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April 29, 1971 D ear Milton: Thanks for your le tte r. Out conversation over the phone was m uch too b rie f and apparently has led to some* m isu n d e rsta nding. I have no q u a rre l with y o u points I, 3. 4, o r 5* I do differ, how ever, on point 2, and I think I can cite a lo t of h isto ry to support m y position. In aay,<nrenV we a r e dealing h e re w ith a very sh o rt te rm m a tte r, and you m a s t not exag g erate its Im plications fo r the future. I want to h e a r good news about Rose eoan. My b est to you both. As always, A rth u r F . B urns P ro fe sso r M ilton F riedm an The U niversity of Chicago D epartm ent of Econom ics 1126 E ast 59th S treet Chicago, Illinois THE UNIVERSITY DEPARTMENT 1126 EAST CHICAGO OF C H I C A G O OF E C O N O M I C S 59TH STREET • ILLINOIS 60637 ; A p r il 26, 1971 D e a r A r th u r : A f t e r p o n d e r in g o v e r ou r c o n v e r s a t io n y e s t e r d a y , I a m m o v e d t o add s o m e c o m m e n ts on a fe w it e m s . 1. M o n e y and in t e r e s t r a t e s . Y o u r c o m m e n ts s e e m e d t o m e t o a ttr ib u te a m u ch l a r g e r r o le t o the F e d in a ffe c t in g in t e r e s t r a t e s than is ju s t ifie d b y e it h e r t h e o r y o r e x p e r ie n c e . On t h e o r e t ic a l g r o u n d s , F e d t r a n s a c t io n s a r e a s m a ll p a r t of the to ta l m a r k e t f o r c r e d it ; th e y d o m in a te the b e h a v io r o f the quantity of m o n e y but n ot the s u p p ly o r d e m a n d f o r lo a n s . On an e m p ir ic a l l e v e l , the F e d and o th e r c e n t r a l ban ks have r e p e a t e d ly f a ile d w h en th e y h a v e t r ie d t o a lt e r in t e r e s t * o r the in t e r e s t r a te s t r u c t u r e a p p r e c ia b ly . O p e r a tio n T w is t is w id e ly r e c o g n iz e d t o h av e b e e n a f i a s c o . T h e a tte m p ts in la te 1965 and e a r ly 1966, and a g a in in th e s e c o n d h a lf of 1968, t o h old r a t e s d ow n a r e h a r d ly e n c o u r a g in g p r e c e d e n t s . T h e r e is n o d ou bt that th e F e d c a n a f fe c t s o m e s h o r t - t e r m in t e r e s t r a t e s but t o d o s o t o an y s ig n ific a n t d e g r e e in v o lv e s m a jo r e f fe c t s on m o n e t a r y g r o w th and e v e n th en ca n s u c c e e d f o r on ly a fe w m o n th s . The u ltim a te e f f e c t s a r e in p r e c i s e l y th e o p p o s it e d ir e c t io n . M o r e r a p id m o n e t a r y g r o w th in it ia lly lo w e r s in t e r e s t r a t e s , but th is e f fe c t la s t s f o r , at m o s t , s ix m on th s o r s o and is th en r e v e r s e d , s o that it s u b s e q u e n tly p r o d u c e s h ig h e r in t e r e s t r a t e s . T h is has b y n ow b e e n th o r o u g h ly d o c u m e n te d b y C a gan , G ib s o n , S a rg e n t, Y o h e and K a r n o v s k y . T h e s h a rp d e c lin e in s h o r t - t e r m r a t e s in 1970 w a s p a r t ly due t o the s h o r t ru n e f fe c t s o f the a c c e l e r a t i o n o f m o n e t a r y g r o w th a ft e r F e b r u a r y 1970 but m o s t ly t o the d e la y e d e f f e c t s o f th e m o n e t a r y r e s t r a in t in 1969. S im i l a r ly , w h a te v e r th e F e d d o e s w ith in c o n c e iv a b le l i m i t s , s h o r t - t e r m r a t e s Photocopy from Gerald R. Ford Library M r. A r th u r B u rn s C h a ir m a n , B e a r d o f G o v e r n o r s F e d e r a l R e s e r v e S y s te m W a s h in g to n , D. C . 