't work. It just didn't fly. The worst mistake he ever made. But telling me he didn't have any apparatus of his own beyond that, you know, that's all he did have, so it makes you wonder. With a nearly constant velocity of money, velocity of money is just the rate at which you spend the money that exists. M is the money supply. It's all the money in the economy. And that would be cash, and it would be some total of checking account deposits. That would be the smallest magnitude that you might want to work with. And each of those dollars gets spent more than once during a year. I buy something from you, and you buy something from somebody else. So you have to multiply M times V to get the total spending, total buying. How much do people buy? Well, here's the money supply they've got, and here's how many times on average each dollar is spent, so M times V is the amount of buying, the amount of spending. If you look at the other side, P times Q, what does that remind you of? That's the price of something times how much of it you bought. It's capitalized, so it's total Q, all the junk in the economy you could buy, times capital P, which is the average price level of consumer price index, for instance. So you multiply P times Q, and that shows you how much somebody's sold. The people are selling the Q and they're getting a price B for it, so that's how much they sold. So in the final analysis, Mv equal PQ really just says selling equal buying. Well, all right. It does. So it's total logical, and Friedman understands that perfectly, but if you dress it up a little bit, you can milk some ideas out of it. So it goes like this. Let's have output growing slowly. So the price level moves with the money supply. So there's that bar over velocity that means it's not changing. That was then when he was writing this stuff. Now velocity is all over the map. Okay, that's no longer a stable magnitude, but when he was doing his monetarism, it was. Pretty stable. Had a slight change to it. So there's the growth. Yeah, it's positive, but not much. Now, suppose the money supply is a pretty big money supply. Well, look at the equations. Something's got to be happened to P to make those two magnitudes equal because buying is still equal selling. So what happens, of course, is P rises not quite as much as M, but almost and not quite simply because Q rose 2. You had some real growth going on. All right. So he milks that out of it. And then an important part that he milks out of it is the direction of causation. Although it's not a rigorous demonstration, but it's plausible. And it goes from M to P. In other words, it's because the central bank increased the money supply that prices rose. It's not that prices rose so much that the Fed decided, boy, better increase the money supply so people can pay those high prices. Logically, you could think it could be that, but it's not. You had the monetary expansion. Why would they do that? It turns out because they depress interest rates and goose up the economy when they do that. But that's not part of this theory. Now, the next part is critical to my lecture here. I'm watching the clock because I don't want to leave out anything. And that is there's a long lag with a lag of 18 to 30 months. 30 months, two and a half years. So in other words, increase the money supply prices go up. It takes two and a half years for it to go up. This is in the literature of monetarism as a long and variable lag. I mean, 18 to 30 is a pretty wide range there. In my time and money, I referred to that aspect, that lag, as the soft underbelly of monetarism. They haven't really accounted for the length of that lag. And in one of Friedman's last writings on last books, on monetary theories called Monetary Mischief, I think it came out in 93 or something like that, Monetary Mischief, he recognized this as the major unsettled issue of monetarism. It's a major unsettled issue of why in the world it would take that many months for prices eventually to adjust to the money supply. Well, we'll milk that a little bit later and show how that works. What Friedman did milk out of this and kudos to Friedman for this, inflation is always and everywhere a monetary phenomenon. Let's go back to that. That was in a 1968 book called Dollars and Deficits or Deficit in Dollars. Much to me in the other way, Dollars and Deficits. That's probably the most quoted thing out of Friedman. Well, good. We ought to get that message across. And so Friedman's monetary rule is he thinks the money supply should be increased at a slow and steady rate to achieve long-run price-level constancy. In other words, here, if you've got that little bit of growth, okay, we'll just get that little bit of money. And he doesn't mean even match it on a year-to-year basis, because you don't know how much the economy is going to grow this year. But look at it on the long term. If the long-term rate of growth is 2% or 4% or whatever it is, well, increase your money supply year in, year out at 2% to 4%, and that probably won't disturb the economy. You'll have constant prices, nearly so, and sustainable growth. But he's in trouble here in two ways. One, having price-level constancy isn't