 Okay, I'm not used to lecturing about non-Austrians, but Freeman's a special case. You've got to pay attention to him, you've got to know something about him, and I think I know enough to give a lecture. In fact, I'll start by telling you a story you may have heard that the beginning of the resurgence of Austrian economics happened in June of 1974. And that was an Austrian conference at South Royalton, Vermont, an extremely small town with a boarding house. And that's where we met. The lectures were Rothbard and Lockman and Kersner. We had three other Austrians there, including Henry Haslund, Bill Peterson, that was the other one. I can't think of the third one, I'll tell you if I think of you. And one more dinner guest for the opening dinner, and that was Milton Friedman. And what had happened is that we were not that far from Dartmouth College, and our host that was running the seminar was from Dartmouth, and he had a colleague to come and stay for the dinner. And turns out the colleague was a very good friend of Milton Friedman, and so Friedman who had a summer home in Vermont, and if you're in Vermont, you're pretty much close to everything else that's in Vermont. And so Friedman was invited to the dinner, and I think he came partly to meet his old friend that was also invited, but he came and we had dinner. We had about 50 people there, that was my count, and most of them had never met one another, so we were meeting each other for the first time. And at the dinner, the economists, the old people at that point stood up and said something and just to break the ice and so on. Well, when Friedman stood up, he said, there is no Austrian economics, just good economics and bad economics, okay? And so that has become legion in Austrian circles. Everybody knows that Friedman said that. And it turns out that just recently Oxford University Press has created a book, about 800-page book, on Friedman. It's called Friedman, where they go, Friedman, Contributions to Economics and Public Policy. It looks like that, you know, and it's pretty thick, $185 in case any of you want one. But in the last section, which is on Friedman and other economists, including, it turns out the Austrians, I have an article I was invited to write on Friedman and the Austrians. And so in doing that, I sort of got up to speed on Friedman, although I sort of kept up with him all along. Now let's see where we go from here. In this show that I've got on the screen, how methods shape substance and the contrast is between the Austrian methods and the Chicago school methods and more narrowly just Friedman's methods. Because typically Friedman and Chicago are synonyms, you know, mean about the same thing. Okay. It's all about the level of aggregation. I picked a little sentence, short sentence, out of Axel Lehnhoff's stuff. And he says, your aggregation scheme is your theory. And that sort of jars you a little bit. And I write here a paraphrase from Axel Lehnhoff. Well, I think it's actually exactly what he said, but I couldn't find it, you know. So I said, I'll claim my paraphrase in case I got it slightly wrong with. That's the essence of it. The aggregation scheme is your theory. And what that means is that once you decide which aggregates you're going to look at and how they fit together, then all you're looking for is a relationship between the aggregates. And you're taking it for granted that whatever is going on within the aggregates is not going to be a part of your theory. They're all concealed in the aggregate, all right? And, of course, that's one of the huge differences between the Chicago school and the Austrian school. The Austrians want to look inside the aggregate and see about stages of production, things like that, OK? So I go along with Axel Lehnhoff and with that statement. And now you saw that the first screen said that we're talking about Friedman and Hayek. Well, that's right. Second screen, I've got Keynes in there. Well, you can't keep him out. You know, if you're going to compare two economists, you end up comparing each one with Keynes. That's the way it works. And I'm looking at the aggregation implicit in the summary of the schools. So let's look at Keynes. He says, theorizing at a high level of aggregation, and boy, that's true. Keynes believed that market economies performed perversely, especially the market mechanisms that bring saving and investment into balance with one another. Seeing unemployment and resource idleness as the norm, he's looking out his window in Cambridge. Keynes called for counter cyclical, physical and monetary policies, and ultimately, for a comprehensive socialization of investment. That's in quotes, that's in the swan song chapter at the end of the general theory. Some of my economist friends write papers on explaining just what he meant by comprehensive socialization of investment. I think I'd be a short article, wouldn't you? He said he meant it. Okay, that's... Now we go to Friedman. And here's something to think about. Milton Friedman's monetarism was based on a still higher level of aggregation. The equation of exchange, mv equal pq. You