Larry White on the Clash of Economic Ideas
May 28 2012

Lawrence H. White of George Mason University and author of The Clash of Economic Ideas talks to EconTalk host Russ Roberts about the economists and their ideas of the past one hundred years. They discuss Keynes and Hayek, monetary policy and the Great Depression, Germany after the Second World War, the economy of India, and the future of monetary policy.

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Explore audio transcript, further reading that will help you delve deeper into this week’s episode, and vigorous conversations in the form of our comments section below.


May 28 2012 at 9:24am

This idea of a stagnant nominal income needs some unpacking. Is the idea that growth is good but not if it entails higher rates of inflation? Somebody help me…

May 28 2012 at 10:04am

Every so often I have head about “natural experiments” – in this podcast, we were reminded of how in Germany, when price controls were lifted, the economy grew (contrary to what some economists predicted) – and yet there were no Oops, we were wrong” books/articles. I have also
heard (several times) how inspite of LOWER Government spending after WWII, the economy grew (and yet, no “Ooops” from the Keynesians) – I read somewhere about 300+ (?) economists who predicted armageddon when Thatcher changed course in the UK with her economic ideas – and of course armageddon did not happen and yet no “Oops” …

Sweden seems to have bucked the European trend – (and Germany) by NOT borrowing and spending – and yet, most of the rest of the Europe seem to gnore those lessons

Seems to me that the evidence FOR “free markets” and “less (no) ntervention” are far, far stronger than “controlled markets” (i.e. planning) and interventions” – and yet the world seems to want
to repeat the same mistakes

Seems to be it is the “Keynesians” (and interventionists) of today who are intellectually dishonest in not recognizing the error of their ways and predictions – What is depressing is that we just keep repeating the same mistakes again and again – Yes, “End the Fed” was published and seems to be “popular” – and yet, here we are – the Fed keeps doing what it has been doing and our debt keeps growing.

I am curious if there is a “list” of “natural experiments” that we can go back to to remind us that in EVERY instance when Keynsians/interventionists predicted “disaster”, disaster DID NOT happen – on the contrary, the economies grew and prosperiy ensured – Is there a good summary of such examples somewhere?

May 28 2012 at 1:17pm

Peter asks:

Is the idea that growth is good but not if it entails higher rates of inflation?

The idea is that growth is good and that it does not entail inflation. If anything, growth naturally entails deflation.

Growth is producing more and better of the actual stuff we want. More and better stuff has been happening since the dawn of civilization, long before the invention of money, prices, inflation, or deflation. Growth–which economists sometimes call real growth or economic growth to emphasize that they are talking about increases in actual goods and services–usually happens independent of low levels of inflation or deflation. Arrowheads, hammers, warmer clothing, and writing improved before money, inflation, or deflation ever existed. Roads improved, eyeglasses were invented, railroads came into being; light bulbs, dishwashers, and the radio, television, and the Internet were created; iTunes improved music accessibility, Apple created the iPad, Microsoft improved MSWord, autos improved gas mileage, mining improved safety conditions–all kinds of growth happened when there was no inflation or even deflation. India, China, Great Britain, the United States, and most other countries throughout the world have experienced growth without entailing or even concomitant inflation. It’s hard to think of invention spurts or productive national improvements or accelerations that happened concomitant with major inflations or that were even followed by major inflations.

The first thing someone might think is that to get a better mousetrap must mean paying more for it. So, it’s easy to think that to keep getting more and better stuff of every kind, prices for everything must have to increase. Isn’t that inflation? Actually, no. Inflation can’t happen that way. Inflation is the increase in the average price of goods, not the price of just some goods. If you yourself buy a better mousetrap, you have less money to buy sports socks or bonds or cable TV or whatever else you want. The prices of those other things have to fall because you demand less of them. So, after everything shakes out, there would ordinarily be a deflation if a better mousetrap were invented and you buy it. Why? The average price–the price level–stays the same or falls for all the other goods, and when you factor in the improved quality of the mousetrap you are buying, the average price per actual good goes down. That is, what is entailed by growth is a deflation.

Actually, inflation itself is inherently neither bad nor good. Same for deflation. It may shock you to hear an economist say that! Inflation or deflation–overall increases or decreases in the general price level–are bad or good only when they are highly variable, highly unpredictable, or so large as to make you have to put thought and effort into figuring out what to do. If growth actually entailed or resulted in a small inflation or deflation, you’d probably take that in stride because you are used to it.

But a bad thing associated with less-than-small or changing inflations or deflations is uncertainty. If a government–the usual producer (printer) of money–over-allows money into circulation, that can quickly cause unexpected inflation or deflation by increasing or decreasing the amount of money people use to buy goods, services, or labor. That can cause a lot of confusion and uncertainty. Banks may be the first to know that there is more or less money around than usual, but ordinary consumers and business owners may not be watching for that if they are not used to that situation. Producers and consumers may first wonder: if the price of a good you want to produce, sell, or buy goes up, is that because more people really want it? If that price goes down, is it because more people don’t want it? Or, is the price only going up or down because the government printed more or less money than usual, so people are spending more or less because the money is flowing more or less freely even if there are no more or no improved goods or services? It’s hard enough to figure out if the prices for your labor–your wages or entrepreneurial rewards–or the goods you produce or are thinking of producing or even selling on e-Bay–are going up or down because people want more or less of them in a real sense. If the government compounds your problem by artificially manipulating prices to rise or fall via its ability to control the money supply arbitrarily, your problem about figuring out whether to produce more of that is compounded.

Some economists argue that to spur growth temporarily, especially during periods of recessions, the government should just on-the-quiet print up a bunch of extra money–over and above the ordinary amount of money people expect to be available even during a recession. (Most economists expect the government to put more money into circulation during a recession as a routine matter, so we are talking about an even greater amount here in order for it to be unexpected.) The government could thereby induce an unexpected inflation. The idea is that that would cause prices to rise so unexpectedly that it would be unbeknownst to the citizenry. Producers would get fooled into producing more and hiring more workers because prices were increasing. Workers would willingly take more jobs, thinking their work was worth more. Consumers would think they had better buy now or prices might go up further. Economists who argued that citizens might be fooled also have usually understood that the effect wouldn’t last long, and that hiring would fall back after the artificial boom. The effects would be temporary and accomplished only by tricking the citizens–but the argument is that it might be worth it. Their argument is that inducing an artificial inflation might jumpstart an economy out of a recession.

Setting aside the distasteful aspect of tricking the public, there is also the observation that any resulting increase in employment or output is not what economists call growth. Growth–economic growth, real growth–is a lasting, long-term result of the economy’s improved ability to produce more. Growth neither entails nor stems from inflation.

May 28 2012 at 3:49pm

Enjoyed the podcast and immediately hopped over to Amazon to order it… to discover it costs almost $120! And no kindle edition! Double ouch. Can’t say I understand book pricing but obviously the publisher decided this was a specialty book for the academic market and libraries. Pity, as it sure sounds like the book merits a wide audience. Any chance of a more economical kindle edition in the near future?

Had to laugh at Russ’s long pause after Larry’s suggestion that the Fed target a steady nominal GDP. After 100 years of inflation we’ve long forgotten that a falling nominal GDP was the norm in the first century or so of U.S. history. Yet today the idea sounds bizarre.