actually argued for as the proper goal. In fact, the Austrians would say that you really want increases in productivity to lead to reductions in prices. That gains from productivity can be enjoyed by customers, by consumers, in terms of getting things for a lower price. So the Austrians would dispute the price-level constancy as the goal, and even Friedman himself in his later writings realized that there's something wrong with his monetary rule because it clashed with his general idea that bureaucrats don't do what's good for the economy, they do what's good for themselves. So the Federal Reserve Bank doesn't have the incentive to implement that rule. They have other incentives to pump up the economy, to finance projects by the government and so on. So anyhow, you get a constant price-level with that deal. But what happens within the Q aggregate? Now we're going to go Austrian on him. What happens within the Q aggregate as a result of monetary injection? Well, I can do this very quickly because you've seen it before. There's a supply and demand for loanable funds, and even if you want to increase the money supply by just 4% or something like that per year, that money is still going out through credit markets. I mean, the central bank lends money into existence. They add to the supply of savings money that was created for the purpose of keeping the price level constant that doesn't involve any saving at all. And so you get that shift to the right of the money of the savings. So Friedman, though, declares in the 1920s that the golden years of the Federal Reserve ignores interest rates during the 20s because they didn't change much. And I add that is they fell through the Keynesian Sib. They were sort of out of play before you even got started. Friedman, by the way, has sent me on one occasion a chart of movements in the interest rate during the 20s just to demonstrate that they didn't change very much. He sticks to his guns on that. And the Austrians, Hayek particularly, would say, but what if they should have changed but weren't allowed to? And it turns out this is the paradigm case. This is what typically happens in business cycles in the Great Depression, in the dot-com boom and bust. And it goes like this. During the 20s, breakthroughs in technology increased the demand for loanable funds and put upward pressure on interest rates. This was what Mises called the entrepreneurial component of the interest rates. In other words, there's new technology, we can implement it and make a profit. So we need to borrow more money. And more people are trying to borrow money to implement the technology and that was driving interest rates up. Or that would drive interest rates up if the Fed didn't step in and hold them down. All right? So what happens here? The Federal Reserve guided by the real bills doctrine. I won't go into that. But essentially if it says that the interest rate goes up, put it back down. We don't need that. Put it back down. Still miss something here. Okay, so seeing no change in interest rates when they should have risen because of technological advances, Hayek was able to identify some critical forces hidden from the untrained eye. That's what Hayek was talking about when he says that's what you have to look for. There's the query. Which of Freedmen's, which view Freedmen's or Hayek's is more firmly anchored in the empirical historical circumstances of the 20s? I think the Austrians are better anchored. Okay, so does Keynes recognize the significance of the loanable funds market in the context of business cycles? No, we've seen already he threw that whole diagram out. No, he denies that saving depends on interest rate and he all but denies that investment depends on the interest rate. So he jettisons the loanable funds market theory. For him, saving is dependent only on income investment and investment expenditures that are based predominantly on psychological considerations. So here's Freedmen. Does Freedmen recognize the significance? And the answer is no, he assumes this market is working well and so ignores it in dealing with the key issues of the relationships between the money supply and the price level. For him, the focus is on total output Q, which includes output of consumption goods and investment goods. So up there at the top, saving equals minus 8 plus 1 minus 3 times y. You don't see any interest rate there. And i equals i sub 0. I know some of you don't like math, but I need to explain that question. If you put a sub 0 by a term like that, it means don't ask me anything else about that term. It just tis what it is and we don't know about it. Okay, we can get rid of them. Now with Freedmen, he's got mv equal pq. Now, he wouldn't throw away that diagram, but he doesn't have any use for it because if you think about it, Q, that's total output, and so that relationship is something that goes on within that Q. And he's not analyzing what's within that Q. So he doesn't use a loanable funds market. There it goes, okay? It's gone. You don't need it. Freedmen's view of monetary contraction, it's the same as expansion except we're going the other way. Sharp monetary contraction puts downward pressure on p and q. If p