 Okay, I think we'll declare it 1015 and begin the lecture on Hayek and Friedman This is a lecture that I draw largely from contribution to forthcoming volume called Elgar companion to Hayek in economics Although there are seeds of this lecture also in my book in time and money So Hayek and Friedman are the featured economists, but as typical in macroeconomic matters Keynes is right in the middle of it. Okay, and so I want to start by a very summary comparison of Keynes Friedman and Hayek and show you that in some ways Friedman is more like Keynes in other ways. He's more like Hayek. Okay, so let's look at this at Looking at Keynes, we say that we see that he theorizes at a high level of aggregation certainly does So he argued that market economies perform perversely Especially the market mechanisms that are supposed to bring saving and investment into balance with one another Seeing unemployment and resource idleness as the norm Keynes calls for counter-cyclical physical and monetary policies and Ultimately for a comprehensive socialization of investment that quoted phrase is drawn from his swan song chapter chapter 24 in the general theory Now let's compare that with Friedman and the point I want to make Primarily is that Friedman is theorizing at a still higher level of Aggregation this this sort of takes him a distance away from Hayek The equation of exchange that we'll get into shortly most of you are familiar with it MV equal PQ Which is says essentially the mount bought equals the amount sold. It's a tautology, but a very useful one as Friedman demonstrates It makes use of the all inclusive output variable Q Putting into a clips the issue of the allocation of resources between current consumption and investment for the future in other words that Issues that both Keynes and Hayek grappled with are simply out of sight In Keynes in the Friedman's theory because of his level of aggregation although Friedman is very much a classical liberal and Believes as you know that markets work And so he sees no problem Emerging from the market itself and so that there's a change in focus here He focuses on the relationship between government controlled money supply and the overall price level Now let's compare Hayek and we see that he's an in-betweener in some ways between Keynes and Friedman Capital-based macroeconomics is distinguished by its propitious Disaggregation I've voiced that on students so they have to look up the word propitious well-chosen Disaggregation which brings into view both the problem of intertemporal resource allocation and a potential for a market solution right Keynes brought into view the problem, but no scope for a solution and Friedman hid both the problem and the solution So Hayek showed that coordination of saving and investment decisions could be achieved by a 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 Okay, so we've got Friedman and Hayek as cohorts is in their support of liberalism generally, but we've got Keynes right between them in the sense of level aggregation and Ability to deal with the issues at hand here Now the subtitle of this talk is how methods shape substances. I just listened to professor Long's Lecture and Think that mine at least in the beginning can dovetail with it fairly substantially, but then we head directly into macro as you might expect Contrasting methods and here I'm going to take my cue from Alan Meltzer who is a Monitorist and who is a Keynes scholar. He's written a book on Keynes and Here's what he says about methods first Keynes 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 right He concentrated on those magnitudes that changed the most often assuming that others Remained fixed for the relevant period so Keynes didn't hesitate to assume a fixed structure of production Thinking you're hoping you would stay fixed during the period over which he was analyzing movements in Animal spirits and that sort of thing right so you get the impression here He's just looking around and seeing what hits him in the face. He wants to hit you in the face Magnitude of movements variation of different magnitudes. That's what he's going to theorize about When Melcher says this he doesn't say it in a critical sort of way he just says that's this kind of economist He was well, guess what Freedman says I believe that Keynes theory is the right kind of theory right so here Friedman is a Keynesian in this sense and Its simplicity is concentration on a few key magnitudes and what makes them key well They flop around a lot, you know, they have a lot of fluctuation and Potential fruitfulness and where's the potential fruit? Well, it's ready made for econometric studies Okay, if you've taken a portion econometrics You realize that you need the econometric equation and then you need some variables that flop around a lot Okay, otherwise, you're not going to be able to get the correlations Freedman claimed Famously back in the late 60s that we're all Keynesians now the first time I came in contact with this Freedman quote. I thought I'm sure I'm sure he doesn't mean that he's in favor of stimulus packages and Crated expansion for getting the economy going and that sort of thing Felt like I knew Friedman stuff well enough to know he didn't mean that he was accused of meaning that in fact In a time magazine article he explained how he'd been misinterpreted. He didn't mean that well At least that's what some of us were pretty sure of but what did he mean? And he explained in the article that we all use the Keynesian language and Apparatus and at that time the Keynesian language and apparatus was something that goes by the name of