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Fiscal Policy

The Seventh Annual Arthur K. Salomon Lecture







Fiscal Policy

Milton Friedman

Walter W. Heller

W •W •Norton & Company •Inc •


Copyright © 1969 by The Graduate School of Business
Administration, New York University

Library of Congress Catalog Card No. 79-80110


Published simultaneously in Canada by
George J. McLeod Limited, Toronto

1 2 3 4 5 6 7 8 9 0




Is Monetary Policy Being Oversold?


Walter W. Heller
Has Fiscal Policy Been Oversold?

Milton Friedman

/ Walter W. Heller



Milton Friedman









The Graduate School of Business Administration of New
York University considers that one of its important mis­
sions is to provide a forum for the exchange of new ideas
and knowledge which may affect the community and the
As we prepared for the Seventh Annual Arthur K. Salo­
mon Lecture on November 14, 1968, we decided to vary
our format in an election year by having two speakers on
the program instead of one as in previous years. In light of
the fact that a new administration would be chosen eight
days before the lecture, it was our purpose to present a
meaningful dialogue on a significant economic issue of the
Therefore, we invited two well-known apostles of eco­
nomics with widely divergent viewpoints to present their
opinions on what each considered the most appropriate



means to stabilize the economy.
Professor Milton Friedman, the leading spokesman for
the monetarist school of thought, was asked to comment on
the monetary policy which he considers necessary to accom­
plish economic stabilization, and Professor Walter W. Hel­
ler, the nation’s foremost advocate of the neo-Keynesian
economics, was called upon to discuss the importance of
fiscal policy as an approach to this problem.
Since each man could easily be identified with one or
the other of the presidential candidates, we hoped that
their confrontation would give some indication of the eco­
nomic philosophy likely to affect, at least to some degree,
the monetary and fiscal policies. In addition, the choice of
these two outstanding economists to appear for the first time
anywhere in a public debate would— we were confident—
attract nationwide attention in the world of business and
The response exceeded our expectations. Not only was the
lecture hall filled to capacity, but an overflow audience had
to be served by closed-circuit television installed in several
classrooms. Virtually all media gave the lecture extensive
coverage and the response by the press, TV, and radio sur­
passed any that we had received at previous lectures in the
Space does not permit us to enumerate at length the ac­
tivities, honors, and accomplishments of the two men who
shared our platform. Each is an authority on economics and
related disciplines. Each is active in research agencies and
in learned societies. Dr. Milton Friedman is the Paul Snow­
den Russell Distinguished Service Professor of Economics
at the University of Chicago. Dr. Walter W. Heller is Re­
gents’ Professor of Economics at the University of Min­



In 1967, Dr. Friedman was elected president of the Amer­
ican Economics Association, which previously had given
him the John Bates Clark Medal. He has been an economic
adviser to presidential nominee Barry Goldwater and to
President Richard M. Nixon. Author of many books and
articles on economics, he writes a column for Newsweek
Dr. Heller was appointed chairman of the President’s
Council of Economic Advisers by President John F. Ken­
nedy and remained in that capacity until late in 1964. Later,
he served as consultant to the Executive Office of the Presi­
dent during Lyndon B. Johnson’s Administration. A widely
published author, Dr. Heller is considered the principal eco­
nomic spokesman for Keynesian economic policies. Dr.
Friedman, on the other hand, is considered one of the prin­
cipal critics of such economic policies.
The Friedman-Heller lecture, as presented in these pages,
includes some revisions of the verbal exchange. Notes and a
glossary of terms and references have been added for the
convenience of the reader.
J o seph


T aggart


November 14 , ig 68

The Arthur K. Salomon Lecture Series
The Arthur K. Salomon Lecture Series, established by a grant from
the partners of Salomon Brothers & Hutzler in memory of a found­
ing partner of the firm, is one of the diversified services provided
by the Graduate School of Business Administration of New York
University. In these meetings, distinguished scholars and men of
national and international repute have shared their experiences,
their wisdom and their leadership in the examination of crucial
economic and financial problems of the day.

Previous Arthur K. Salomon lecturers:
February 1963
P e r Ja c o b sso n

Chairman of the Executive Board and Managing Director
International Monetary Fund
“The Role of Money in a Dynamic Economy”
November 1963
A l la n S p rou l

Federal Reserve Bank of New York 1941-1956
“Money Will Not Manage Itself”
November 1964
R u d o lp h A. P e te r s o n

Bank of America National Trust and Savings Association
“Debt in a New Environment”
November 1965
Jo h n K e n n e th G a l b r a i t h

Paul F. Warburg Professor of Economics
Harvard University
“Economic Policy Since 1945 : The Nature of Success”



T h e R ig h t H o n o r a b le
T h e E a r l o f C r o m e r , M.B.E.