is sticky downwards, he didn't generally think they were sticky downwards, but certainly during the Great Depression, they didn't fall, didn't fall very much, didn't fall very fast, but precisely because of New Deal policies and Hoover policies to prop them up. So it's really dangerous to have a money supply collapse and have the government cropping up prices. Evidence shows that between October of 29 and March of 33 decreased in was the essential primary dominant cause of the decrease in Q. So if p is either sticky as Keynes believed or wasn't allowed to fall much as Hoover and Roosevelt ensured, then a decrease in m is going to give you a big decrease in Q, okay? That's the cave into depression. The correlation between movements in the money supply and movements in total output leaves no doubt as to the central issue. Again, that's Keynes' focus. Here's a critical comparison, and I want to go through this pretty quickly but I think you can see. I'm going to compare the dot-com boom and bias, that's the 90s, and I say cushioned by an underlying real growth. I mean, the dot-com revolution, boy, talk about an increase in technology that could be exploited for the good of lots of people. There it was, okay? No question about it. There was something good going on, all right? The other one is the housing boom and bust. And I don't say cushioned by, I say compounded by, mortgage-market distortions. Now, the distortions were good for a few people that were able to buy a house and hold on to it and not get caught underwater later. But by and large overall, it was a disaster from the beginning. So that aspect of the boom that was driven in large part by mortgage-market distortions, holding interest rates down by eliminating the risk, not really eliminating it, but far beginning off through Fannie Mae and Freddie Mac and everybody wants to buy the derivative securities. And the homeowner then doesn't have the risk that otherwise would have been there. And look at the two cases. In the case of dot-com, you start out with an increase in the demand for loans because people want to take advantage of the new technology in the dot-com industry. So that puts upward pressure on interest rates. Well, fine. Let the market adjust. We have a new equilibrium rate. We've got more savings and those savings can be used to bring into fruition the new technology, the dot-com. But the Federal Reserve wouldn't have it that way. The Federal Reserve wanted to drive that interest rate back down. And they did. So in other words, they increase the supply of money, they don't really increase savings, they just add to it some increment of money. And it causes the supply to shift rightward and puts the interest rate back down. But now look what's happening. Now savings is back where it was before. But investment reflects the money provided by the Fed. So you've got investment exceeding saving. And you've got an overinvestment, you've got malinvestment because interest rates are lower than they should be. So you really do have to tease that out of the history because you don't see the interest rate rising. You see it not rising when technological developments suggest that they should. Now look at the big contrast with the boom and bust in the housing episode. That didn't start by new technology. That started with a distortion of the housing market. And that is, we have increased supply of credit that put downward pressure on interest rates. Now you have all these subsidies to housing. And when you do that, that gives you low interest rates. But guess what? If it had stopped there, then that would have meant that funds that generally were available to manufacturers are going the other direction because you're getting more secure loans since the government is picking up the risks. So to keep that from happening, they increased the money supply still more. Like that. And now all of a sudden, you've really got the interest rates in the basement. That's why you saw interest rates so low around 2004 and 2005. And of course, lower still now. And so if you look at this, so you have a double shift in the supply of loanable funds compounded both the downward pressure on interest rates and the excessive borrowing. The artificial boom rode piggyback on the distortion of mortgage markets. So that didn't leave you a cushion to fall back on because you've got monetary distortions added to regulatory distortions. So when that sucker comes undone, the economy really is going to be in bad shape as it is, as it was. In fact, there's a little chart that shows you that period back there where the interest rates were too low for too long, although of course not nearly as low as they are these days. Okay, I'm going to have time for this in just a few minutes. Friedman's plucking model. This is an Austro-monitorist story here because about the time that the review of Austrian economics was coming into existence, Walter Block had a particular strategy to get articles from well-known economists and he would challenge them to write negatively about the Austrian theory. And he challenged Friedman. He said, would you write an article explaining just what it is you think is wrong about the Austrian