ISL M analysis the big multi-quadrate diagrams that show the Keynesian magnitudes Moving around as they do Later in 1999 he claimed that Force-fitting his own theory in terms of those Keynesian Magnitudes that particular apparatus was the worst mistake of his career and yet. He never says what he should have done what sort of Framework theoretical framework did he have in mind? Instead so Monetarism got presented back then and still yet in terms of the Keynesian framework. He wrote a two-page or two issue article in the JPE where he set out The monitor's view using the Keynesian apparatus. You'll notice so When he says we all that's a little bit too all-inclusive isn't it we all that is Keynesians and monitors Not we all including Hayek Because Hayek didn't use ISL M analysis, okay Now Hayek, and I get this from a pure theory of capital Hayek says the role of the economists. Well, actually this is my Paraphrasing the role of the economists Hayek points out in the pure theory of capital 1941 is precisely to identify the features of the market process that are hidden from the untrained eye And if you want to underline the differences in your notes it's Keynes hit you in the face flopping around variables Versus Hayek Hidden from the untrained eye. That's why an economist becomes trained So he can see what's hidden from the untrained eye the local news Anchor can tell you what's flopping around Okay For Hayek then again, this is paraphrased from my contribution to the Elgar companion For Hayek then the cause-and-effect relationship between central bank policy during the boom and the subsequent economic downturn Have first order claims on our attention Despite the more salient co movements in macroeconomic Magnitudes that characterize the post-crisis spiraling down into deep depression, right? Yes Yes, we know about how an economy can spiral down into depression with both output falling and money supply falling and so on but What we're more interested in is how did this all get started? You know what happened during the? Pre-crisis period To trigger that kind of a response Okay This is out of his No bell talk and you can see how it relates to what we've just presented Hayek says there may well exist better scientific evidence and scientific is in sort of scare quotes or sneer quotes That is empirically demonstrated regularities among key macroeconomic magnitudes for a false theory Which will be accepted because it is more scientific than for a valid explanation Which is rejected because there is no significant quantitative evidence for it emphasize that quantitative call a show later that maybe there's some qualitative evidence for it that the auspices are privy to but the Monitors tend to overlook or downplay Now here I want to contrast Freedmen and Hayek in terms of their focus and Precisely the the different questions they ask in any Field and certainly in economics early in macroeconomics when you see economists coming up with different answers The first thing to suspect is maybe they're asking different questions And they each have answers to their own questions, but then it's important To look at the questions and say are those really the questions when most need answered So let's take a look at it and I'll try to drive the point home here. Here's here's Keynes Keynes attributes the downturn itself to Psychological factors affecting the investment community rather than the movements in the interest rate and Here is the direct quote. He says and this is in his chapter on notes on the trade cycle chapter 22 He says I suggest a more typical and often predominant explanation of the crisis is a sudden collapse in the marginal efficiency of capital And if you know that your Keynes, I mean me see the marginal efficiency of capital is just is just investment demand The demand for loanable funds to undertake investment Purpose in other words all of a sudden the business community Cools its heels loses its nerves turns pessimistic. This is all psychological talk and Therefore Quits investing That's that's the cause of the downturn, but it's almost a throat clearing remark In Keynes because what he's more concerned with is not what caused the initial downturn His main focus is on the dynamics of the subsequent spiral downwards That's a multiplier and all that stuff and on the policies aimed at reversing the spirals direction that stimulus packages Okay, and all that so he's he tells his story of business cycles Peek-to-peek in other words he starts with the downturn. Okay. We got a downturn now. What's gonna happen? One of the things you can look for when you hear Keynesian talks or you're reading They'll talk about how a bad situation gets worse Keynesian theory is largely about how a bad situation gets worse and it makes you wonder well Wait a minute wait a minute And we're started in the middle of our story why did it turn bad in the first place and of course Keynes answer is the psychological aspects of things now This is still Friedman Or this is Friedman Friedman's dismissive of the whole issue of the cause of the initial downturn in 29 referring to it as and I'm a collector of these phrases If you if you come across others, let me know Referring to the downturn as an ordinary run-of-the-mill routine garden variety recession He doesn't use them all at once, you know, I mean it's just one one at a time But to say it's a garden variety recession really is to say that the method. It's not anything that would Attract the economist attention. You don't need to explain a garden variety recession because it's just a garden variety recession Okay, but once you get the garden