May 28 2012 at 4:45pm

Great conversation (though a little too short for my liking) about one of my favorite topics. I would have liked to hear a little more about the disagreements between Monetarists and Austrians. The awkward pause was hilarious. But – excuse me if I’m being paranoid – what’s with the whole “he whose name shall not be mentioned”-shtick? Does this still harken back to the alleged GMU/Mises Inst. beef?
I’d love to hear you have DiLorenzo, Kinsella, Bob Murphy, David Norton, or Gregory Anthony on.
Anyway, thanks for another excellent podcast.

Word press
May 28 2012 at 6:21pm

I thought the host’s thoughts on the current state of American civil liberties was far off the mark and far from thoughtful ( something that is rather rare). Our country currently has the largest prison population as a percent to general population on earth. our President has famously killed two US citzens with out trail or attempting to apprehend them (only one was accused of any crimes) and his my oponate has indicated that he would do the same, the NDAA allows for the arrest and detention over seas of any US citzens suspected of supporting groups the Taliban ( a group of people who never attack the US) or al quada (which the US government currently aids/aided in Syria and Libya) the meaning of the word “support” being left vague. A let’s not forget that at random citzens who wish to use air trial are subjected to a search fitting those entering prison. All and all the record on civil liberties over the past decade have been rather aweful.

Greg G
May 28 2012 at 9:14pm

I enjoyed the podcast but would like to make two points:

There was a good deal of discussion about Milton Friedman, monetarism, and what current policy ought to be. How do you leave out all discussion of the fact that Milton Friedman was on this podcast in August 2006 and didn’t show even a glimmer of recognition that the Fed was, at that very moment, fueling one of the biggest financial bubbles in human history?

I thought I must have remembered it wrong so I just went back and listened to it again. Milton had very high praise for Greenspan and Bernake. He referred to the 20 years leading up to his interview as a “golden period” of enlightened Fed policy. He said he was optimistic about the future. He said there was “no danger” of a deflationary depression and that he was worried mainly about inflation.

Russ you presciently asked if it was not now harder to measure the money supply. He replied that it was “not harder.”

Friedman made his reputation by correctly predicting stagflation. He should be held accountable for his utter failure to see the housing bubble and the effects of the monetary policies that fueled it.

I also want to comment on that trope about the Supreme Court taking “the step of declaring everything interstate commerce.” It was huge advances in transportation and technology that made “everything” interstate commerce. The Supreme Court merely recognized that fact – belatedly.

Jonas V
May 29 2012 at 4:07am

Dear Russ,

a clarification about Spain, the problem was not that they had large deficits in the past. The problem was that there was a construction boom when cheap money flooded in from elsewhere in Europe.
Spain ran a surplus of 3% of GDP in 2007. That way the government tried to offset the effects of the boom. Also, the total debt of Spain was around 50% at that time.
Their problem now is that Spanish banks are sitting on lots of houses that they cannot sell so the banks are not solvent.
To summarize, it is incorrect to say that the Spanish government borrowed too much money in the past. The problem is that they had the euro so that Spain could not raise the interest rates when the construction boom started.

Russ Roberts
May 29 2012 at 5:41pm

Word press,

I do not like the things you mention. But I don’t think the size of the prison population reflects a lack of civil liberties as it does a law against drug consumption that is not possible to enforce in any meaningful way.

But my main response is that you do want to talk about historical perspective. America today is not a police state. There is still a respect for the rule of law, at least outside of property rights. Political speech remains very free.

Russ Roberts
May 29 2012 at 5:46pm

Greg G,

I agree that hindsight is 20/20 and it is easy to construct ex post stories. I also agree that Milton in 2006 appeared to be optimistic about the future.

But it is not clear that the Fed fueled the housing bubble. I suspect that what Milton would argue were he alive today is that M2 growth was not out of line in the mid-2000s. I think he would find the cause of the housing bubble elsewhere.

I am agnostic on the question. Was it low interest rates that fueled the bubble? I don’t think we really understand the nexus between money growth, interest rates (those that the Fed plays with) and real activity.

Fred Fenimore
May 30 2012 at 6:16am

Frogs don’t sit in water once it gets too hot for them. They jump out of the pot if possible. This is a tired and incorrect metaphor. Please refrain from using it. Might I suggest the slippery slope? Equally cliche and incorrect for different reasons.

(sorry, you hit one of my pet peeves because (1) as an engineer we are taught never to estimate when you can measure and (2) frogs are cool and talking frogs are double-plus cool)

May 30 2012 at 9:14am

Dr. Roberts,
Another great podcast and unintentionally funny. I got a huge laugh when HR asked me why I downloaded a podcast titled “Whiteideas”. I explained and luckily did not have to go to sensitivity training.

Lauren [Econlib Editor]
May 30 2012 at 10:26am


So sorry, munger>hayek, that you got hassled by Human Resources. I’m relieved that you got a laugh.

I’m the one who ultimately gives the names to the mp3 files. I admit that I sometimes pick provocative combinations. In part that’s because I’m trying to come up with file names that are unique, that still obey a basic system of including the guest’s last name, and that also are file names I can remember without having to look them up. I confess that I realized that this filename choice might look ambiguous; and that I smiled cringingly at my own choice. It was either Whiteideas or Whiteclash, though; so I kind of went for the black humor [yes, I do have the ability to pun now and then] because I knew I’d be able to remember it. In the end, it’s just a file name, not a reflection of philosophy. The English language is so rich that last names and ordinary words all have secondary connotations.

Big Dog
May 30 2012 at 10:44am

Yo Russ!

Be careful when you start talking about economists seeking power. The FED is gonna snatch you and your podcast.

Marielaina Perrone DDS@Henderson Dentist
May 30 2012 at 8:48pm

Very enlightening audio. Seems we are at a real crossroads in our econ thought. Just hope we choose the right path otherwise we will suffer for generations to come.

Greg G
May 30 2012 at 10:36pm


I don’t doubt that Milton would say that M2 growth was not out of line. And I don’t doubt that he would be right about that. I probably should have said that the creation of money in the shadow banking system was the thing that fueled the bubble. That is what I was getting at when I commented that your question about the difficulty of measuring the money supply was prescient.

It is remarkable that a truly great economist, whose reputation was built on understanding the money supply could (like the rest of us) not notice the biggest financial bubble of his lifetime and the growth in the money supply that fueled it. This has to cast doubt on the effectiveness of a rule for the growth of M2 in guiding Fed policy.

I don’t know how much the Fed’s raising interest rates to curb the bubble would have helped. I’m pretty sure they would have tried it if they had understood better what was going on at the time.

May 31 2012 at 11:00am

Nazis, from the NZ on the ballots which stood for National Socialists (begins with a Z in German), are “right wing” only in the sense that they are NATIONALIST and hearken back to imperial aspirations. In Europe, the “right wing” or “conservatives” are historically imperialists/monarchists.

Nazis were ideologically socialists (left wing) but replace the international proletariat with the German worker. The full party name was the National Socialist German Workers Party. Hitler had been a member of the socialist party (as had Mussolini) prior to joining their respective National socialist movements. Stalin’s “motherland” appeal is arguably the same approach. It’s all ultimately socialism, just varying the justification for the imposition on liberty – propaganda.