20551 w ill r i s e in 1971 b e c a u s e o f th e d e la y e d e f fe c t s of the r a p id m o n e ta r y g ro w th of 1970. C o n c e n tr a tio n on in t e r e s t r a t e s , and on the im m e d ia te e f fe c t s on r a t e s , is a C e n tr a l B ank d e lu s io n that s e e m s a lm o s t im p e r v io u s t o e v id e n c e . T h e r e is n o m o r e c e r t a in r o u te t o e r r a t ic and u n w ise m o n e t a r y p o lic y . M any the t im e I have- h e a r d y o u in v eig h a g a in s t -this d e lu s io n in the p a st, w h ich is w hy I fe lt s o c o n fid e n t that y o u w ou ld not fa ll p r e y t o it w hen y o u to o k o v e r . D o le t m e u r g e y ou t o c h e c k the a c c u r a c y of th e in t e r e s t r a te p r e d ic t io n s o f y o u r s ta ff, and p a r t ic u la r ly f o r s o m e m on th s ah ea d. 2. In te r e s t r a t e s and the e x p a n sio n . Y o u r r e m a r k that p e r m it t in g s h o r t - t e r m r a t e s t o r i s e m ig h t h av e n ip p ed a p u ta tiv e e x p a n s io n in the bud s e e m s t o m e to put the c a r t b e fo r e the h o r s e . G iv e n m o d e r a t e m o n e t a r y e x p a n s io n , w hat w ou ld c a u s e r a t e s t o r i s e ? T h e r i s i n g d em a n d s f o r c r e d it c o m in g f r o m an e x p a n s io n in e c o n o m ic a c t iv it y . In d eed , I have in t e r p r e t e d the r e c e n t te n d e n c y f o r r a t e s t o r i s e d e s p it e th e m a s s iv e a c c e le r a t io n of m o n e t a r y g r o w th in the p a s t fe w m on th s a s the s t r o n g e s t f p ie c e o f e v id e n c e c o n fir m in g the e m e r g e n c e o f e x p a n s io n . I fin d it d i f f i c u lt t o s e e an y l o g i c a l l y co h e re n t a rg u m e n t that ca n m a k e the in t e r e s t ^ r a t e m o v e m e n t an in d ep en d en t s o u r c e of, o r o b s t a c le to , e x p a n s io n . T h e m o n e t a r y e x p lo s io n p r o d u c e d b y f e a r o f n ip p in g the e x p a n s io n in th e bud w ill f o r c e y o u t o u n d erta k e s e v e r e r e s t r i c t i v e m e a s u r e s m u c h e a r l i e r in th e e x p a n s io n than w ill b e d e s ir a b le on o th e r g r o u n d s . 3. T h e r e c o r d of m o n e t a r y g r o w th . Y o u r d e fe n s e of r e c e n t p o l i c y in te rm s of a lo n e and f o r a r ig id p a ir o f d a te s is c o m p le t e ly out of c h a r a c t e r . I le a r n e d f r o m y o u t o c a s t m y v is io n m o r e b r o a d ly , t o lo o k at s e v e r a l s e r i e s , and t o lo o k at the w h o le r e c o r d and n ot on ly s e le c t e d d a te s. On s u c h a v ie w , m o n e t a r y g r o w th w a s a m p le f r o m F e b r u a r y 1970 t o J a n u a r y 1 9 7 1 --m u c h m o r e r a p id in M 2 than in M-^ b e c a u s e of r e i n t e r m e d ia t io n a s in t e r e s t r a t e s c a m e th ro u g h th e r e g u la tio n Q c e ilin g s . It is h a rd