 Okay, I think we'll declare it four o'clock and begin the lecture, my last lecture, that's entitled Hayek and Freedman, Head to Head. And I want to make a few points before I start looking at slides today. And that is that many Austrians have a love-hate relationship with Milton Freedman. And so I want to start by telling you about the love part, okay, because I'm one of those Austrian economists who have a love-hate relationship with Milton Freedman. And what we can notice about him is he's just an extremely good neoclassical microeconomist, and he can put his skills to good use there and has them for decades before others had. I'll give you several examples. The issue of rent control, which today sounds like, well, everybody knows about that and they know why it's a bad thing. But in the 1940s, they didn't. And Milton Freedman wrote a paper against price ceilings for rental apartments in New York. And he was taken to task for it virtually by the whole profession, so he was sort of standing alone on that issue. But he persevered with it and others. He wrote an article called roofs or ceilings, or ceilings, meaning that you could have a roof over your head or you could be subject to rent ceilings, in which case you wouldn't have an apartment. So roofs or ceilings. And he published it with the Foundation for Economic Education. He also went after early on minimum wage legislation, arguing that that hurt the very people that it was trying to help. Of course, most economists understand that now. Not too many did at the time Freedman was writing. And especially significant, he spearheaded the move to eliminate the military draft. This was in the late 60s and prevailed. And I only have one big complaint about that. And that is he didn't do it in quite enough time to save me from the military, okay? So I served my four years. But I applaud him for having accomplished that. Now that's neoclassical micro. Macro is a different story, especially as it involves the business cycle. And you could guess, and you've heard my other lectures, that that's going to be one of my focuses in this lecture. Let me start here. I'm going to start with just the issue of levels of aggregation. All macro economists aggregate to one extent or another. And it turns out, here's a statement that's a bit of an overstatement, but just barely an overstatement. And that is that your aggregation scheme is your theory. Well, not quite, but almost. And this was, this is something I got from Axel Lehenhoefit. And what he meant was that as soon as you spell out the aggregates with which you're going to build your theory, you are already at that point suggesting that nothing going on within the aggregates has any claim on our attention, while relationships among the aggregates is going to tell us all we need to know. Well, that's almost wrong in all cases, or at least in many cases. And if you choose an aggregation scheme that won't quite get the job done, then you're cooked from the beginning. So pay attention to aggregation, and it's especially true in textbooks. The first chapter or two, it's like a throat clearing paragraph to tell you what the aggregates are. And so you buy that hook, line, and sinker before you go into the next chapter and you never recover because you don't understand why things are turning out so perverse. Well, it's because you chose the wrong level of aggregation. Now I'm going to look at the several, this is about Hayek and Friedman. And yet Keynes always intrudes, as he does in this particular case too. But look what Keynes says, actually this is simply my own summary of what he does, theorizing at a high level of aggregation C plus I plus G. John Maynard Keynes believed that market economies perform perversely, especially the market mechanisms that bring saving and investment into balance with one another. Seeing unemployment and resource idleness as the norm, Keynes called for counter-cyclical physical and monetary policies, and ultimately for a comprehensive socialization of investment. That last phrase in quotation marks is directly from the general theory, from his chapter 24, that's the last chapter in the general theory, and Keynes' supporters argued that Oh, Maynard was just flying his kite, no he didn't really mean that, meant something else. I don't think so, I think he meant a comprehensive socialization of investment. That's Keynes, okay, look at Friedman, Friedman, Milton Friedman's monetarism was based on a still higher level of aggregation, he's going the wrong way, okay. The equation of exchange, that's mv equal pq, money times the velocity of money, that's the frequency with which it turns over, is equal to overall price level times the output of the economy, quantity output. So mv equal pq made use of an all-inclusive output variable q, in other words q is the output of consumption goods and the output of investment goods, so he's just put those things together, called it q, and so you don't worry about how much of it is c and how much of it is i, investment. That puts