variety session then some bad things can happen and make it much worse so again his focus is also the same as Keynes in that sense and so his focus on policy is on 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 Those are the two things that hit you in the face as a big changes So he's Keynes in certainly in that respect and a typical way that Hayek or that Friedman would conclude a lecture or conclude an article Let's see. Do I have it here to pass it up? Let me go back for just a minute. Okay. I Missed one little quip there, but that's okay So Hayek then focuses on the policy-infected aspects of the boom And their implications for the boom sustainability, so he's asking a different question. What was it going on before you got that? garden variety recession To cause the garden variety recession which then got turned into a monumental Great depression the post bus reallocation of labor and capital takes time But the particular dimensions of the depression its length and depth Are to be explained largely in terms of the policy perversities in each particular cyclical episode in other words the Austrian theory in the business cycle is not a theory of the depth and length of Historical business cycles it doesn't explain the depth and length of the Great Depression Or the depth and length of our current downturn It explains why there was a downturn and how that subjected the economy to still other forces that made things worse many of those forces political It's almost as if I'm calling into question here something that Austrians often say And that is the bigger the boom the bigger the bust is that true? Can we claim that and I would say yes, but only in a limited sense think of it this way Mainstream economists when they talk about unemployment, they divided into categories, you know about this you've studied this stuff There's frictional unemployment. There's structural unemployment And we've named those to get them out of our way so that we can analyze the third category Which is cyclical unemployment that is it's not structural is cyclical, right? Well in the Austrian view What counts as cyclical unemployment is a particular kind of structural unemployment in other words this intertemporal structure That's what's out of whack right, and so at the point of crisis the crisis is all about How out of whack the economy is because of structural maladjustments? and if you focus on that in other words the cyclical Component of structural unemployment Then it's true that the bigger the boom the bigger the bust you've got more structural unemployment is going to take longer to Write the economy with a larger amount of structural Unemployment, but it's not true bigger the boom the bigger the bus beyond that is certainly not true with a great depression because that particular amount of malinvestment and dislocation and so on Was swamped. I'm talking about just in historical terms. It was swamped by perverse policies of all sorts Including tariff policies including trying to prop up prices in terms of burning potatoes and burning Are killing pigs and plowing under cotton in terms of make work projects in terms of monetary policy and all the rest so That's a particular Historical episode that we have to look at at piecemeal to see what's going on Okay, Friedman's monetarism now see in in this lecture. I don't have a bunch of interlocking graphs Because I'm just working with monetarism, which is largely MV equal PQ and his application of that equation of exchange is based on his Empirical finding that the velocity of money Is constant or nearly so tolerably slow actually has an upward trend to it, but that can be taken into account. It's very stable In Friedman's view at least in normal times And that's what Gives them an anchor to work with the rest of the equation and by the way, there was a long period at the University of Chicago when Many many dissertations written under Friedman Were about the stability of the velocity of money right and looking at different countries in different time periods and monetary data and uh output data And finding if there was any evidence that velocity was changing much in a successful Dissertation was one that showed pretty conclusively that velocity is not changing much Which seems like kind of a limp conclusion, but it's a critical conclusion and is what allowed Friedman to show such a strong relationship between the money supply and the price level because he knew it as Many economists knew at the time that output grows pretty Not very steeply output grows it, you know 3% a year something like that maybe four So if you got that nailed down and you know the velocity is not changing much Then you get a pretty hardcore relationship between money supply and the price level So output that's q grows slowly Which means the price level moves with the money supply So i'll put a bar over velocity uh and i'll show Output increasing but only slightly And then money supply increasing Fairly dramatically. Well, can we predict then the price level goes up too, right? And that's you know a hat tip to Friedman for this The equation of exchange has been known for many many decades before that But Friedman almost single-handedly was was able to wrench it back into existence And uh beat some Keynesians over the head with it, right? And he was fairly successful at doing that and and uh Our hats are off to him uh for that. There was a little problem here though We get uh, yeah the money supply is what's causing the prices to go up you identified that as the The cause on the one hand the effect on the other on the basis of the lags But he also measured the lag