theory? And Friedman wrote back and wrote back his right. We didn't do email in those days, but he wrote back and he says, well, I've already done that and I don't want to do it again. So Block had to ask him very apologetically, I'm sorry I missed it, where did you do it? So what he cited was an interim report of progress on a project he was doing for the National Bureau of Economic Research published in 1964. It's actually in Friedman's book, Quantity Theory of Money and Other Essays. That's what it was, but then he said, but I actually didn't mention the Austrians, but I thought you people wouldn't know who you are, you know. So it was left at that. Well, of course, Walter got that literature in Reddit and it was something called a plucking model. He called it then at the time. And here's the way it goes. Friedman says, if you look at what's going on during a business cycle, let's start with a country that's growing steadily. He called it an incline plane. I don't know why he used this terminology. Take an incline plane that represents growth and then realize the actual path of the economy is not quite so smooth. But the reason it's not quite so smooth is it dips down occasionally at different extents and different places. And so what you get is something like this. And he labeled these or described these as bust and boom. Although in my rendition, I suggest that what he's calling a boom is actually a recovery. But he called it bust and boom. And so you could think there was maybe something in the early 20s and then a big thing, a great depression, and then a later depression, maybe dot com. That's the way it is. He says those silly Austrians, they're always talking about boom bust cycles as if the bust depends on the strength of the previous boom. He says it's not that way at all. Let's look at the data. We bow before the data. That's the standard monitor's refrain. We bow before the data. And what we see is we don't have boom bust sequences. We have bust boom sequences. Bust boom, bust boom, bust boom. And yeah, sure enough, the boom is just about the same as the previous bust. So it's not that the Austrians are just wrong. They're really kind of cute, but I'm not sure he said cute. But they're just not talking about, they're not explaining anything that needs to be explained because of this bust boom cycle. Well, it turns out just shortly after that there was a birthday party for Friedman. And he was asked to do a paper. Well, he hadn't worked on monetary theory for years. So what he did was write about the plucking model and got his lead article in Economic Inquiry. Well, that was great for me because it came out in 93 and so now it's legitimate target for criticism. So I wrote a comment on his plucking model from an Austrian perspective and submitted it. It initially got rejected, but rejected on the basis that Friedman shouldn't have written that article that he wrote and so we do want to waste more paper with a comment on the article. Eventually the editor overruled and published the paper in Economic Inquiry. So I have a plucking model and of course what I show there is that his boom is really a recovery, one, and two, the actual boom is something that's already hidden in his incline plane because it's at the high level of aggregation. It's C plus I. And so that gets hidden away in the incline plane. Okay, what have we got? Oh, there's Friedman. Now, I want to get through this too. We'll make it Friedman and Knight versus Hayek and Minger because I want to link this to my first chat. How many saw my first article on capital theory? A lot of you see it anyhow. Why was Milton Friedman so unreceptive to the Austrians' capital theory? And my first answer is because of his attitude towards prices and production, I was at a conference in San Francisco, I think it was in 1986, and during a break there was a three-way discussion between me and Leland Yeager and Milton Friedman. Friedman, for some reason or other, was talking about how hard to read Dennis Robertson is. You can't read his book very easily at all. It's really turgid, you know. I don't know why he was talking about that, but he was. And then, all of a sudden, he interrupted himself and he turns to me and pointed at me. And when Friedman points at you, you kind of pay attention. He pointed at me. He says, I'll tell you another book that's impossible to read. He said, Prices and Production. He said, I challenge you to read that book and tell me what's in it. Well, right there, you know, he's not exactly warming up to the theory. So what does he do instead? Here we're going with this lag again. What goes on in the short run? It's night and clerk, all right? Now, let's read through this. We've got time. He starts his story when the Fed has already increased the money supply and it's in the hands of the public. Now, something funny went on in that process, but that's where he starts. So he says, holders of cash will bid up the price of assets. If the extra demand is initially directed at particular class of assets, say government securities or commercial paper or the like, the result will be to pull the prices of such assets out of line with other assets and thus