In America the right wing conservatives also have a historical orientation – but America is historically a classical liberal and constitutional government – a very different set of ideas. That’s what conservatives are trying to conserve.

The European right wing and the American right wing have very little in common. It is best to avoid the confusion and refer to the specific ideologies espoused.

Great podcast! Thanks Russ.

Jun 1 2012 at 5:46am

@Greg G.

Agree with your last comment.

Jim Bryan
Jun 1 2012 at 11:17pm

Enjoyed. thanks for the podcast, I agree with the comment that it was too short. I have listened to it twice. Thanks again.

Jun 2 2012 at 8:06pm


I think you were right to be skeptical of White’s sentiment that disinflation is desirable, using the example of that which existed under the old gold standard (as a result of growing demand, stagnant supply of gold, not a nominal price decrease). Was this disinflation not widely considered to be the cause of the “First Great Depression” of ~1873-1896 and the driver of the first pushes to abandon the gold standard? I think his statement that it led to greater quality of life is way off.

Word press
Jun 4 2012 at 10:04am

Dr. Roberts,
I am a bit confused by your answer. I think if we where to construct a negative definition of a police state it would be in part or in whole “a state with limited civil liberties”. I agree with you that the large prison population is evidence of a lack of civil liberty.
Also I think we should look to history for our definition of a police state. What well find is that in some case it is obvious to see a police state and in other case it is harder to make our definition cleanly fit. This is not an exceptional claim any time we dream up a definition for words that try to covey complex ideas this is the case and states are complex ideas. So is the United States of 2012 an obvious case for a police state probably not, is there a case to be made given the facts stated in my last post, I think so.
I might be hyperbolic in calling the US a police state, but when consider how easily and with how little opposition the NDAA pasted, how after the still on going experiance of the Iraq war we easily went to war (with out any sort of Congressional athority) in libya, how little up roar there has been over the intrusions of the TSA or the plans to allow the air force to operate drones with in the US and so on I find that my worry over the trend line over shadows my dislike for hyperbolely.
As for you point that free speach is alive and well, I think you fail to consider how this adminastration has been going after journalist and whistle blowers(prosecuting more than all other adminastration combined). Or how past administrations have used the IRS or other governmental agencies to intemidate people for there speech ( I will admitt that clear and systematic evidence of this latter point does not exist but there is anidotal evidence), is evidence to the contrary.

Jun 4 2012 at 1:30pm

I’m overly sensitive to the difference between the monetary base and the money supply because I spent a fair portion of last year assaulted by people who were certain that hyperinflation was underway because the Fed tripled the monetary base. But of course most of that money remained as bank reserves, and the money supply grew modestly.

But it did seem odd that both of you were sloppy with this distinction, particularly since that distinction was at the heart of Krugman’s comments on Friedman: that from 1929 to 1933 the monetary base — which the Fed controls directly — increased by 17% while the money supply — which the Fed influences indirectly — dropped about 25%. It seemed you were discussing some other issues for the 1930’s era Fed, but you lost credibility points for the mixup. That’s too bad because I would have liked a more detailed comparison between how the early Fed and pre-Fed institutions handled depressions and panics.

And it’s hard for me to imagine how any professional economist wouldn’t know that the Obamacare penalty was a tax, not jail. What’s up with that? Maybe I deal with insurance and Actuarial issues too much…

Jun 17 2012 at 4:41pm

Wait, expectations are the only risk of deflation? Did you forget about your talk with Tyler Cowen on macro?

“Employees don’t like hearing that their wages will be cut by 3% this year but that the price level will also fall by that much or even more. These are our current expectations, which won’t go away soon. ”

And what about incentivizing money hoarding? Why invest if just holding money gives real returns? I would love to hear another econtalk where Larry White can respond to these things.

Also, Bryan Caplan on The Ultimate Resource and Julian Simon! That would be the best econtalk ever.

Jun 21 2012 at 7:42am

I loved that moment of silence. I have to cry foul though. You ended the podcast with a cliff hanger. I’m anxiously waiting for the discussion on deflation to continue.

Comments are closed.