in his his uh phrase repeatedly uses a long and variable lag and if you had to pin him down he'd say oh 18 to 30 months And I want you to make a note about that 18 to 30 months. It'll come back uh to us In the later part of the lecture and that was a little bit of a thorn in his side He wasn't quite comfortable with that long a lag. Why should it be so long? Why should it be so variable? And even in one of the last things he wrote about Uh the issue this was in monetary mischief a book In the 90s. I can't remember the publication date, but he listed this as one of the Problems remaining to be solved how How do we get a better handle on that lag and why is it so long? Why would it take 18 to 30 months for more money in the economy to bid prices up? It just seems like it would happen sooner than that Especially if you're working with mvq will pq. Okay. Well, we'll come back to that Inflation is always and everywhere a monetary phenomenon other people knew that uh earlier uh including David Hume But it's direct quote from Friedman and he made that statement sing. Okay, he drove the point home And again, he beat the Keynesians over the head with it and he even influenced Economics in the policy realm in the in the Reagan administration and in the Thatcher administration Turn the tide on the issue and The tide is an apt metaphor because the tide comes in and the tide goes out They turn the tide but the tide didn't stay turned But at least you have to credit him for turning it when he did Hayek for all of his debating with Keynes Unfortunately didn't turn the tide in quite that way So Friedman's monetary rule. Well, it's just a rule to avoid inflation If the if quantity is growing at a slow rate. Well, so should the money supply Actually a little faster if you want to take account into slight rise in velocity, but I'm ignoring that And if you do it right, then you get a constant price level a stable price level These days stable price level Goes by the name of two percent inflation But here I'm just taking constant price level stable price level just As an illustration of the equation of exchange and the quantity theory of money Now a problem that you might see with that now that you know some of the Austrian theory Is is to think well now wait a minute when you increase the money supply That stuff comes through credit markets and it puts downward pressure on the interest rates or about that So we don't want to forget Our old friend The loanable funds market. Okay, then and money comes out through Credit markets increases the supply of loanable funds Yeah, we did have and it gives you that Decrease in the interest rate which causes some problem. This is not any part whatsoever of Friedman's theory and Laier will see why But it's just out of play Which is what leaves that long lag as a mystery I will argue Now Friedman declares the 1920s as the golden years of the Federal Reserve So he's he's on a par with Keynes here that neither Keynes nor Friedman saw any problem during the 20s It was only when we bumped into that garden variety recession That the problem started so Friedman is with Keynes here Golden years of the Federal Reserve ignores interest rates during the 20s because They didn't change much in other words when when they hit you in the face changes. How much would they have had to change? you know The interest rates stays within a fairly small band Maybe jumped up to 50 or so that that would have gone into their econometric equations But it didn't change much and more on this later because it turns out It historically is actually true that during the 20s there wasn't much of a change in interest rates But with Hayek's methodology He's able to tease out the problem in any case For Friedman though, they just don't pass the Keynes criteria They'll ask the burning question here. What if those interest rates should have changed? But weren't allowed to they should have changed but weren't allowed to Didn't breakthroughs in technology increase the demand for lovable funds and put upward pressure on interest rates? Yeah, any historian knows that in the 1920s that there was tremendous increase in technological innovation From mass producing automobiles to electrical appliance to process food chemicals of all sorts There's there was tremendous investment opportunities and plenty of entrepreneurs who wanted to take advantage of those and therefore Made for an increase in the demand for lovable funds Okay, that would put upward pressure on interest rates. Isn't that right? In fact Hayek talked about that in prices and production He called it an interest rate break B r a k e in other words as the interest rate goes up it limits It limits the extent of which the entrepreneurs can take advantage of these technological innovations because they're aimed at future output And consumers want some current output too. Thank you very much. All right So the rise in the interest rate would be just a normal market condition Now it turns out that the interest rates weren't allowed to rise because the central bank was accommodating accommodating the increase in the demand for lovable funds with an increased supply And therefore putting downward pressure on interest rate with the net result that the interest rate didn't change. This is the hidden forces To you know the the untrained eye has to see these hidden forces And this this would be Hayek's view That a reserve guided by the real bills doctrine met each increase in the demand for credit with an increase in supply thus keeping the rate from rising So seeing no change in interest rates Friedman dismissed interest rates as a potential