into eclipse the issue of the allocation of resources between current consumption and investment for the future, let alone the eclipse of stages of production that are differentially sensitive to interest rate changes, and yet he's a microman, he knows microeconomics and he thinks markets work, he knows market work, so seeing no problem emerging from the market itself, Friedman focused on the relationship between the government-controlled money supply and the overall price level, that's really his whole research agenda, to see about movements in prices and the money supply, what causes what and so on and looking at different countries, he sort of rehabilitated the old quantity theory of money, didn't invent the quantity theory of money, it was part of the old classical system, but it had gone out of disfavor, especially with Keynes, and Friedman brought it back, well okay, three chairs, well maybe two chairs for him, for doing that. Okay, now Hayek, I can summarize and you can see that it's what I've been talking about, capital-based macroeconomics is distinguished by his propitious, I like that word, disaggregation, which brings into view both the problem of inter-temporal resource allocation and the potential for a market solution. Hayek shows that a coordination of saving and investment decisions could be achieved by market-government 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. So that sort of shows you the characters here, now contrasting methods, first was Maynard Keynes as exposited by Alan Meltzer, who wrote a book on Keynes, Meltzer is a monetarist himself, but he wrote on Keynes, and that was a good combination there, his writing on Keynes, but listen to what he says, and he's right, I'm convinced of that, Keynes was the 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. So he concentrated on those magnitudes that change most often assuming that others remain fixed for the relevant period. Now when I read that, the thing that came into my mind is what I've called a variation sieve, does that look like a sieve? Yeah, it sort of does, it is a sieve, it's hard to recognize it in a lecture like this, you know, is that a sieve? Yeah. And so, I mean, trying to imagine, you gather up a bunch of variables, and some of them vary a lot and some of them don't vary so much. Well, you just pour them through the sieve, I mean, it's a special sieve, so you pour them through the sieve and all the ones that don't vary just fall through the sieve on the ground, okay, and the ones left in the sieve are the only ones that Keynes wants to look at, that's how he's going to construct his theory, those are the building blocks for his theory. Now that was Keynes' method, and this, here you'll see why I put Keynes in the picture, because Friedman says, I believe that Keynes' theory is the right kind of theory in his simplicity. Its simplicity is concentration on a few key variable magnitudes and his potential fruitfulness, so he endorses Keynes' theory. The implication here is that big effects have big causes, if you have a depression, that's a big effect. Well, there must have been an awful big cause, all right, and Friedman actually says that in his monetary history that big causes have big effects, says that in essence, and yet it's not true. Now it's true in some cases, in some cases, Mount Vesuvius and Pompeii come to mind, you've got big cause and big effect, okay, but a thrown away cigarette, but in a forest fire is a little cause and a big effect, okay, so small causes can have big effects, hard to detect causes can have big effects, and those are the things that may well have fallen through the sieve that's used by both Keynes and Friedman, we'll see. Now Friedman, about the same time that he was talking about the methodology, he wrote in the New York, what in New York Times, what was it, you get down here, Time Magazine, he wrote, we're all Keynesians now, and people jumped on him thinking, oh he's gone to the other side, but he insisted, no, no, he'd been taken out of context, and so he explained the context, and the context says we all use the Keynesian language and apparatus, all right, we use C plus I plus G, we throw in some MV equal PQ, too, but generally we use the Keynesian macroeconomic framework. Well, that all is just too big an all, it doesn't include the Austrians, okay, Hayek is not a Keynesian now, but a Keynesian then, and didn't use the Keynesian language and apparatus, and so by that we sort of compare Keynes and Friedman against Hayek, as far as your methodology goes, and so look what Hayek says in, rather than saying we need a variation SIV, he says the role of economist, he says this 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, all right, and in fact it turns out that what they need to pay attention to is some of those things that fell through the SIV, and particularly the rate of interest. 