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Podcast Episode Highlights
0:36Intro. [Recording date: May 14, 2012.] Russ: Topic is your book, The Clash of Economic Ideas. It's a real tour de force; it covers, as promised, the major debates of the last century, the economists who were involved; and it dips back into the past to talk about those economists' predecessors, including Adam Smith, David Ricardo, Mill, Malthus, Say, and so on. The writing is incredibly clear. You'll learn a lot of you read this book. I learned a lot. You begin, not surprisingly, with John Maynard Keynes and Friedrich A. Hayek. What I found most interesting is your revisionist take on two seemingly true claims--that Keynes was the first macroeconomist and that everyone before Keynes was pretty much laissez faire. You take a different approach to both of those claims. Explain. Guest: Yes. I'm able to use Paul Krugman as the foil, having made both those claims. Russ: He's not the only one, though. Skidelsky. Guest: No, not the only one. I'm sure he learned it from someone else. Right, Robert Skidelsky, Keynes's biographer, suggests that Keynes invented macroeconomics. So, if we define macroeconomics as the study of business cycles, which seems like a natural definition, economists have been discussing business cycles ever since there were business cycles, and the deep theoretical discussions, I think, have to go back at least to the 1830s, when people were arguing about renewal of the Bank of England's charter, and the question of whether the Bank of England was responsible in some way or in some part for the business cycles that were happening in England in those days. So, there were the famous currency and banking schools, and a group I call the free banking school, who were arguing against the Bank of England's privileges. But they all had business cycle theories; they all had theories about what was causing the up and down in the economy and whether the Bank of England was to blame. The banking schools didn't think so, but the currency school and the free banking school thought that the Bank of England and to differing extents the rest of the banking industry were responsible. So there were monetary theories of the business cycle. If you want to talk about macroeconomics in terms of aggregation, in terms of thinking in large concepts like the money supply and total output, I would say you have to go back at least to Irving Fisher. He develops all those concepts--in fact develops index numbers so that he can measure the price level. And so those concepts are already around when Keynes comes on the scene. Russ: Fisher was early part of the 20th century. Guest: That's right. So, Keynes's famous General Theory is 1936, but Fisher is already talking about these things around the turn of the century. Russ: There was also Mises, and other of the Austrian folks who were interested in business cycle theory. That was independent of that earlier discussion. Guest: Absolutely. Well, they are building on the earlier discussion, actually. Mises is explicitly building on the currency school and the debate in the middle of the 19th century. And between the currency school and Mises is the great figure of Wicksell in Sweden, who tries to combine the currency theories of free banking schools with Austrian capital theory, which he learns from Bohm-Bawerk, and actually improves, clarifies, makes a little more rigorous. So, Mises is building on those predecessors. But right, in the 1920s the leading business cycle theory is the Austrian theory, which I talk about in Chapter 3 of the book; and then Keynes's contribution I talk about in Chapter 5. So, disagreements over economists over the role of government in the economy go back well before Keynes, and there are people on both sides. Keynes himself refers back to the debate between Malthus and Ricardo, where Malthus sees a bigger role for government in trying to steer the economy. But the language and the terms in which the argument has been conducted have changed, but there's always been a range of opinion as to whether the government should be larger or smaller.
5:28Russ: But the part that struck me about the book--and I think in a way--we'll talk more about this as our conversation goes on--but, I think there is sort of this stylized view that, until the Great Depression--forget Keynes--everybody was a laissez faire capitalist, and you throw around names. Like: Look at Adam Smith; or, you know. And yet clearly, with the late part of the 19th century, which brings us Marshall and Pigou, we get the beginnings of a very different, much more interventionist approach that really grows out of the progressive movement that's sweeping the world, a view that we can solve our problems by applying human reason. I often call this, on this program, the engineering perspective. Engineers have called to complain to me that that's unfair to engineers, but it's a confidence in the ability of bringing academic disciplines to bear on social problems, and economics was just another aspect of that. And it was not a minority, tiny opinion. It was growing and increasingly widely held. It seemed to me, based on your book. Guest: Right, and one of the clear indicators of that is the foundation of the American Economics Association (AEA) around the turn of the century. The people involved in that were institutionalists, who had learned their economics in Germany in the era of Bismarck, and came back to the United States with all these ideas about how government can play a larger role in the economy. And in the initial statement of principles of the AEA, drafted by Richard T. Ely and some of his cohorts, there is an explicit statement that: We believe in the positive role of the state in improving the behavior of the economy. I don't remember exactly what words they used but a pretty explicit dismissal of laissez faire as a way of organizing the economy. So, they are bringing the ideas of the 1870s and institutional economics in the United States is a very important input into the progressive movement in the United States. Ely and John Commons and other institutionalists were important in pushing for labor reform regulation and other kinds of federal intervention into the economy. And they play a big role in the policies of the New Deal, as it turns out. Russ: In what way? Guest: The ideas of the National Industrial Recovery Act and the Agricultural Adjustment Act, which are the first New Deal programs, are created by an economist named Rexford Tugwell from Columbia University, who was a member of Roosevelt's brain trust. But Tugwell got his ideas in large part from the institutionalist school. He added a few things into it. But the idea of these acts was to create committees--or cartels, their critics called them--but groups that would regulate industries with participation from big business and labor but with the Federal government as kind of the senior partner, setting prices and quantities and labor-hiring quantities. So, that comes out of a very top down view of government's role in the economy. Russ: I found that part of the book extremely interesting because it wasn't something I was aware of. Especially the early days of the AEA, which I think a lot of economists would just presume were doctrinaire free marketers. Guest: Well, there were of course more free market economists than those who started the AEA. And they joined, eventually, the AEA. And it's become less ideological and more just a professional organization. But the beginning of it, it was modeled after the [?] fur Sociopolitic in Germany, which was the organization of the German historical school for social reform, basically.
9:54Russ: Now, while we're on the topic of the Great Depression, it comes up later in the book when you are talking about monetarism, you address something that has bothered me for a while, which is an article that Paul Krugman wrote shortly after Milton Friedman's death--which I thought the timing was rather strange. But in that article he accused Friedman of being intellectually dishonest in his claim that the Great Depression was caused by the Fed. It's a legitimate argument; I just don't think its insulting was very appropriate. But the argument was the following: If you go back to Friedman and Schwartz's Monetary History of the United States, they argue that the money supply dropped dramatically--I think by a third--at the beginning of the Great Depression. And the Fed should have intervened to expand liquidity. And instead they felt that monetary policy was actually expansionary and they refused to expand as a result. And some of this is semantics. But Krugman's point is: That's not quite the same as causing the Great Depression; it's a failure to fix the Great Depression. You have an interesting take on that. What is it? Guest: So, Krugman accuses Friedman of something close to intellectual dishonesty, in his scientific writings having the view that the Fed should have done more to restore the size of the money stock, but in his popular writings saying the Fed was to blame for the depth of the Great Depression, leaving the impression that the Fed did too much. Whereas, Krugman says, what they are really saying is the Fed didn't do enough. What Krugman doesn't seem to realize is there's a standard by which to measure whether the Fed did enough, and that is: What did the clearing houses associations do in the earlier financial panics, like the Panic of 1907? The institutions that the Federal Reserve Act in a sense nationalized--their roles were taken over by the Federal Reserve. So, the clearing house associations in those panics, especially 1893 and 1907, had acted as lenders of last resort, had issued more currency--which actually wasn't legal for them to do, but they did it and nobody prosecuted them because it was clearly helping. And the Fed, in the crisis of the early 1930s, 1930-1933, just sat on the sidelines, didn't expand the quantity of currency, didn't try to make loans to illiquid banks. So, the Fed did less than the banking system would have done for itself in the absence of the Federal Reserve Act. So, Friedman and Schwartz's conclusion