independent variable in his econometric equation Well, that's sort of hardwired into his methodology Isn't any of you have taken econometric scores? How many have taken econometric scores? Okay, bunch of you You know that if if your independent variable doesn't change you're in trouble Is it's got to change to explain anything if it doesn't change then out with it, you know, it's not gonna It's not going to help you And it's true historically it didn't change in fact as I'll point out later, but I'll mention it here too because it's relevant Is that when I had some correspondence with Friedman over article of his and a comment of mine in the journals He he told me that I should not be paying that much attention to interest rates because they didn't change and he even Attached a photocopy of a time series of interest rates. He says look at the 20s the interest rates aren't changing It's so much for interest rates So that certainly was his view about Interest rates So seeing no change in interest rates when they should change Should have risen because of the technological advances Hayek was able to identify some critical market forces hidden from the untrained eye. That's a huge difference in methodology So a query here Uh at which view Friedman's or Hayek is more firmly anchored in the empirical that is historical circumstances of the 20s Austrians get a bad rap by saying they don't like empiricism They just don't like plunky empiricism plunky is a Rothbardian term by the way They don't like plunky imperialism Empiricism they want a broad-based empiricism that includes Historical understanding of the period and what was going on at the time the austrians were being a little more Empirical I think than the monetaries Uh, and I put in these slides just to show you a start difference between the dot-com boom in this respect And the housing boom is sort of rings true when you see what's going on with the dot-com episode Like the 1920s You had lots of opportunities Because people want to borrow lots of money It was a digital revolution. All right. And so what would happen initially Is that the demand for loanable funds? Would rise okay, so the demand for loanable funds shifts rightward and The fed should have allowed it to shift rightwards. That's how the market works That's what brings forth the additional saving You can see that additional savings there in the horizontal arrow, but the government steps in the fed steps in and puts a lid on that interest rate keeps it from rising All right And as a result you kill off the say the extra savings that would have been available And you replace it With money created by the federal reserve All right. So here's another example of a boom Where the increase in credit Rides piggyback on another Shift namely the shift in the demand for loanable funds Now let's contrast that And we had low interest rates during that period but not all that low they didn't change much just like in the 20s But if you look at the boom bust in the housing episode you get a different story Because what was driving that boom Was not Technological innovation so much although there was some during the period but more More predominantly it was policies by fanny may and freddy mack. They were subsidizing Lending by eliminating the risk from 30-year mortgages. So that subsidy is sort of a subsidy to saving okay In other words more people could borrow more money So there's an increase in the supply of saving uh because fanny may and freddy mack was Siphoning off the risk associated with all that lending that put downward pressure on interest rates The fed steps in and lowers the interest rates still further And why'd they do that well partly they were trying to get the economy to recover from the dot-com bust And partly they were trying to keep resources from leaving Sectors that were not housing in other words All the sectors that weren't building houses would have to pay higher interest given so much of the available funds Went into housing So the interest rate was lowered still further and that's why during that episode you got incredibly low Interest rates, all right That's what that says And if you want to look at the fed funds rate during both those periods It looks like that And it it shows the period During the dot-com boom when interest rates were so-called too low for too long And the reason they were too low for too long was partly because of that effect of fanny may and freddy mack and of course after the bust and lower still were down to zero and With no sight you know change in sight okay Friedman's idea of monetary contraction Is the same thing it's just the money supply going down now instead of up And so if if there's a reduction in the money supply And prices are sticky downwards All that's necessary actually is that Prices don't immediately adjust to the new equilibrium Then we get a lower money supply And consequently guess what a lower real GDP There it is, okay So evidence shows that between october 1929 and march of 1933 decreasing m was the essential primary dominant cause Of the decrease in q in output the way Friedman would conclude this This is this is sort of paraphrase the way Friedman used to write and talk The correlation between movements in the money supply and movements in total output leaves no doubt About the central issue The central issue being one that you can Deal with with the econometrics Now to drive the point home If it hasn't already been driven home, I want to spend a couple of minutes on The case of the cabbage eating mississippi monster. Have you heard about this? It goes like this Suppose it in late october of 1929 A