know what that means. If you don't, well, m is just the money stock. How much money is there anyway in US dollars, I suppose? V, as they call it, velocity of money. That's the wrong Newtonian metaphor. Velocity implies not just speed, but also a direction. So, you know, which is going north or south, you know? But anyhow, economists call it velocity. Equals the price level, okay, p, times output, which is q. And I'm not sure why q is output. But I think, oh, it might look like a zero. They put a little tag on it. It's q. So, that's total consumable output. It's final output, all right? And if you look at that, if you stare at that very long, you know that it really is just a truism, that mv is the amount of money people spend, okay? And q is the same thing as what they spend on the output, okay? So, it's pretty much an identity. So, he made use of the all-inclusive output variable q, putting into a clip the issue of allocation of resources between current consumption and investment for the future. And we'd have to go with Keynes on that. At least he makes this distinction between consumption and investment. So, seeing no problems emerging from the market of self-freedom and focused on the relationship between the government-controlled money supply and the overall price level, all right? So, that was his focus. Well, we'll go on to Hayek. Capital-based macroeconomics, that's what I call it, although it's caught on. And other Austrian-oriented economists call it capital-based macroe, too, is distinguished by its propitious, I like that word, propitious disaggregations, or got it right, which brings into view both the problem of intertemporal resource allocation and the potential for a market solution, okay? So, FA Hayek showed that coordination of saving and investment decisions could be achieved by market-governed movements in interest rates. He also recognized that this aspect of the market economy is especially vulnerable to the manipulation of interest rates by the central bank. And, of course, when the central bank manipulates interest rates, that's when you start to get booms and busts, okay? So, he's got, I think, the right level of aggregation. Okay, so we got that straight. He's much better than Keynes. Much better, what I say. The Austrians are much better than Friedman or Keynes in that sense, okay? Now, here's the way Keynes goes at it. Keynes was the type of theorist who developed his theory after he had developed a sense of the relative magnitudes and the size and frequency of changes in these magnitudes. He concentrated on those magnitudes that changed the most, often assuming that others remained fixed for the relevant period, right? Now, this, when I read this, it caused me to suggest a new economics tool for the economist tool chest. And that tool is called a variation sieve, all right? So the ideas are what Keynes is doing is before he even tries to figure out what's going on in the world, he looks at all the different possible variables and you pour them through the sieve and the ones that hang up in the sieve. Those are your building blocks for your theory. And it's going to be consumption and investment, income, the biggies. They vary a lot, especially in a business cycle. And other things that just seem not to very much fall through the sieve. Well, one of the first things that falls through the sieve is the interest rate, okay? Especially in a business cycle situation, because what typically happens, and it did happen in the 20s, where it crashed in 29, is that there really was something of a real boom in the economy. All sorts of technological innovations in automobiles, in plastics, in nylons, in on and on refrigerators, and so on. There was a boom afoot, all right? And in order to take advantage of the technology, lots of investors wanted to borrow lots of money and make all these things happen, okay? Well, that puts upward pressure on the interest rate, doesn't it? But the central bank had a policy of holding the line on interest rates. So they didn't let the interest rates rise. And so the interest rate didn't change much, but it didn't change much at a point when it should have changed. And that's what gave us a strong boom that wasn't geared to the actual investments. Okay, let's go on. Now, look what Milton Friedman says. I believe that Keynes' theory is the right kind of theory in its simplicity, its concentration on a few variables, magnitudes, and its potential fruitfulness. Now, he said that for a different reason than Keynes did. I'm not sure why Keynes decided that's the way to go. But can any of you guess why Friedman said that's the right kind of theory? Because Friedman is econometrician. His early degree was in statistics. And if you have an interest rate that's not changing, and you stick it into your equation to see how it doesn't have an effect. So anything that goes through the sieve is simply not going to help you out. And so you look at all the things that hang up in the sieve, and that becomes your theory. And you'll make a story out of it somehow. And yet, if you stand back and look at all of the variables, including