Formerly Governor of the Bank of England
“The International Capital Markets”

December 1967
P i e r r e - P a u l S c h w e it z e r

Managing Director
International Monetary Fund
“The New Arrangements to Supplement
World Reserves and Their Implications
For the Developing Countries”


Is Monetary Policy
Being Oversold?



J V l y intent today is neither to praise nor to bury that
towering iconoclast Milton Friedman, for to praise him and
his works would absorb far too much of my limited time,
and to bury him is, in a word, impossible.
Also, a word about the title, "Is Monetary Policy Being
Oversold?” You should keep in mind that a speech title, like
a biblical text, is a point of departure— and depart from it
I shall. In one sense, in striving for symmetry with Milton’s
title, I may have made it too broad. It might better have
read ‘I s Money Supply Being Oversold?” But since the twin
topics under review are really fiscal versus monetary policy
and discretionary versus automated policy, this title may be
too narrow. In this sense, it might better have read “The
Future of Discretionary Fiscal— and Monetary— Policy.”
At the outset, let’s clarify what is and what isn’t at issue
in today’s discussion of fiscal-monetary policy, both inside


Walter W. H eller

and outside this hall. When we do this, I m afraid that the
lines may not be drawn quite as sharply as the journalists,
who love a fight and drama, would have us believe with
their headlines like "Is Keynes Defunct?” But have no fear.
There will be plenty of grist for the mill of today’s dialogue!
The issue is not whether money matters— we all grant
that— but whether only money matters, as some Friedmanites, or perhaps I should say Friedmanics, would put it. Or
really, whether only money matters much , which is what I
understand Milton Friedman to say— he is more reasonable
than many of the Friedmanites.
It’s important in this connection, too, to make clear that
the economic policy of the i96o’s, the "new economics” if
you will, assigns an important role to both fiscal and mone­
tary policy. Indeed, the appropriate mix of policies has
often been the cornerstone of the argument: It was, for
example, early in the Go’s, when we feared that tight money
might stunt recovery, might thwart the expansionary impact
of the 1962-64 income tax cuts. It was again, in 1966, when
in strongly urging a tax increase, we put heavy emphasis on
avoiding the ill effects of imposing too much of the burden
of restraint on Federal Reserve policy. It was once again,
in 1967-68, when we sought the surtax in considerable part
to insure against a repetition of the monetary crunch of
1966. And it will be in the future, when full employment
surpluses in the federal budget may be the only defensible
way to buy the monetary ease that commitment to rapid
economic growth implies. In short, to anyone who might
fear that the "new economics” is all fiscal policy, the record
offers evidence, and the new economists offer assurance,
that money does matter.
With that straw man removed, we can identify the real
monetary issues with which the monetarists confront us:

Is Monetary Policy Being OversoldP


First, should money supply be the sole or primary guide to
Federal Reserve policy? Should it, at the very least, be
ranged side by side with interest rates and credit availa­
bility in the Fed’s affections? Second, should we rely on the
Federal Reserve authorities to adapt monetary policy flex­
ibly to changing economic events and to shifts in fiscal
policy, or should we instead not only enthrone money sup­
ply but encase it in a rigid formula specifying a fixed in­
crease of 3, 4, or 5 per cent a year? In other words, should
we adopt the Friedman rule and replace Bill Martin at the
Fed with an exponential curve— or would we simply be
throwing him one?
Again, in the fiscal field, the issue is not whether fiscal
policy matters— even some monetarists, perhaps in un­
guarded moments, have urged budget cuts or tax changes
for stabilization reasons. The issues are how much it mat­
ters, and how heavily we can lean on discretionary changes
in taxes and budgets to maintain steady economic growth
in a dynamic economy: Is the close correlation of activist
fiscal policy and strong expansion— which has brought our
economy into the narrow band around full employment— a
matter of accident or causation? Does a fair balancing of the
successes and shortcomings of active fiscal policy suggest
( a ) that we should now take refuge in rigid fiscal rules like
the lock-stop tax cuts espoused by Barry Goldwater and
Milton Friedman, or rather (b ) that we need to modify our
fiscal institutions— especially our procedures for cutting or
boosting taxes— to step up their speed and precision, espe­
cially in dealing with inflation?
Pervading these operational issues is a basic question of
targets, as yet not answered in any conclusive way by either
analysis or evidence. Should the target be, as the Phillipscurve analysis suggests, somewhat less unemployment in