thousand pound monster descended on mississippi soil It's been the next three and a half years Eating all the cabbages and in quite a few rabbits Between tupelo and pascagulla Okay, by early march of 33 the monster weighed 4000 pounds Two investigators are just sent to mississippi to handle get a handle on the situation. One's from vienna. The other was from chicago You see this coming The b&es and investigator asked where in the world did his hideous thing come from? Okay Then after further study Discovers that it was that the monster was unintended consequences of some ill-conceived government sponsored by awnings project Case closed. We got that one figured out The chicago economist shows up shoves the austrian aside And says never mind never mind how this thing got here The real question is how did it grow from a thousand pounds to four thousand pounds? How did an ordinary run-of-the-mill garden variety monster quadruple is weighed in 40 months? Okay, chicago's answer of course is it was all those cabbages He couldn't get good data on the rabbits So the correlation between Cabbage consumption and weight leaves little doubt About the central issue Okay That's hyacinth freedmen in a cabbage patch. I guess I don't know So query here. Do we suspect that the data availability is what led chicago and to his conclusion and the lack of hard data pertaining to the monster's origin caused him to be dismissive of the questions about where the thing came from So these and related suspicions are what underlie the message in hyax nobel addressed the pretense of knowledge All right Now let's see where we go I'm going to zip through some things here because I want to get some other things but Yeah, you've seen this inflation is always an everywhere monetary phenomenon, but boy that hinges critically on Velocity actually being constant or stable predictable. Okay And it turns out that that's what did Monetarism in this form in That's what did it in Prices move with the money supply. Yeah, if V is constant And so let's look at the first the inflation Rate and it looks like this You get it on there. There it is the money supply Has a much stronger upturn In the recent years. This seems not to be mimicked In the actual inflation rate So is the equation of exchange wrong? Well, it's not wrong. It's just that the velocity has become unstable Let's look at velocity If you look at Velocity just up through Into the 80s about 82. It looks like that. Okay Which is not exactly constant, but it's stable. It's predictable. It rises at a fairly slow rate. I mean the The scale exaggerates the rate, but it rises At a rate that can be taken into account with the equation of exchange But if you look at velocity beyond that If I can get it, there it is It goes wild All right, so starting in 82 if you want a particular date The economy went wild We can explain why as I will the velocity of money became unstable After 1980 Friedman's policy rule lost its velocity anchor The federal reserve abandoned the money supply targeting In favor of interest rate targeting Didn't do any good the target the money supply because the velocity didn't change Or the velocity was unstable And we can look at a plot of velocity. There's m2 another version of it Very unstable Let me just mention the the reason it became unstable was because of a so-called deregulation act in 82 it was really re-regulation, but they called it deregulation where A certain Requirement was eliminated called regulation q It's not q as in quantity. It's just a the regulation after p Well, it's not p for price. It's just in alphabet. Okay the qth regulation and the qth regulation um Kept banks from paying interest on checking accounts and it It kept banks from allowing people to write checks on savings accounts. So it made a gave us a crisp definition of Money namely m1 Okay That was eliminated. So it blurred the distinction and Nobody knew just where to draw the line on money. We'll see that shortly The other thing that went wild and you've seen these graphs before with Bob Murphy Okay excess reserves demand deposits the money multiplier All these things went wild and just made Controlling the money supply for the business of stabilizing the economy impossible um Irony of monetarism. This is relevant to regulation q The monetary rule It allows the economy to perform it as laissez-faire best according to Friedman Presupposes a critical piece of intervention. That's the irony. You have to have that one piece of intervention Regulation q that makes the money supply operationally definable but after 82 You got greenspan saying things like this. We don't know what money is anymore he actually He actually said that in sort of a forlorn tone When testifying before the joint economic committee, we don't know what money is anymore And it got popularized by Jay Leno who used it on In his uh in his monologue he quoted greenspan. He says, you know, I don't know who should be running the fed but It should be somebody knows what money is, you know, I Didn't know what money is anymore so that explains why they switched to uh interest rate targeting At that period they didn't know what money was anymore Okay, we got time to do this and maybe one other thing here Friedman's plucking model How many have heard of Friedman's plucking model some people some people have it's not very well known uh, this is this is a something that Friedman Invented back in the 60s but brought it out again in the 90s uh and uh the occasion was that In 92 that was his 80th birthday He was invited to a monetary panel to present a paper. Well, he hadn't written on money in years and so he