is the banking system would have been healthier if the Fed had never been created. And Krugman thinks that's inconsistent with saying the Fed did too little. But it's not at all inconsistent with saying the Fed did too little: given that the Fed had been given the roles of the clearing house associations, it was the Fed's duty to behave like a clearing house association and not sit completely on the sidelines, but try to organize some self-help efforts for banks that could use the help. Russ: Now, one of the parts that's interesting about your book is, of course, you put many things into an historical and intellectual context that often are forgotten. A lot of people treat the Great Depression as being a 1929 problem. If you are Keynes--the early Keynes calls it a "magneto problem," a metaphor for a car. Magneto is the British term for the alternator. Somehow the system is out of whack. And Keynes emphasized what he saw as the inability of the system to self-correct without government intervention. That's the Keynesian view, and of course comes to sweep the field. Friedman later says: No, no, no, no, no; it wasn't a magneto problem. It was a collapse in the quantity of money, and the government had the tools to fix that, given that, as you said, they had destroyed the tools that had previously been available; so it was a government problem. It wasn't something inherent in capitalism. But the Austrians--and you--point out the economy didn't start in 1929. It started before, long before; and the period from 1921-1929, the post-1920 depression period, which was a Great Moderation of its day--a time of growth and prosperity, causing many people to think it would last forever, including Irving Fisher. Guest: Yeah, and price stability. Russ: And so, what puzzled me about that view--and you and I have talked on this program before about the Hayekian view of that period and the Austrian view generally--but what I found interesting was just a small note you made about what Friedman would have said about that period, that he didn't think it was problematic. And I'm surprised you said that. Here's why. I think you said that during this period, money supply growth was quite large--it was about 6%. So, you also just mentioned that it was a time of relative price stability--relatively stable prices, I should say. And those seem inconsistent. Did Friedman really suggest that the 1920s was a golden era of monetary policy that could have been sustained? Six percent money growth? Guest: Well, he did say things suggesting that. He also said at one point that if the money supply hadn't collapsed, that there would have been simply a garden variety recession. So, in that way I guess he did recognize that there was going to be a recession; it wasn't that the boom could be sustained indefinitely. But as you say, what I try to emphasize, which is in contrast to the view of Friedman and, it turns out, of Keynes, that everything was pretty peachy in the 1920s and the problems only began in 1929, you have the Austrian view, which is that problems were building up before 1929, and the downturn in the economy and the crash in the stock market were symptoms of problems that were already in the works. But I do give Friedman credit for helping to explain why the Depression was so deep and so long. I don't think the view that the economy was heading for a recession predicts that it would have been a recession of 15 years--an incredible drop, unprecedented drop in output. Russ: True.
17:21Russ: You have a story in there--I apologize, I have to pull it up from memory--of, I think it's Mises, when he's asked: Surely he wouldn't suggest doing nothing. Do you remember this story? What's this story? Because it's a complaint that those of us who are skeptical of government intervention today to solve the economy painlessly are often confronted with this challenge, that: You wouldn't just sit around and do nothing! What was the story? Guest: Well, it's an apocryphal story; I don't really have a source for it, but I've heard it second hand. So, Mises gives a lecture and talks about how the economy needs to be left alone to recover in a recession. And a woman in the audience raises her hand and says: Professor Mises, surely you are not suggesting that the government should do nothing. And he says: Madam, I'm suggesting that the government should have started doing nothing a long time ago. They had created the boom, and now we had the recession, and we can't avoid going through the recession. Russ: Yeah, there is a certain feeling that we just have to find the right, painless cure. I find it strange--we're recording this in May of 2012--and there was an article in the Washington Post just yesterday that Spain maybe is going to reconsider austerity. As if austerity were a choice, a strategic maneuver on the part of some European nations rather than a reality, when you've spent-- Guest: It's as though a household who've maxed out their credit card have a choice but to moderate their consumption. Russ: Right. Now, in theory, you could go get another card. But when you've asked all the people for a new card and they've turned you down because they don't like your past pattern of behavior, you can either go to jail or you can cut back. It's not like: Well, but cutting back's going to be so painful. Yes, but it's better than going to jail; and there isn't a third alternative if no one will want to lend you money. Of course, there is: you can quit the Eurozone and start printing money of your own. But that's not so pleasant, either. In that sense there's a choice. But it's not like they picked the wrong strategy. To me, the right analogy is a gambler who keeps losing and keeps borrowing money from his friend, and finally his friend says: I don't want to keep lending you money. And he says: No, you don't understand--just give me a little bit more; if I win I'll make it all back. Well, that's always possible. That's the Keynesian: But I'm going to grow so much from this borrowing it's going to pay itself back and then some. But sometimes you just get tired of betting on a loser. Guest: Well, countries that are deeply indebted can go into the international bond market and try to sell their bonds. But they are not going to find many takers at any interest rate they are happy paying. Russ: Yeah, that's right. Guest: In the last chapter of the book I talk about the sovereign debt crisis. Russ: Where do you think we're going? I don't know what I mean by "we're". Where do you think some nations are going? Guest: Well, Greece has already defaulted. It looks like there may be some other partial defaults in Portugal; and I'm not sure about Ireland. I think you're right: they don't have much choice if they want to avoid default but to try to rebuild their credit, which means making a credible commitment to having the wherewithal to service their debts. Which means they can't run large deficits indefinitely. They need a credible plan for bringing enough revenue, minus expenditure, to pay the interest and principal on the debt. Whether they'll be able to do it--well, clearly Greece wasn't able to do it. In the United States we've hit 100% of debt-to-GDP ratio. And the debt keeps growing faster than the economy, so the ratio of debt to GDP keeps rising. And that can't go on forever. And as Herb Stein famously said: If something can't go on forever, it won't. Something needs to change. But if we want to avoid falling into the same kind of debt trap that Greece fell into, where there is no way they can afford to roll over their debt--even if they started running zero deficits tomorrow, when you are paying 12%, 15%, 20% interest on your debt, the debt is growing faster than your ability to repay it. Russ: When you say they've defaulted, you are saying that because they forced their creditors to take a loss. Guest: A very large haircut, yeah.
22:27Russ: Going back to philosophical issues: I have to say that one of the themes that runs through the book is the refrain from my song with John Papola:
Which way should we choose?
more bottom up or more top down
...the fight continues...
Keynes and Hayek's second round
Guest: Yeah. I have suggested in some presentations of the book I've made that people should regard it as a handy compendium to your videos. Russ: Yeah, it definitely--I appreciate the ironic humility there, Larry. Comparing your work as scholarship to what John and I did. Guest: Yeah, but you have 3 million hits. If I can sell 3 million copies. Russ: If you could just sell 10% of that. But what I noticed--you don't highlight this particularly, but you can't help but notice it--is that the debate which Keynes and Hayek started in the 1930s, it's the same debate in Germany after the war; it's the same debate in India after Independence; it's the same debate we're having right now. It's always a question of whether we should have more or less government rather than more or less bottom-up and emergent decision-making. Guest: There is that aspect to it. But I don't want to be seen as treating all of these debates as the same debate. There are different aspects and angles and forms they take. There are different forms of government intervention that are being advocated in different times and places. So, in India, it's 5-year planning but with a privately owned economy. So, it's not quite the same as the Socialist Calculation debate, where people are talking about government owning and running everything directly. Russ: In Germany it's price controls. Guest: That's right. In post-war Britain, it's nationalizations. Russ: I like the story you tell of Erhard comes to Lucius Clay or was on the phone with Lucius Clay, the U.S. army commander in Germany. Tell that story. Guest: So, Ludwig Erhard is a classical liberal economist who has spent the war in Germany and manages to become the economic director of the U.S.