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, despite the more salient code movements in macroeconomic magnitudes that characterize the post crisis spiraling down of the economy into deep depression, and what you'll find is that any macroeconomist is basically an econometrician, statistician. When they look at the Great Depression, they look at things that they can correlate and get some pretty good correlation parameters on, all right, and those things are found during the period where the economy is crashing into depression. Lots of things are going down, and so you can calculate the extent to which they go down at about the same rate. If you look at the boom, you don't necessarily see anything that you want to correlate, and more about this later. Now, again, we'll go back to Hayek. He says there may well exist better scientific evidence. He put scientific in quotes, as if doing econometrics makes it scientific. That is empirically demonstrated regularities among key macroeconomic magnitudes. For a false theory, which will be accepted because it is more quote scientific, you've got the correlation coefficients, then for a valid explanation, which is rejected because there's no significant quantitative evidence for it. He might have overstated that. There's not much, and there's only weak quantitative evidence for it. So now how methods shape substance. And here I'm trying to deal with the issue of identifying the cause. Think about this, the cause. I put it in quotes because Friedman puts it in quotes. Cain attributes the downturn to psychological factors affecting the investment community rather than to monetary and physical disturbances. And this is, do I say this? I suggest that a more typical and often prominent explanation of the crisis is a sudden collapse in the marginal efficiency of capital. That's directly from Cain. So in other words, that's where he starts. He starts his business cycle theory with the fact that, you know, sometimes people just get cold feet and it tends to be contagious and they do it all at once and they just cut back and the economy starts down. Okay, now we can start our business cycle theory and find out what goes on after that and how to fix it. Okay. So Cain's main focus then is the dynamics of the subsequent downturn, downward spiral, and on the policies aimed at reversing the spiral's direction. So he said, okay, we've got everything going down now. We want to do something to get it turned around going back up. And of course, what's that, gushing up the economy, putting in more money, lots of fiscal policy, lots of government projects and so on. Try to pump up the economy. Just on the basis of this collapse in the investment in the first place. It just collapses. There's one passage I read years ago and I can't find it again. So I'll ask you if you find it, send me an email and tell me where it is. But Cain's had gone into a seafood restaurant, was waiting in the lobby and there was an aquarium there with fish swimming from one end towards the other in the aquarium. So it wasn't invented by Red Lobster, they did that back then too, you know, the aquarium for everybody. And Cain's noticed that when the fish got no more than halfway or so towards the other end of the tank, they all of a sudden and all at once turned around and started going the other way. He noticed that. And he remarked to his dining companions, that's just like investors. They all turn around at the same time, they all get pessimistic at the same time. Okay. And nobody knows why these fish just all of a sudden turn around and go the other way. You're not even to the other side. A student in my class when I talked about that here at Auburn, she raised her hand and said, Dr. Garrison, they see their image in the reflection of the other side. Well, she knew more about fish than I did. I mean, what can I say? So Friedman, I get this, Friedman is dismissive of the whole issue of the cause of the initial downturn. I put, should have put cause in quotation marks here in 1929, referring to it as now he doesn't do this all at once. I just, I can just find it throughout his works, calls it an ordinary run of the mill routine garden variety recession. We started, that's what we started with. And what do those words mean? What do those things mean? That means that downturn, that's, that's just part of the market. It has no particular claim on our attention. You know, and it's only when things really get bad that we've got something to deal with. We've got something to explain. Actually, we've got something to correlate. I mean, that's what it's about. 