he dredged up a section of an old report in progress from the early 60s and introduced what he called was the plucking model Plucking model is is sort of stylistically Empirical and it goes like this He says we can imagine a a Growing economy with no cyclical problems at all And you can see the upward growth there He referred to it as an incline plane an incline plane. So imagine this incline plane slope like that to represent you know healthy growth But if he said if you look at the actual track of the economy It it has lapses from that. It says if it gets plucked down So he says imagine a string where it comes up with this metaphor. I don't know a string glued to the bottom of the incline plane But at various points And to various extents the string gets plucked down Now it's not like a guitar string where it snaps back or uh, and it's more like Taffy or something you pluck it down. It stays down. So See if we can draw the string. There it is. Okay Uh, and sometimes you see some are worse than others and so on And this is this is his plucking model He called it the plucking model And it's my drawing. It's not Friedman's. He just talked his way through it But if you read his Text what you get is that the the down pluck is the bust and the up pluck is the boom And then he says In the 93 edition but not in the 63 edition. He says Those austrians are just off base. They've got a Boom bus theory and they need a bus boom theory All right, well, you can see here. They're misidentifying Friedman's misidentifying the boom. That's a recovery All right, it's a recovery And he doesn't see the Boom at all the real boom comes before the bust And he's got it concealed because he's plotting total out cup A total output if he plots The different stages of production you'll see some are going up and some are going down Okay, and at an empirical level The the net movement may be very little and so it doesn't pass the Keynes test All right So he ignores what's going on before the bust But picks up the bust And so this is this is his model. Let's see what I've got here Oh, yeah, there he is He was in there somewhere I'll say before I go on that This is where Friedman and I had our correspondence on On the whole issues and this is where he sent me the Photocopy of the interest rate not changing during the 20s which he considered Sort of a game changer in our debate, but really wasn't Why was Friedman so unreceptive to the Austrian theory? Well, you got some idea already But I can draw on my first lecture I hope most of you were here to hear the first lecture on Keynes around on Knight and Clark And it goes like this see we're still trying to explain that 30 Month lag 18 to 30 month lag Interest rates seem to be no part of the problem And our question is what goes on in Friedman's mind During that short run those critical 18 to 30 months Well, guess what? He goes for the Clark Knight model in Looks like this First he talks about what happens when there's more money and it doesn't come in through credit markets It just gets in the hands of consumers gets in the hands of people This is where his helicopter thing comes in, you know helicopter flies over the landscape and drops Money and is picked up by people. So they're the holders of cash And so look what he says. He says holders of cash once the helicopters out of the way Bid up the prices of assets If the extra demand is initially directed at a particular class of assets say government securities or commercial paper or the like Now see he hasn't got the fed buying those things. He's got these people who've already got the money from the helicopter Uh, the result will be to pull the prices of such assets out of line with other assets And thus widen the area into which 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 and he puts it in quotes on interest rates, okay If a more cosmopolitan and I put in there that is austrian Interpretation of interest rates is adopted in the usual one Which refers to a small range of marketable securities Well, the austrians are not talking about a small range of market securities They're talking about the general intertemporal terms of trade through financial sector Now here's where he brings in night and clark and I've drawn my Model up there and instead of calling out capital. I say sources. That's night And instead of saying consumption, I say services That's night sources yielding services. And if you didn't have that diagram up there to know what we're talking about You make your head swim to read this next passage, but let's read it and see what he says see if you can follow it I'll see if I can follow it. Okay The key feature of this process during which interest rates are low Is that it tends to raise the price of sources That's interest sensitive capital goods of both producer and consumer services Relative to the prices 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 of the sources But these reactions in their turn tend to raise the price of the services relative to the price of the sources That is to undo the initial effects of the interest rate The final result may be a rise in the expenditures in all directions without any change in interest rates at all In other words after you get the boom in the bus and everything clears the interest rate might be the same Interest rates and asset prices may simply be a conduit Through which the effective monetary change is transmitted to expenditures without being altered at all Well, the reason they're not altered is because you have this timeless Sources and services moving first up and first down. Okay, then down and in the end They had nothing