the ones that fell through the sieve, what you see is that what got in the sieve is typically the consequences. It's not the cause of anything. It's the consequences of the things that went on before the sieve. The implication is that big effects have big causes. Well, I mean, that's true in some cases. Pompeii, I guess, in the volcano. Pretty big cause. But it doesn't have to be a big cause. And in this case it's not. And yet Friedman signed on with Keynes. We're all Keynesians now. And what he says is we all use the Keynesian language and apparatus. Well, that all is too inclusive, isn't it? He wasn't thinking about the Austrians. That was in Time Magazine in 68. Now, so you can see here, both Keynes and Hayag, just looking for whatever's changing the most, and then trying to correlate them and see what kind of a story he can make out of those without bothering about the interest rate. Look what Hayag says. He says the role of the economist, Hayag points out, in the Pure Theory of Capital in 1941, is precisely to identify the features of the market process that are apt to be hidden from the untrained eye. And boy in the 1920s when interest rates didn't rise in circumstances where a good economist like Hayag would know they should have. Unless somebody's got their thumb on the spigot. For Hayag, then, cause and effect relationships between central bank policy during the boom and the subsequent economic downturn have a first-order claim on our attention despite the more salient co-movements and macroeconomic magnitudes that characterize the post-crisis and the spiraling of the economy into deep depression. And here, let me give you the terminology here when he says post-crisis. What does that mean? Is that after the depression? No, it means after the initial downturn. In other words, the first thing you notice and the first thing that has to be explained is how was it that the economy was going up and then it tipped over and started the other way. It's a crisis. That's a crisis. Now, what happened after that was a catastrophe, the Great Depression. And so the Hayagian theory or the Austrian theory is aimed at explaining the crisis, explaining the downturn. They're not trying to explain everything that happened after the downturn. We'll see what some of those things are if you didn't already know and maybe most of you do. And so here's Hayag again. He says there may well exist better scientific evidence that is empirically demonstrated regularities among key macroeconomic magnitudes and what do you think makes them key? They flop around, flop. For a false theory, which can be accepted because it's more scientific and puts that in scare quotes, not really more scientific, it's more econometric, than for a valid explanation which is rejected because there's no significant quantitative evidence for it. Now that might be too strong to say no significant quantitative evidence for it, but there certainly is a problem in figuring out what the rate of interest would have been. And our question and answer sessions throughout this week, there's been a number of people who ask how do we know the interest rate is below the natural rate? What is the natural rate? And boy, you have no way of determining that because the central bank has taken that away from you. They've done something that you know that they're not in the right spot but you don't know where the right spot really is. And yet, in debate, and Friedman's a great debater, he can put that on him and stay with his aggregates. So that's how methods shape substance, isn't it? If you're dying the wool of econometricians and that's the way you go at it, then you're going to miss what actually caused. This is identifying the cause. Here's Keynes again, but I think it's just funny. Keynes attributes the downturn to psychological factors affecting the investment community rather than to monetary or fiscal or interest rates or anything else. Psychological factors. Well, it's not an economic explanation. And then he says, listen to this, I suggested a more typical and often prominent explanation of the crisis is a sudden collapse in the marginal efficiency of capital. That's just the rate of return on real capital. That's not an explanation, is it? How do you explain this? Oh, sudden collapse. And if you hang in there and say, well, what caused the collapse? You know what the answer is, don't you? Animal spirits. In the story. Keynes-Main's focus, however, is on the dynamics of the subsequent downward spiral and on the policies aimed at reversing the spiral's direction. Okay, something happened. Animal spirits have collapsed and now here goes the economy that way. Well, we'll focus on that one, you know, and try to figure out how to stop it and turn it around. And of course, it's fiscal policy, monetary policy. It's pumping in more money, not realizing that, well, wait a minute, it was pumping in the money that caused the problem in the first place. And here's Friedman. Friedman, I've combed this out of the literature. Friedman is dismissive of the whole issue because of the initial economic downturn. And I've picked