t o f o r m a g o o d ju d g m e n t on e it h e r a g g r e g a t e a lo n e b e c a u s e , p r i o r t o abou t 1966, w e n e v e r e x p e r ie n c e d s u c h d iv e r s e m o v e m e n t s in th e s e t w o m a g n itu d e s h en ce t h e r e is n o s a t is f a c t o r y b a s is of e x p e r ie n c e on w h ich t o ju d g e w h ich is m o r e c l o s e l y c o n n e c t e d w ith o th e r e c o n o m ic m a g n itu d e s . A n a ly t ic a l c o n s id e r a t io n s r e c o m m e n d lo o k in g at both. M y ju d g m e n t, and I b e lie v e y o u r s , t o o , is that m o n e t a r y g r o w th w a s , if an yth in g, s o m e w h a t t o o e x p a n s iv e f r o m F e b r u a r y 1970 t o J a n u a ry 1971 but n ot d a n g e r o u s ly so. F r o m J a n u a ry 1971 t o date m o n e t a r y g r o w th has b e e n e x p lo s iv e and the e x p lo s io n has c o n tin u e d f o r ab ou t te n w e e k s b y n ow . F o r M 2 , t h e r e is - 3 - n oth in g lik e it in the r e c o r d s in c e W o r ld W a r II. F o r M ^, the c l o s e s t r e c e n t e p is o d e is J a n u a r y t o M a rch ,1967, h a r d ly a g o o d p r e c e d e n t , and e v e n that w a s l e s s e x t r e m e . ' 4. M y a n s w e r t o y o u r q u e r y w h eth er I w as g ettin g c o o p e r a t io n f r o m the F e d , w h ile l i t e r a l l y c o r r e c t , put th e m a tte r in th e w r o n g p e r s p e c t iv e . O p e r a tin g the d e s k th r o u g h in t e r e s t r a t e s o r th r o u g h r e s e r v e s o r th eir" e q u iv a le n t is p r i m a r i l y an o p e r a tin g q u e s tio n f o r the F e d . M y c o n c e r n w ith it is n ot a s a s c h o la r , not a s p a r t of ou r r e s e a r c h p r o g r a m h e r e , but s o l e l y b e c a u s e I b e lie v e it is s o im p o rta n t f o r g o o d m o n e ta r y p o lic y . I a m n ot s e e k in g c o o p e r a t io n f r o m the F e d t o s e r v e m y s c h o la r ly in t e r e s t s . I h av e s im p ly b e e n t r y in g t o s e r v e a s a c a t a ly s t , t o p r o v id e a fo r u m f o r F e d p e o p le , in th e h op e of s tim u la tin g th e F e d t o d o the jo b that it a lo n e ca n do. 5. I r e m a in p e r s u a d e d , a s I have b e e n f o r at le a s t tw o y e a r s now , that th e F e d s h o u ld g iv e h igh p r i o r i t y t o tw o ta s k s : (1) im p r o v in g th e m o n e t a r y s t a t is t ic s ; (2) a lt e r in g the o p e r a tin g p r o c e d u r e s at the D e s k . T h is r e m a in s an u r g e n t ta s k . I h op e y o u w ill p a r d o n m e f o r b u rd en in g y ou w ith t h e s e c o m m e n ts . I r e a l i z e how d iffic u lt y o u r ta s k is and how b e s e t w ith p r e s s u r e s and c r i t i c i s m s on a ll s id e s . T h e u rg e n t n e e d is t o k e e p o n e 's e y e fix e d on th e lo n g e r - r a n g e p r o b le m s and the u ltim a te g o a ls and not b e c o m e d iv e r t e d b y th e t r a n s i t o r y a n n o y a n c e s . It is b e c a u s e I h ave s o m u ch c o n fid e n c e in y o u r a b ilit y t o d o s o that I v e n tu re t o p a s s t h e s e c o m m e n t s on. C o r d ia lly y o u r s M ilto n F r ie d m a n ah
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