to do with anything All right But how then does Friedman account for this lag? We're back to this lag because if that's what happened and it happened in such a clean fashion that nothing really happened With real capital or whatever then then where's the lag? and Friedman has to think hard for this and he actually Wrote a whole article on the lag structure and it finally it finally came to him what it was That would account for the lag and here it is see if see if it sounds familiar Friedman accounts for the mp lag of 18 To 30 months he says well, you know, it may be that monetary expansion induces someone within two or three months to contemplate building a factory Within four or five to draw up plans Within six or seven to get construction started The actual construction may take another six months And much of the effect of the income stream may come still later Insofar as initial goods used in the construction are withdrawn From inventories that only subsequently lead to an increased expenditure by suppliers Has anyone ever heard a story like that before anyway? This is the Austrian theory the business cycle for crisis. Okay. Now what doesn't make sense say that You know this this this article is in that optimum quantity money and other essays in 1969 book What doesn't make sense is that Friedman thinks that the those austrians are silly. They got all this capital stuff. We don't need it And just we just leave it alone And the only time we need it the only time we need it is bring it in to explain that lag And then once we've got that lag explain we get it out again, right? Well, no, I'm sorry. It doesn't work that way if this explains the lag Then this is the theory, right and all of the prattle about sources and services Goes away Now so what i'm suggesting here is that during that All that planning all those That's when the economy is in the boom period All right, and then when it all comes to naught because of resource availability Then you get the downturn And there's nothing Run of the mill about it or there's there's nothing Um garden variety about it. It's it's the expression. It's the explanation of the downturn. Yeah. Yeah, there's a secondary contraction Hayek knew that he wrote about it before Cain's ever wrote the general theory, right? But those are complicating factors and no more I've got a couple of minutes. I got to show you one other thing if it comes up next. Oh, yeah, I think it will I can't help but tell the story I Was in Menlo Park. That's when the Institute for Humane Studies was there right next door to sandford Sandford University in the sandford Freedmen was at the Hoover institution And he parked there close to the Hoover Tower And I'd been told many times that his license plate was the equation of exchange and I wonder Is that really true? I mean vanity tags were in in california, you know, they didn't start in alabama. They started in california vanity tags so When I went to the library a time or two or three or four I always took my camera thinking eventually I'll find I'll find it okay, and I looked and I looked and I didn't find it. I'm sorry. I didn't find it But a photocopied A photoshopped A 1970 Cadillac. I know you drove a Cadillac. I don't think you drove one white a red with a white vinyl top But you drove a Cadillac And it had a california plate on it and I did a little photoshopping and we got mv equal pq out of it Okay, so I could show it to my students or whatever and then Something appeared on the mancube blog Out of the blue a student sent me this He got around And mancube is asking how can you identify my car? Does he have one of these tags? No, his is ec10. I wouldn't do that at all. I wouldn't put my Course number or anything else on it. That's that's it. Okay. Well, there were some comments Let's see if we can get some comments. So, you know, I hate to spoil things But I must say I think Milton Friedman has a better play Okay This is from an article I came across he says years ago trying to find Friedman's apartment in san francisco I knew I was in the right location when I spotted a car with a license plate reading mv equal pt Well, t is the fisher as serving fishers transactions version of the equation of exchange So someone else writes in says Milton Friedman's license is mp equals pq not mv equals pt Here's the picture And it's a french side. It turns out. Are we on internet here or not? Let's see Yeah That's france And it's scrolled down. Yeah, I see down there it says la vauture. Is that the way you pronounce that? Of Milton Friedman So we finally get to see the real one They cribbed it from me, okay And the worst thing like the worst thing is on the same side you find they complained That that the equal sign had been dubbed in said well somebody's dubbed in the equal sign I thought I did a pretty good job of it In fact better than Friedman because eventually another student showed me a picture Oh, this this goes on That's pretty ridiculous. He says And then the next one I love economy Well, let me go back to that one. There's Friedman's real tag and he's got a y in there That's What does that mean that's supposed to be in there? That's a nominal income though He would use a lowercase y To mean real income. I can just hear Friedman Trying to get the department of motor vehicles to give him a lowercase y there They wouldn't do it. You could have put q in equal pq. That would have been fine with him But I don't know. I assume that was already taken. Is that it? Yeah, that's true. That's true. Yeah, that's true So anyhow in case you're doubt, that's the real picture in mine is a funny one Okay, thank you much