widen the area which the extra cash spills. The increased demand will spread sooner or later affecting equities, houses, durable producer goods, durable consumer goods, and so on, though not necessarily in that order. These effects can be described as operating on interest rates. He puts it in quotes. If a more cosmopolitan, I put, i.e. Austrian, interpretation of interest rates is adopted, then the usual one of them refers to a small range of marketable securities. Now, here's the killer. See, there's the Knight-Clark model. And even to help you read this, so you can read it without your head swimming, I put sources in orange and services in green. Now, see if you can follow this. He said, the key feature of this process, he's thinking he's got a hardwired Frank Knight-Clark in his mind, and he didn't know what Hayek wrote. The key feature of this process in which interest rates are low is that it tends to raise the price of sources, orange, of both producer and consumer services, green relative to the price of the services themselves, it therefore encourages the production of such sources and, at the same time, the direct acquisition of the services rather than the sources. But these reactions in their turn tend to raise the price of services relative to the price of sources, that is to undo the initial effect of the interest rate. Well, if you just convert the Knightian stuff to Hayek stuff, you get a much different story, don't you? You don't get this service and sources stuff. But then he goes on. The final result may be a rise in expenditures all the way around, and that's P going up without any change in the interest rate at all. I mean, the whole boom by cycle is finished. Now, at that point, interest rates and asset prices may simply be a conduct through which the effect of monetary policy change is transmitted to expenditures without being altered at all. How can it be altered? All it's doing is juggling sources and services. What about the actual hardware in the economy? Nothing about that. And I think when he does try to account for the lag, here's what he says. It may be that monetary expansion induces someone within two or three months to contemplate building a factory within four or five to draw plans within six or seven to get construction started. The actual construction may take another six months, and much of the effect on the income stream may come still later. Insofar as initial goods used in construction are withdrawn from inventories and only subsequently lead to increased expenditures by suppliers. So here, that's the Austrian theory. That's the Austrian theory. In other words, get rid of sources and services and put in full-bodied capital structure. And his 18 months is simply this period where the economy is overheating and you've got misallocation of resources, and then the rest of it is the Keynesian spiral. So that's what it amounts to. I've got to show you this. Forgive me. The story here is when I was in Menlo Park, that was a short walk to the Stanford library. Friedman was at the Hoover Institute, and I had heard that he drove a Cadillac and he had NV Equal PQ as his license plate. So I went over there with the camera several different days, sometimes not even finding a Cadillac, let alone the license plate. But I went over there one day and I found two or three Cadillacs, two or three. And I found one, this one, that I took a picture of. However, this one didn't have the NV Equal PQ, but at the time I was discouraged I wasn't going to come back, I was getting ready to leave. So I just took the picture and I thought, well, Photoshop will do the rest. So I put it on here. And then, not too much later, on the blog of Mankiw, he said, this was back in 06, he asked about, does anybody know what my license plate was? Well, it turns out EC-10. Is that what he teaches, I guess? I don't think I would advertise that, but that's what he did. And so, here was the discussion. It's kind of small, I'll read it. You know, I hate to spoil things, but I must say I think Milton Friedman has a better plate. And he quotes this, years ago trying to find Friedman's apartment in San Francisco, I knew I was on the right location when I spotted a car that said NV Equal PT. T was Fisher, Irving Fisher, T for Transaction, NV Equal PT. Friedman didn't use T because he couldn't get data for it. It was like the rabbits. So he used Q. And he represented it as Y. In other words, Y is what you earn to buy Q, so okay, we could use Y. And then the next quote, it says, Friedman's plate is NV Equal PQ. Not NV Equal PT. There's a link. Can we get on the internet here? Yeah. Well, there's France. It's the French side. And if you go down there in the French side and see, can anybody read French? It's too small. La Voix Tour of Automobiles. Okay, you click that. They cribbed my picture off of my website. But Friedman does have a name. Went the wrong way. No, I don't need to get back out of there. Anonymous writes, that's pretty ridiculous. And the next one writes, I love economists. And Friedman does have the license plate. But it's NV Equal PY. Look at his crappy equal sign. It looks like it's electrical tape. Okay, thank you very much.