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 real GDP. And he has those correlations in all of his texts. That's, that's what it's all about. So for freedom and the correlation between movements and money supply and movements in the total output leaves no doubt about the central issue. That's what, that's what business cycle theory is all about. That's the central issue. Now here's Hayek. Friedrich Hayek focuses on the policy infected aspects of the boom and their implication for the boom sustainability. The post bus reallocation of labor in capital takes time. But the particular dimensions of the Great Depression, its length and depth are to be explained largely in terms of the policy perversities that hampered the recovery. And especially in the Great Depression, I mean, when the Great Depression started, you had first Herbert Hoover, who paid lip service to the market system, but did lots of things that hurt the market. And Roosevelt just did that in spades. I mean, he came in, he had all sorts of wage controls, price fixing, retain profits, tax, and all sorts of regulations that themselves, independent of an initial downturn, would put the economy into depression and keep it there for a long time. So how methods shape, shape substance as a summary. For Friedman, the full analysis of a business cycle consists almost wholly of an empirical accounting of the depression's depth and length. For Hayek, the ABCT, Austrian business cycle theory is fundamentally a theory of the unsustainable boom and the subsequent reallocations of misallocated resources. According to the actual depth and length of the depression that ensues requires an economic and historical account of each particular period. In other words, what did Roosevelt do, thinking he was going to help get the economy back? Of course, he was doing all sorts of perverse things. And that's what has to be understood. Now, here's something I came on to not too long ago. A paper by Ike and Green, that'd be Barry Ike and Green and Metschner. I can't think of Metschner's name. There it is, Chris Metschner, 2003. And look at the title. I don't know if you can read the title in that small print. The Great Depression as a Credit Boom Gone Wrong. That sounds like a Hayekian paper, doesn't it? And it was a very Austrian paper. It was done under the direction of the BIS, that's Bureau of International Settlements. Working paper number 137, you can find it on the web, make for international settlements. Now, Friedman was asked to rate that paper. What do you think about that paper? And look what he says. He says, Ike and Green's paper is excellent, clear, well-written, thoughtful. There's little in it that I disagree with. At the same time, I share the views expressed by my discussions or by his discussions, Michael Bordeaux and Charles Goodheart, that it does not contribute much to the key issue of the question. He says, the issue is whether the depth and the seriousness of the depression is attributable to what took place in the 1920s or to what took place during the 30s. He goes on, does it go on? Yeah. The only item that has any bearing on that is the correlation of his measures of the Credit Boom with the depth of the subsequent depression. Here he gets a positive correlation of 0.43. Now, shame on Ike and Green to even present that number. You don't want to present that number, say, hey, correlation is 0.43. That was it, you know, that was the cause. No, that's a pitiful number there. It's positive correlation, 0.43 for the height that measures the stock market. Okay, that's pretty low, Mr. Friedman said. The bulk of his evidence is that what happened in the 30s explained the 30s, not what happened in the 20s. That's actually private correspondence to Mark Scousen in 2004. But you get it. I mean, that's what he's saying. It doesn't matter. You got to get the correlations and they find the correlations in the 30s, not in the 20s. I think my point is made, but I've used this before, so I'm going to use it again just to give you something to remember so you'll know it's been okay. The case of the cabbage eating Mississippi monster, you probably haven't heard about this, have you? Austrian and Chicago methodology in action. All right. Now, how's this work? Suppose that in late October of 1929, a thousand-pound monster descended on Mississippi soil. It 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. Two investigators are sent to Mississippi to get a handle on the situation. One is from Vienna, the other is from Chicago. Okay. That's it. That's the Mississippi monster. Can you see him down there? I just Googled Mississippi monster and that's what I got, so I'll take it. The V&E's investigator asked, where in the world did this hideous thing come from? It turns out on further investigation that the monster was the unintended consequences of some ill-conceived government sponsored by Onyx project. Case closed. Went back home. Okay. The Chicago one shows up, shoves the Austrian aside, okay, and says, never mind how this thing got here. The key question is how did it grow from a thousand pounds to 4,000 pounds? How did it, an ordinary run of the mill garden variety monster quadruple its weight in 40 months? The Chicagoans answer, of course, was that it was all those cabbages. He couldn't get good data on the rabbits. The correlation between cabbage consumption and weight gain of the Mississippi monster leaves no doubt as to the central issue. Okay. So they're doing the same thing with business cycles. Query, do we expect that data availability is what led the Chicago to his conclusion and that