-U.K. Occupation Bizone. There's a whole story about how he fortuitously fell into this job. But anyway, he's in charge. And jointly he and the U.S. military have decided to introduce a new currency, the Deutschemark to replace the old war currency, the Reichsmark; and General Clay's office gets wind that Erhard is planning not just to announce the new currency, but to announce decontrol of prices. Now, one of the ironies is that the Nazis had controlled prices and rationed goods all through the war--not surprising--but the U.S. occupation authorities continued the system when they took over. Just inertia, I guess; or they didn't know what else to do. Russ: Or maybe they felt it would enrage the populace and they needed to keep them on their side. Guest: Well, one of their advisors who urged them to keep the price controls and rationing in place was John Kenneth Galbraith, who was seconded by the U.S. State Department. Galbraith of course had been a price controller in the United States during the war; was in the process of writing a book called the Theory of Price Controls defending the practice. So he comes to Germany and says: There's no chance of getting recovery by decontrol. Anyway, against this background, Clay calls up Erhard and says: My people tell me that you're planning to announce a decontrol of prices and elimination of rationing for some goods; and they tell me that would be a big mistake. And Erhard says: That's okay, General Clay; my advisors also tell me it would be a big mistake; but I'm going to do it anyway. Erhard was actually being humorous. I mean, his advisors were actually telling him that it was a good idea, or at least some of them. He had people he was listening to who were telling him that if you want markets to clear, if you want production to revive, you need to decontrol prices and quantities. Russ: He had not joined the Nazi party during the war--is that correct? Guest: That's right. Russ: I just felt compelled to mention that. Guest: There are three heroic German economists I talk about: Erhard, Walter Eucken, who not only didn't join the Nazi party but participated in sort of an underground group which was planning what can we do after the Nazis lose to revive the economy after the war, something that was completely illegal to do. And Eucken was very lucky not to be arrested during the war because he was friends with a politician named Carl Goerdeler, who was involved in the Valkyrie Plot to assassinate Hitler. Goerdeler's character is actually portrayed in the movie Valkyrie with Tom Cruise. And then the third one is Wilhelm Roepke. Roepke is fired from his job at the University of Marburg for giving anti-Nazi speeches. And I start Chapter 6 with Roepke being visited by two members of the SS who suggest to him that if he'd like his job back he should stop criticizing the Nazis. And Roepke just tosses them out of his house. And once he's shut the door behind him, he says to himself: I'd probably better leave the country. And he spends the rest of the war in Instanbul. Russ: You point this out--it's important that people remember that the German words that form the acronym for Nazi were National Socialism, not some free market, right-wing--they were right-wing but they were not free market. So, people who were on the other side, the classical liberals-- Guest: Well, that's one reason the term right-wing is dangerous to use at all. Russ: Yeah, I agree.
28:37Russ: Let me ask you about Galbraith. Now, to those of us who like prices, us Hayekians who really are big fans of the ability of prices to signal information, steer resources, and do all their magical stuff; then we have people on the other side, and they appear throughout the book--people like Galbraith, who don't trust prices. There are people like Pigou who say there are externalities; we've got to adjust them. There's a lot of folks like that who appear throughout the book. And then we get an episode like this German episode. You could argue it's as close as we could get to a natural experiment: after Erhard removes price controls and is told it will be a disaster, it's not a disaster. Guest: Not at all. Almost immediately shelves fill with goods. The black market activity comes out in the open; the factories go back to work; construction crews start rebuilding the cities; and it's a remarkable recovery. Russ: So, I don't want to pick on John Kenneth Galbraith because he's not alone, and you and I might do the same thing in the face of empirical evidence that shakes our world view; but did he write an article saying he was wrong? Did anybody from that experience say: Wow, we really underappreciated what prices can do? And we should leave them alone. Except sometimes. Guest: Galbraith, I do not think ever wrote that article. And in fact he went from advising post-war Germany to advising post-war India. In fact, he became the Ambassador to post-war India under John F. Kennedy. And India was considering central planning of a sort, and Galbraith said: No question you have to do that; there's no other way for the economy to develop; if you rely on the market, nothing's going to happen. He gives a series of lectures which is published as a book in which he basically gives that advice: You are not going to develop unless you have a central government plan for generating the right amount of investment in heavy industry, and so on. So, I don't think Galbraith ever did learn that lesson. Russ: So, is the glass half full or half empty? One way to look-when I made that remark about the debates, same debate, it's really an ideological debate, a philosophical debate--one view says the glass is half empty; we are arguing about the same things over and over again. The other view says it's actually half full, because there are a bunch of things that are not on the table any more; central planning is not really on the table any more. Guest: That's right--comprehensive central planning is not. Industry by industry, we can debate about that. Russ: That's the half-empty back again. Guest: But price controls are no longer taken very seriously. Except industry by industry. In medicine if we call it something else, we can make price controls work. We call it cost containment. Russ: Although Milton Friedman said on this program in 2006 that the only reason price controls weren't on the table any more is because too many people are alive who lived through them in the 1970s in the United States; and as they start to die off, they become appealing again. I hope he's wrong about that. I suggested naively that it was due to the great job economists have done in explaining how bad they were. But--he had a different view. Given this view of economists, it's hard not to see the role of economists through rent-seeking eyes. The persistent faith in: We can do better than the price system on its own. There's a cynical temptation to say that: Well, economists would say that; it's what gives them power. Guest: I don't try to do that in this point. Russ: I know you don't. Guest: Somebody could write a different book in which we find out what private axes people have to grind. But I treat the economists who have bad ideas as sincere people who have bad ideas. Russ: Yeah; I think they could be sincere. Guest: Well, sincere and disinterested. Russ: Okay. I think that's impossible. But you are kind. But you are right; it's not in the book. The book is very non-judgmental about the motivations of folk; and it should be. I'm just speculating. I have no idea what really motivates people. But I think if you step back outside the profession, what appears to motivate people, based on the evidence, is power. Everybody else is motivated by it. Why wouldn't we be? Not a very attractive thought. Guest: And I'm sure we could both think of examples that would illustrate that. Russ: We'll keep them to ourselves though. It's funny; there's something classless or distasteful about suggesting that; but I think there's some truth to that. Guest: But I think we have to consider the ideas on their own merits: Will it help the economy be more prosperous? Russ: Oh, I agree with that. Otherwise you are in a form of ad hominem. Guest: That's right. Russ: But the point I'm really trying to make--and the other side would make it about us, too--is that the unwillingness to accept new evidence is damning of one's position. So, the left, the interventionists, would look at us and say: Isn't it obvious that 2008 proved that markets don't clear, markets are destructive, capitalism runs amuck now and then and government has to intervene? And the other side looks at that and says: Don't you realize that 1948 proved once and for all that prices are great? I guess we just keep telling our stories, our ex post stories. Guest: The story I tell about the financial crisis is: look, it happened under central banking, it happened under a heavily regulated banking system. It didn't happen under laissez faire; so how can it be an indictment of laissez faire? Russ: Well, the other side has an answer to that. Of course, I'm sympathetic to that view; I would be: that's my view.