the words he used out of a number of articles. He refers to it, excuse me, he refers to it as unusual, ordinary, routine, normal, run-of-the-mill and garden-variety recession. So when he said, even in the Great Depression, he says, okay, so it started out with a garden-variety recession. What does that mean? It's a garden-variety recession. And then in parenthesis, although it was a pretty big one, even the crisis was a big one, and then it starts down. And so what you have to realize, and I don't know many economists who have realized, they've got it stuck in their heads, is that the monitors and the Austrians are talking about two different phases. The Austrians are talking about why it turned down. And the monitors are thinking about why it went so low after that. And the reason they are, I think, is because they can use econometrics to do it. They don't have the econometrics to say why it turned down. For Friedman, in between the subsequent movements and the money supply and the movements and total output leaves no doubt as to the central issue. That's, I mean, that just sounds like, you've heard Friedman or Red Friedman, that's the kind of thing he says has no doubt as to the central issue. Hayek focuses on the policy-infected aspects of the boom. That is, the artificially low interest rate, even though it didn't change, it's still artificially low because it should have changed and the implications for the boom sustainability. The post-bust reallocation of labor and capital labor and capital takes time, but the actual dimensions of the recession, its length and depth are to be explained largely in terms of the perverse policies that happen for the recovery. That's not my wording, but that's what Hayek is talking about. And if you think about all of the things that are perverse wording that's starting with Hoover and then Roosevelt, and here we have good history complimenting our good economics. When Rothbard talks about the depression, he blames as much of it on Hoover as he does on Roosevelt. And so what was going on there? Hoover had a high wage policy. Hoover was involved in the passage of the smooth hauling tariff. And for Roosevelt, you have the cartelization of industry. You had crop destruction programs. Now, we don't do that anymore. We don't destroy crops. Okay? Even Obama wouldn't destroy crops. And why is that? Because he could crush cars instead. You know, you know. It's the same effect. It's an increase in technology. I don't know. Blue Eagle price fixing. Prices were high. And an undistributed profit tax which is just deadly. Think about what that means. If you earn profits you can't use those profits to build your business unless you first pay a big tax. Okay? And that was debilitating for a lot of people. Okay. Let's go on. High value and how methods shape substance of summary. For freedom of the full analysis of the business cycle consists almost wholly of the empirical accounting of the depression's depth and length. For Hayek, the business cycle theory is fundamentally a theory of the unsustainable boom and the subsequent reallocation of resources. Accounting for the actual depth and length of the depression that ensues requires an economic and historical account of each particular episode. So there's nothing that's all that similar from one to the other. Somebody crushes cars and somebody else plows under potatoes and so on. Now, here's an article by Evans what's his name? Icon Green, that's said in Mitchner. You can't read that. I can't read it on this little screen. So Icon Green's paper is excellent so says Friedman. It's excellent, clear, well written, thoughtful. There's little in it that I disagree with. At the same time I share the views expressed by the discussants, which is Michael Bordo and Charles Goodheart, both of whom are monetarists, that it does not contribute much to the key issue in the question. The issue is whether the depth and seriousness of the depression is attributable to what took place during the 1920s or what took place during the 30s. Well, of course, the depth and seriousness of the depression has to do with what went on during the 30s. But during the 20s, we got that initial crisis that set it into motion. And yet, this is one of the things that Friedman throws up to the Austrians at every opportunity. Now, here's, he goes on and I underline his only the only item that has any bearing on that is the correlation of the measures of credit boom with the depth of the subsequent depression. Here, he gets a positive correlation of 0.43 for the height of that measure, the stock market boom. Okay, that is pretty low. The bulk of the evidence is that what happened in the 30s explains the 30s, not what happened in the 20s. Well, see, he has just blanked out that initial crisis, his only focus was on the rest of it. And I could just say, obviously, he didn't blank out the whole depression, but he realized it was due to a lot of things going on. So I think that's very telling. Okay, I got the wrong PowerPoint here. No, it's right. Because I'm trying to drive the point home, but now just standing here, I think, well, wait, I've