lack of hard data pertaining to the monster's origin caused him to be dismissive of questions about where the thing came from. These and related suspicions are what underlie the message in high- tax, Nobel, Nobel address, the pretense of knowledge. Okay. How are we doing on time? Okay. Now look at Friedman's monetarism with the equation of exchange and there it is, mv equal pq, m is money supply, v, frequency of turnover of money, of velocity of money is called p, the overall price level in q is the output of the economy. With a nearly constant velocity of money, and that's in normal times, you can get out of shape in unnormal times, you have output q growing slowly, couple three percent, movements in the price level largely reflects movements in the money supply. So I put a a bar over v means not changing to any significant degree. Real q real output is growing slowly. Okay. And under those circumstances, any increase in the money supply shows up as an increase in the price level. And Friedman argues that the cause and effect goes from m to p. I think it does, but but he's here's where he's using the word cause. And actually he uses it uses cause freely in popular writings, and he even says this, but in in academic writings, he uses some different word. Not sure what it is. And with a long and variable lag, it says with the long or with a lag here of 18 to 30 months, that is variable 18 to 30 months. And and that issue, why does it take 18 to 30 months? That's what year and a half to two and a half years. Why would it take that long for an increase in money supply to show up as an increase in prices? And Friedman says, well, that's that's one of the unresolved issue of monetarism. And quite get the answer to that one. Inflation is always never where a monetary phenomenon. That was his claim. And here what I've done if how many of you have heard my first lecture on capital theory, most of you. And I'm not going to read this because it makes your head swim. You couldn't. But I'd have shown my nighting in capital theory diagram. And you can see that Friedman talks about how this business cycle goes on by by using or this monetary injection goes on by using sources and services instead of some capital structure and a consumable output. And even even comes to a conclusion. The final result may be a rise in expenditures in all directions without any change in the interest rate at all. The interest rate in asset prices may simply be the conduit through which the effect of the money of the monetary change is transmitted to expenditures without being altered at all. In other words, he's got a model there that has no time to mention in it. And so he figures out what the interest rate does. It goes this way and then that way and then back the other way. And when it settles down, it's right where it started. So there's no effect. Okay. Well, the reason is no effect because there's no time for an effect. But if you have a capital structure, structure, production and so on, there is time for an effect. And during that time, we have, guess what, a depression. Friedman missed that. Friedman's monetary rule here, that's increase the money supply at a slow and steady rate to achieve a long run price level constancy. In other words, if Q is going up, we'll make money go up at the same rate, say, enough to keep prices from rising enough to accommodate that increase in Q and keep P from rising, let M rise instead. All right. And now lately won't blame this on Friedman, but the last couple of three Federal Reserve Chairman have adopted the notion that we need about a 2% inflation. And that's not 2% increase the money supply. That's enough money to actually cause price level to go up by 2%. So you not only increase the money supply by what's already shown, but you increase it a little more so that the price level actually goes up. But what happens within the quantity aggregate as a result of the monetary injection? And of course, we see that by using our capital-based macroeconomics, that the money is lent into existence and that depresses interest rates. All right. And so the interest rate goes down and it no longer signals what it's supposed to signal and that can give rise to a cyclical upturn and then a bust and a downturn. One thing that Bernanke said, this was just before he turned or became Chairman of the Fed. He was asked the question, this is an interview with the Minneapolis Fed. He was asked the question, why would you want this 2% inflation going on? Oh, we want the 2% inflation going on. So that if the economy starts to falter into depression, we'll have the maneuvering power to fix it. You never consider that the 2% inflation may actually lead to a downturn. Well, he hasn't read IAC. That's all I can say. So Friedman declares the 1920s the golden age years of the Federal Reserve. That's one of his chapter titles in his monetary history. It's the golden years of the Federal Reserve. He ignores interest rates during the 1920s because they didn't change much. There was one instance