35:00Russ: Let's turn to The Road to Serfdom, which Hayek writes in 1944. It's been treated as a prediction; and Hayek was very clear that it was a warning. What's the distinction? Guest: The distinction is that you can change your ways, or mend your ways, I sometimes put it. If, when central planning fails to deliver the goods you try even harder to centrally plan and eliminate black markets and every way in which people are trying to get around the plan, then you will make things worse. And you will end up throwing people in jail for being in the black market or for saying things you think are encouraging people to be in the black market, or criticizing the plan--you can accuse them of undermining the effectiveness of the plan. So, civil liberties become endangered. So, The Road to Serfdom is not simply a summary of Hayek's criticism of socialism or market socialism as a workable alternative. It's a warning about the political implications of it. If, when it doesn't work, the people trying to implement it don't stop and step back and say, we need to try something else, then you are headed down the road to serfdom. Then you are going to end up limiting people's liberty. But you can always step away from that path. Russ: Do you think it's anything to worry about today? Governments spending a lot of money in the United States relative to what it has in the past. Federal spending as a function of GDP is 25%, which is up dramatically from 19%-ish a couple of years ago. Guest: To be accurate, Hayek isn't really warning about that. In particular he is not warning about government collecting a lot in taxes and then writing a lot of people checks, like Social Security checks, rather than to spend their own money in markets. What he's worried about is government trying to control industry, trying to control output and planning and investment. That's what he's warning about. And we're in danger of that in the way we're treating the health care industry. Russ: And the financial sector perhaps. Guest: Yes. Russ: Education. Guest: Higher education. Special education. Russ: Lower, higher, yeah. It's hard to know how important it is. We're not close to tyranny in the United States; you have to avoid the temptation to get overly worked up about it. At least it seems that way to me. Guest: Right. But there is an important Constitutional issue that has been argued in front of the Supreme Court and we're waiting for their decision on it; which is: is it an infringement on your Constitutionally protected liberties to be told you have to buy health insurance, or you go to--well, I'm not sure what the penalty is. But you have to. Russ: I have to say--and I'm not sure how I feel about that--my first impulse is that I should be free not to buy health insurance. But there are so many other things the Supreme Court has condoned as Constitutional, it's hard to understand why this one is--it's the boiling the frog problem, the idea that you turn the heat up a little bit, a little bit, a little bit, just a little bit hotter; and then when the frog's boiled it's too late. But it's hard to understand why this is a quantum leap in temperature. Guest: Yeah; I'm with you. It's a step. It's not all that much bigger than the step of declaring everything interstate commerce. Russ: Yeah. There you go. Guest: It's where we are now, so if we want to draw a line somewhere, this is where we have. Russ: Yes, that's true. Keynes's reaction to The Road to Serfdom--Keynes as most people know died relatively young relative to Hayek, who lived to a ripe old age of 90-something. 92, 93? Guest: 92, I think. Russ: But Keynes died in the late 1940s. Guest: 1946. Russ: Hayek in 1992. But we do have Keynes's reaction to The Road to Serfdom, and we have Orwell's reaction, which is kind of cool because Orwell had also written 1984, which was a dystopian, apocalyptic vision, sort of his own Road to Serfdom. Describe their reactions. Because the Keynesian one, the full one, is not widely known. Guest: That's right. Keynes writes Hayek a letter and I believe he writes Hayek this letter while he's on a ship crossing the Atlantic from England to the United States to attend the Bretton Woods conference. It has two parts, and people sometimes just quote the first part. In the first part, Keynes says: It's a magnificent book and I'm in wholehearted agreement with it--in fact deeply moved agreement. And then the rest of it says: But, I don't agree with you when you say what we need is less planning; I think we almost certainly want more planning; and it will be safe to have more planning as long as the people in charge of the planning are people who share your and my liberal sensibilities. So, in a community where people think rightly, this is all safe; but yes, we have to worry about a community where people don't share these same ideas. So, he basically missed the point of the book, which is: it's not about the personalities of the people in charge. The very system selects people who will disregard liberal sensibilities or the rights of their fellow citizens. I mean, Hayek has an entire chapter entitled "Why the Worst Get On Top." So, Keynes missed that point. Keynes seemed to think that so long as he and his friends from Cambridge were in charge, everything would be okay. Russ: Well, I think the reason he missed that point--to defend Keynes--was that he was on top. He was the most influential public intellectual during his lifetime, by an enormous amount. He had the ear of the powerful and he occasionally had his hand on the throttle, on the steering wheel--whatever metaphor you want to pick. And I think it was reasonable--talking about casual empirical evidence as we were a few minutes ago, and natural experiments--his view was the Hayek was wrong: the worst don't get on top. Look at me--I'm not the worst. Which was for sure. And it's fine--civilized countries, the people who get power are the decent sorts, not the people Nazi Germany or the Soviet Union. They're not Beria and Himmler. It's people like Keynes and good Cambridge folk. Guest: One of the episodes I learned writing the book and put in the book is that Hayek's Road to Serfdom is reviewed by an economist named Evan Durbin, who was, you might say, the chief theoretician of the Labour Party at this time--the same Labour Party that was doing all the nationalizations just after the war. Russ: In England. Guest: And as he reviews Hayek's book, Durbin says: Well, this idea that it's going to lead to serfdom is way out of line. When we get into charge--we, the Labour Party--we absolutely will not have, say, forced allocation of labor to what jobs we think people ought to take. We'll still have a free market. And when Labour does get into power, this question arises: Do we want to allocate labor by sort of drafting people and telling people what industry they have to work in? And Durbin says: No, we don't want to go down that road. So, I think Hayek's argument may have helped moderate where planning led in England. They never really adopt a kind of ghost-plan system, a kind of Soviet planning system where quantities and transfer prices are dictated to firms. They do nationalize industries, and together the nationalized industries employ about a fifth of the workforce, so it is serious. But they don't try to centrally plan the entire economy, although some within the Labour Party wanted to. That doesn't become the dominant view. I think partly because they were sensitive to the civil liberties issues. Russ: Yeah. Could be. And we do still have--the Constitution here in the United States is pretty good about civil liberties. There's not been the erosion there that there's been in the economic policy area. Although with terrorism there's been some erosion. Obviously. Guest: Yes.
44:29Russ: Let's go back to India, because you spend a chapter on India, which I think is particularly important given its current situation in the world. And you go back and talk about the post-war planning era that they went through, the influence of Nehru, and Indian economists. There was a lonely voice in India, Shenoy. He stood up and said: This is a mistake, this centralized planning. And he was a very lonely voice in the wilderness. But ultimately a number of Indian economists who had been trained initially in a more interventionist way came around to his view. Is that correct? Guest: That's right. And I particularly focus on Jagdish Bhagwati, who is trained as a sort of planner. He and his whole generation come to Western universities and study with people like Tinbergen and Koopmans and Rosenstein-Rodin--people who are advocating central government planning of industrialization in order to lift poor countries out of poverty. And I quote somewhat extensively from an interesting interview Bhagwati gave, and he said: Look, we were trained by people like Nicky Caldor and Joan Robinson, two very left-wing Keynesians, somewhat influenced by Marxism, at Cambridge University. He says: Amartya Sen and I were trained by these people; and when we came back to India we were always looking for market failures and where we could fix them. And of course we could find them everywhere; and we thought empowering government to fix them would make the economy work better. And Bhagwati was initially rather dismissive toward Shenoy's critique of planning because Shenoy was not writing in the most rigorous mathematical style that the younger economists had been trained in. But Bhagwati comes around when he looks at the actual results of the planning effort. The way it was implemented in India, firms were given quotas and if you wanted to produce more than your quota you had to get permission. You had to get a permit. And if you wanted to enter an industry you weren't already in, you had to get a permit. If you wanted to import foreign equipment, you had to get a permit. So, it was called the Permit Raj, or the Permit Regime. And the economy just stagnated, produced a very weak rate of growth. And Bhagwati looked around the world and said: Other countries are growing faster; we really need to rethink this in India. And that was very influential on his generation of Indian economists, who had been sort of trained in the planner approach to things. Russ: Certainly after the Indian economy was liberalized in the 1980s and 1990s-- Guest: Well, the liberalization began. It isn't finished. Russ: Right, no it isn't finished at all. But certainly it's much more free than it was in the 1950s and 1960s. Guest: Yeah. The permits are gone. Russ: So, the economy is growing well now. But I was surprised at how well it grew then. It challenged my own preconceptions. When you described the Permit Regime and the philosophy of Nehru and others toward planning, you'd think they'd have stagnated. And yet it appeared--my crude calculation from your summary was like 3% a year. Not bad. Guest: That's right. Russ: So, they didn't grow as fast as Korea. Big deal. Korea is a tough standard to match. Is it reasonable to hold them to that? Guest: Well, it's 3%; it's less than that per capita, because the population is growing. So, it's a little over 1% per capita. Russ: Not so good. Fair enough. Guest: The description of it often in the literature is that it was the "Hindu rate of growth", which is actually a joke that a lot of people don't get when they use the term. It was supposed to be a play on the term "secular rate of growth"; in India, there are mostly Hindus, so it's the Hindu rate of growth. Russ: Secular meaning over time, rather than non-religious. Guest: Yes. Russ: That's a bad joke, a pretty obscure joke. Guest: It was considered a pretty meager rate of growth at the time, and it was, in fact, per capita. Russ: That's a pretty good point. I have to say, when I read that passage, it struck me that maybe a better way of understanding it, going back to my public choice view of economists, is that it wasn't so much that India's economists got free market, but that India got more free market and the economists came along. Do you have any feel for how important they were--were they leaders or followers? Guest: That's a very good question. I give some evidence that there was influence from economists running to the government; and of course the current Prime Minister, Manmohan Singh, was one of the leaders of the decontrol movement in the 1980s. So, I'd like to think that ideas helped influence him in changing policy. But of course what made the policy change possible was a crisis--in particular, it was a rupee crisis. There was a devaluation of the rupee. And then suddenly ideas about decontrol as a way of reviving the economy because politically palatable. But the ideas had to be there before they could be taken off the shelf. Russ: Yeah. It's always a question to me whether those are just convenient covers for what they would have done anyway. I don't know. Guest: I think the idea you referred to earlier of Friedman's, that people have to learn from experience that a certain program of control doesn't work, is true. And it was true in the Indian case. And so it's more about learning by doing. But I think somebody has to tell you what you need to learn from what you see. It's easy to learn the wrong lesson from experience. Russ: True. Speaking of which: People who have different ideology from yours want to learn very different things from the current European problems, which we referred to earlier. Would they learn the same thing from India, do you think? Is there anybody who wants to defend the earlier period from India and thinks they are on the wrong path now? Again, this is sort of the half-full version of where we think we are. Guest: I can't think of anybody. I mean, there are Indian politicians and bureaucrats of course who don't want decontrol, deregulation to proceed too far, too fast, because they have their interests and constituencies to look out for. But I can't think of any respectable economists who think the Permit Regime was the way to go, in retrospect. Russ: I think you are right.
52:03Russ: Let's turn to the United States and monetary policy, which we talked about briefly earlier, and which you talked about at length in your chapter on Bretton Woods, and monetary policy generally. And of course it runs through other parts of the book. We had a rather remarkable time in U.S. monetary policy history, although I don't think there's any likelihood that tomorrow or even in January of 2013 there's going to be an abolition of the Federal Reserve. Guest: Yeah, I'd agree with that. Russ: But it's on the table. On the table is a radical remaking, an impossible reimagining of monetary policy. Are you surprised that that's happened in your lifetime? It's a tribute to your work to some extent. Do you think anything will happen from it? Of course, it goes back to the argument we just had--I don't think you are a follower, but hard to know how much of a leader you are; I like to think you are, that you've had an impact on this debate. Certainly the ideas are there for others to grab. And they are grabbing them. They are actually taking seriously the possibility of a radical change of monetary policy. Guest: Well, yeah, I don't take any credit for that. But I have to say I am surprised that in my lifetime somebody had a bestseller entitled End the Fed. And the author of the book was invited to be on the "Daily Show" and plugged the book and was treated respectfully. Russ: Yeah. That's shocking. Guest: So the climate can change a bit. Russ: What do you think is in the realm of the feasible? Or the imaginable for how things might change? Guest: Well, in the next ten years? Russ: Yeah. Guest: I think it's feasible to put some kind of single mandate on the Federal Reserve System to constrain their freedom of action. I think it's possible to nail down some rules which would make it possible to prevent the ad hoc crony interventions they made during the 2007-2008, where they decided to bail out Firm X but not Firm Y, or they decided to overpay for assets, or they decided we're going to give loans at below-market interest rates to the following list of banks. Those are important reforms. But I agree with you that it's not going to be on the agenda in the next ten years to shut down the Fed. It may be possible to open up alternatives: decriminalize the use of gold and silver coins, decriminalize the use of online gold transfer services or transfer services in other currencies that make it possible for people to have more easy access to an alternative to Federal Reserve currency. Federal-Reserve denominated payments. Russ: That would be good. Those would all be good. When you talk about the single mandate, I assume you would keep the mandate for a low rate of inflation. And you'd get rid of the mandate to keep low employment. Guest: Yes. I would take away any mandate to monkey with a real variable, and just have a mandate for a single nominal target. I would prefer something other than the price level. I would prefer nominal income or an index of producer prices, following Hayek, rather than consumer prices. But something like that. Russ: The irony to me--you and I see totally eye to eye on the crony part and the ad hoc interventions--what's weird to me--we see eye to eye on the next part, too--but what's weird to me is that the Fed is despised not just for that, which is what really upsets me, but also for its grotesque expansion of the money supply. But that hasn't made it out into the real economy. Guest: Well, that's right. It's only the monetary base that's expanded grotesquely. Russ: And when you ask them--Bernanke when he testifies or speaks on what he's done, he always says: Well, I have a mandate to fight inflation and I don't want to do more than this. I've done plenty. We've done enough. If we need to, we'll do more; we could, but we've done enough. Seems to me they've done very little. They've printed a lot of money but made sure--either made sure or for whatever reason--it's stayed in the banks. I don't see monetary policy as being very expansionary. And certainly Scott Sumner, who is in the Hayekian nominal income camp that you just mentioned--he'd trace a different lineage to it, but he'd certainly be in favor of that--he would say the Fed has failed terribly to keep its single mandate. And its second mandate. It's failed both. Guest: Well, yeah. Scott has an article entitled "The Real Problem Was Nominal," where he thinks the reason we have a slow, slow economy is that we are not back up to the nominal income path that we were on before the financial crisis. That the Fed fell asleep at the switch and let nominal income drop; that we had two quarters of actual deflation. And that it needs to get back up to the trend line we were on before. I'm not so sure we need to get back up to the trend line we were on before. Nominal income is currently growing at more than 5%, so Sumner's view is that it should continue to grow at 5% per year. I would rather see it grow at 0% per year. But I do recognize that you need to prepare the public's expectations for a switch to a less inflationary regime. Russ: When you said 0%, you didn't mean nominal income--you meant prices. Guest: I meant nominal income. Russ: You wouldn't want nominal income to grow at zero. Guest: Why not? Russ: You want it to be flat? Guest: So that as real output grows, prices decline. Russ: Hmmm. Guest: We could take another hour to talk about that. Russ: Yeah. I just want to make sure I understand the numerical example. You want to get to a point where real income is growing--I understand. Nominal income is flat but prices are falling. You want steady deflation. You would prefer to see fixed nominal income with steady deflation as productivity grows. Guest: That's right. It's a productivity norm, as George Selgin calls it. Russ: Let's take two minutes to talk about that, since we put it on the table. I know we could take an hour. The standard argument is that that would be very destructive. Partly because of expectations. I would say only because of expectations. Do you worry about those? Guest: Yes. So, like I said, you need to prepare people to expect it. You don't want to continue people raising their prices and raising their reservation wages when they are looking for a job at a 3% rate per year until they find they've priced themselves out of the market. You want them to charge prices and demand wages that are consistent with what they can actually get. But what I'm talking about is approximated by the regime we had under the classical gold standard, where when the world output of goods grew faster than the stock of gold, you had gradually declining prices. And people enjoyed a higher standard of living because everything got cheaper and cheaper. Russ: But that's true because of productivity, not because nominal prices were falling. Guest: That's right. But that's the way the productivity gain was communicated to them. Russ: How long was that regime in place? Guest: Well, basically from 1879 to the eve of WWI. You didn't have falling prices every year, but you had a long patch of prices falling at about 1% a year. Russ: I find it fascinating, the fear of deflation that we live in now. But I do accept the point that in a time when people expect inflation, deflation can be destructive. Guest: So, we do need to distinguish between destructive deflations, like 1930-1932, and benign deflations, that take place because output is growing. How can that be harmful. Russ: Yeah. Well, that will be a subject for another podcast. I'd like to talk some more about that. Guest: A technical footnote--we do need to make adjustments for things like population growth and so on.

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