already driven it home, but let's do it anyhow. Suppose that in late October of 1929 a thousand-pound monster descends on Mississippi soil. Okay? You spend 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. Jesus. Two investigators are sent to Mississippi to get a handle on a situation. One's from Vienna. The other's from Chicago. That's that, you know, I googled Mississippi Monster and that's who I got, or what I got. I don't know. The Viennese investigator asked, where in the world did this hideous thing come from? It turns out on further investigation that the monster, this is the Viennese, yeah, the monster was the unintended consequence of some ill-conceived government sponsored bionics project. End of story. That's it. That's what it was. All right. Chicago in shows up, shoves the Austrians aside and says, never mind how this thing got here, the key question is how did it grow from 1,000 pounds to 4,000 pounds? How did the ordinary unusual routine normal run-of-the-mill garden-grinding monster Quadruple's answer, of course it was all of those cabbages. He couldn't get good data on the rabbits. This is Chicago economics. The strong correlation between cabbage consumption and the way gain of the monster leaves no doubt as to the central issue. That's the story. So query, well, I don't have to query, we'll go past that one. Now, more about freelance laundry, I'm going to pick up a little bit. MV equal PQ, with a nearly constant velocity of money, it droops down a little bit, but not very much. Output growing slowly well, maybe 3%, movements in the price level P largely reflects movements in the money supply M. So there's, we call it a constant V, even though it goes down a little bit. And a little bit of upward movement in Q, but a pretty substantial movement in M, especially in pre-crisis mode. And so that gives a big boost to P. It's not quite as big as M, but part of it is Q going up. And then here's the final line, that the cause and effect is between money and prices. Well, I think that's true. And then though, with a lag of 18 to 30 months, which seems like a long time, you know, if you pump a lot of money in the economy, why would it take a year and a half, up to two and a half in order for that to show up in inflation. And he's hard pressed. You see, he doesn't use any kind of Austrian capital theory. He uses the Frank Knight capital theory. You can't do much with services and sources. So you can't, you don't get any time element there. In fact, Knight says there is no time element in capital. So it all has to be somewhere else. And so what he does is put it on wage rates, that workers go to work and prices go up and it takes them 18 to 30 months to realize they're not making as much now as they used to. So more people came into the labor force to take advantage of the boom. And yet it took them up to two and a half years to figure out not making as much money as they did before. So really, how does it take that long for people to figure out what the real wage is? And the answer here, it's only because we don't have any capital theory and the only thing else you can pin it on is the labor force. It goes that way. And one thing I point to and I think it would make a good dissertation is that even if you take his ideas seriously on that just think that booms and busts have a shorter phase in South American countries than they do in the U.S. U.S. is very much more capital intensive and the South American countries aren't. So you think that the less capital intensive economy would get that boom bust thing out of the way much before an economy like the U.S. where it's a long production process and it takes a long time to figure out that the thing is dis-coordinated in the middle. Inflation is always in the monetary phenomenon. We'll not buy that from Friedman. And the monetary rule he wants is to increase the money supply at a slow and steady rate to achieve long run price level constancy. And by a steady rate he means decide the rate and keep it at that level and don't look at anything else. And yet what I do here is suggest see there if you have a slow and steady rate it matches the increase in Q and so you end up with a constant price level. That's the price level constancy that he's talking about. But it also turns out and then show up very good that it distorts the loanable funds market because even that rate goes through the loan markets and is likely to give you a downturn even with a constant price level. Friedman declares the 20s as the golden years of the Federal Reserve. See, that's a chapter title in his big book on monetary theory. Ignores interest rates during the 1920s because they didn't change much. But what if they should have changed but weren't allowed to see and that's where you come in with Hayek during the 20s breakthroughs and technology okay we've said that so I'll go on. The Federal Reserve guided by the real bills doctrine so if people are doing something real, if they're making something they need credit they get credit and of course more of that happened during the 20s with the innovations and so on. So that keeps