when Friedman and I were having a back-and-forth based on an article he wrote in a comment that I published about his article. And he sent me a graph that showed interest rates during the 1920s. He said, see, they didn't much change during the 1920s. There's nothing much you can say about that. But what if they should have changed but weren't allowed to? Monetary increasing the money supply to keep it from it. During the 1920s breakthroughs in technology increased the demand for loanable funds and put upward pressure on interest rates. But the Federal Reserve guided by the real bills doctrine, that means if there's more real stuff to buy out there, we'll put out more money to buy it, met each increase in the demand for credit with an increase in supply thus keeping the interest rate from rising. So during the 1920s, that's the time where you had lots of productivity. And so it turns out that if you pump in money to keep the interest rate from rising, that simply adds unsustainable element to that boom. So I like to say it rides piggyback on the technological breakthroughs. Seeing no change in the interest rate, Friedman dismisses interest rates as a potential independent variable in his econometric equations. In other words, it went through the sieve. So the equity. Seeing no change in the interest rate when they should have risen because of the technological breakthrough, Hayek was able to identify some critical market forces hidden from the untrained eye. So that's what Hayek had in mind. Those are the critical market forces hidden from the untrained eye. You can't imagine some non-economist or even some entrepreneur or some capitalist who supposedly has, quote, rational expectations. You know all about that theory. Can you imagine him saying, oh, look, look, look, the interest rate hasn't changed. I think it should have changed. Fed from changing. No, that's not going to happen. Query, which view Friedman's or Hayek's is more firmly anchored in the empirical, that is, historical circumstances in the 1920s? Well, I think the Austrian view is anchored. Empirical doesn't mean crunching numbers. It doesn't mean gathering data. It means understanding the real world and what's going on. Oh, there's Friedman in his Cadillac. MV will PY. And there's a story about, well, there's two stories about that. One, I can tell it just with this picture. That should be either MV equals PQ. Because really P times Q is equal to Y. And if you write PY, you've got P squared Y versus P squared Q. So that's wrong. But he knew it was wrong. He knew it was wrong. But in monetarism, for some reason or other, they use capital letters for nominal terms, nominal income is capital Y. And they use lowercase for real income. Little Y. How many knew that? Oh, okay, so I'm not telling you any. And so he needed P, little case Y. Now, I can just see Friedman at the DMV, arguing that no, I need a lowercase Y. And the amazing thing about it, if you knew Friedman or could know Friedman like I knew the guy, didn't know him that well, but I knew him well enough. Okay. I'm surprised he didn't prevail. Okay, I'm going to skip this over because we're getting close. And I want to show you one other thing. Maybe I don't. Yeah. You recognize him, Greg Main Q? What was his, I probably say up there, Chairman of the Council of Economic Advisers. And on one of the quiz shows Sunday morning, he asked a burning question, how can you identify my car? And there it is, EC 10. That's not so, that's not such a great thing. But there it is. So I know I hate to spoil things. But I must say, I think Milton Friedman has a better plate. Okay. Years ago, blah, blah, and he says his, his plate read mb equal pt. Now, t means transactions. That's the whole nightian view. So that wasn't right either. And here it says Milton Friedman's license plate was pv, mb equal pq, not mb equal pt. And they claimed to have a plate, have it on the web. Well, of course, we've seen the license plate. It was p y. All right. Now, it turns out that when I was in California at the close to Stanford University, and Friedman was at the Hoover Tower, he parked his car in the lot there. I walked over there. I can actually walk from where I was to, to that place to take a picture of Friedman's license plate. And I looked and looked and looked and I didn't find it. I came back in every other day. And I still didn't find it. But that, that link that was given, what I did find was a Cadillac. I knew he drove a Cadillac, but it was read with a white top. I thought, would Friedman buy a Cadillac red with a white top? And it didn't have that license plate. I was desperate. I took a picture of it anyhow. And then when I got back to school or back to the Institute, remain studies, I fiddled with the license plate some. So this person says this was in French. Hey, there's France there. This is on the web. And there it is, in VEGLE PQ. In other words, they've stolen my picture of the Cadillac and did it that way. Okay. Well, good enough. We're at an ending point now. Thank you.