the interest rate from rising. He said seeing no change in interest rates Friedman dismisses interest rates as a potential independent variable in his econometric equations. Well you'd have to because you stick it in it's not going to show any effect anything. Seeing no changes of interest rate when they should have risen because of the technological advances Hayek was able to identify some critical market forces hidden from the untrained. Okay. So which view Friedman's or Hayek is more firmly anchored in the empirical that is historical circumstances of the 1920s. I think the Austrians. Anchored, yeah I want to show you that. The story is that I had heard a long time ago that Friedman had his license played in the equation of exchange. And at the time I was an institute for human studies in Menlo Park, California which was adjacent to Stanford University where the Hoover equation is and where Hayek and where Friedman was. And so I got my camera and walked over it had to climb the fence or something but I walked over and looked around I wanted a picture of his Cadillac with NV for PQ. Now I'll have to confess it was a hot day and it was a big lot and I really couldn't find it but I did find this red and white Cadillac and so I took the picture and then did a little jiggling best I could do. I know some people I had it on my website and some people copied it and sent it to Milton I think. But now look here's Greg Mankew's blog this seems to be beside the point but you'll see yeah there he is. So somehow rather while he was on TV he asked something about how can you identify my card you know that and it turns out that's it it's kind of limp you know that's the course he taught you see equals 10 well okay and then some things people wrote in hate to spoil things but you know found somebody else that said years ago trying to find Friedman's apartment in San Francisco I knew I was in the right location when I spotted the license plate that read nv equals bt t t means transactions and that's everything Fisher which is all transactions not just for consumables but all down the line you know so that's Fisher equation they can't be right so there was more Milton Friedman's license is nv equal pq I nailed it see not nv equal pt and then there's a link to the internet I don't know if we're on the internet we'll see anonymous rights that's pretty ridiculous and then Kearney says I love economists so let's see if we can get that well there's France the thing is in France in French isn't that France okay there it is okay there on the bottom in purple you have to read it in French oh they stole mine I now there's Friedman he's got nv equal p y okay and why why is nominal income and it's wrong that if you if you know enough if you read the monitor stuff for real magnitude they use lowercase letters and it seems backwards to me if it's real make it capital letter you know if it's real it's a lowercase level so that should be nv equal p little lowercase y and here there's Friedman he'll get his way he'll talk anybody into anything I wonder how much time he spent at DMV trying to insist lowercase y and they kept saying we don't have any so he put the y in there and it looks to me like the equal sign is made by some black tape and I think my rendition was better okay now we'll go on I want to go on just a little bit does Keynes recognize the significance of the little funds market in the context of a business cycle no he denies that saving depends on the interest rate and he all but denies investment depends on interest rates he jettisons the little funds market savings depends only on income and investment expenditures are based on predominantly on psychological considerations okay Friedman doesn't get it either no so s equals minus a plus one b y there's no interest rate in there and investment is i sub zero no interest rate there okay and for for Friedman it's mv equals pq and here it doesn't throw it away it just gets subsumed there in q okay this is Friedman's plucking model so called a comment got some letters back and forth from Friedman but he actually draws he didn't draw it he just explains it and I drew it this is the path that you have when you have business cycles but he misidentified things he's got a bust and then the recovery from the bust he calls a boom and and then he says that we really don't have a boom bust cycle we have a bust boom cycle because the bust is first and then you get a boom you don't matter so oh there he is the empirical evidence then shows that we simply don't have a boom bust sequence to theorize about we have a bust boom it's hard to say Friedman takes this empirical study which initially was published in the annual report of the national bureau as being utterly inconsistent with the von Mises theory he goes on so far as to say that this one little bit of evidence is decisive for refutations against Mises have the von Misesians in any way stop saying exactly what they were saying for 50 years not a word of it they keep on repeating the same nonsense he's kind of adamant there yeah okay that was an interview and there you are okay thank you