Walter W. Heller

exchange for somewhat more price creep? Or is this trade­
off illusory, as the adherents of the classical real-wage doc­
trine are now reasserting? To hark back to words and men
of the past— Is a little inflation like a little pregnancy? Or
was Sumner Slichter prophetic when he said that if we
wanted to live with steady full employment and brisk
growth, we also had to— and could— live with a little
chronic inflation, with a price creep of 2 per cent or so
a year?
Summing up the key operational issues, they are: Should
money be king? Is fiscal policy worth its salt? Should flexible
man yield to rigid rules? You will note that I purposely cast
these issues in a show-me form to put both the monetarists
and the new economists on their mettle.
Let me review with you the factors that say "stop, look,
and listen” before embracing the triple doctrine that only
money matters much; that control of the money supply is
the key to economic stability; and that a rigid fixed-throttle
expansion of 4 or 5 per cent a year is the only safe policy
prescription in a world of alleged economic ignorance and
human weakness and folly.
One should note in passing that Professor Friedmans
findings and conclusions fit into a steady process of rescuing
monetary policy from the limbo into which it was put by
the interest-rate peg of World War II and the late 40^—
a rescue effected by the Monetary Accord of 1951 and by
the subsequent steady expansion of its scope. This has been
a healthy renaissance. But having been resurrected from
the debilitating rate peg of the i940,s, does monetary policy
now face the threat of a new peg, Milton’s money-supply
peg, in the years ahead? Is it doomed to go from cradle to
grave in twenty years?
I exaggerate, of course, for emphasis. President Nixon,

Is Monetary Policy Being Oversold?


for example, has been reported as saying that he doesn’t
buy the fixed-throttle formula. At the same time, he has
reportedly suggested that he intends to put more emphasis
on money supply. So this is a particularly apt juncture for
a close look at the monetarists’ doctrine.
Now, turning to doubts, unresolved questions, and un­
convincing evidence, I group these into eight conditions that
must be satisfied— if not completely, at least more con­
vincingly than they have been to date— before we can even
consider giving money supply sovereignty, or dominance,
or greater prominence in economic policy. These conditions
center on such questions as: Which money-supply indicator
do you believe? Can one read enough from money supply
without weighing also shifts in demand and interest rates
— that is, don’t both quantity and price of money count?
Don’t observed variations in monetary time lags and velocity
cast serious doubt on any simple relation between money
supply and GNP? Can a rigid monetary rule find happiness
in a world beset with rigidities and rather limited adjust­
ment capabilities? That is, is the rigid Friedman rule per­
haps a formula made in heaven, that will work only in
I claim no originality in my catalogue of doubts. My debt
to people like James Tobin, John Kareken, Lyle Gramley,
and others, whose painstaking research and analysis I draw
on, is virtually complete.1
The first condition is this: the monetarists must make up
their minds which money-supply variable they want us to
accept as our guiding star— Mi, the narrow money supply,
just currency and bank deposits; M2, adding time deposits;
or perhaps some other measure like the "monetary base?”
And when will the monetarists decide? Perhaps Milton
Friedman has decided; but if he has, his disciples do not


Walter W. Heller

seem to have gotten the word.
Let me give you an example. Last spring, Mi (the money
stock) was all the rage. It spurted for four months in a row,
from April through July. But when that slowed down, most
of the alarmists switched horses to M2 (money plus time
deposits), which quite conveniently began rising sharply in
July. And listen to the latest release from the St. Louis Fed­
eral Reserve Bank— the unofficial statistical arm of the
Chicago School— which very carefully throws a sop to all
sides: “Monetary expansion since July has decelerated as
measured by the money stock, accelerated as measured by
money plus time deposits, and remained at about an un­
changed rate as measured by the monetary base. As a result,
questions arise as to which monetary aggregate may be
currently most meaningful in indicating monetary influence
on economic activity.” 2 Precisely.
It doesn’t seem too much to ask that this confusion be
resolved in some satisfactory way before putting great faith
in money supply as our key policy variable.
Second, I would feel more sympathetic to the moneysupply doctrine if it were not so one-track-minded about
money stock— measured any way you wish— as the only
financial variable with any informational content for policy
As Gramley has noted, for example, if we look at money
stock alone for 1948, it would indicate the tightest money
in the post-war period.3 Yet, the rate on Treasury bills was
1 per cent, and on high-grade corporates 2%per cent. ( That
does sound like ancient history.) But isn’t it curious that
we had tight money by the money-supply standard side by
side with 1, 2, and 3 percent interest rates? We were
swamped with liquidity— so interest rates do seem to have
been telling us something very important.

Is Monetary Policy Being OversoldP


Or, if we look at 1967 only in terms of the money stock,
it would appear as the easiest-money year since World War
II. Mi was up 6 per cent, M2 was up 12 per cent. Yet
there was a very sharp rise in interest rates. Why? Probably
because of a big shift in liquidity preference as corporations
strove to build up their protective liquidity cushions after
their harrowing experience the previous year— their mone­
tary dehydration in the credit crunch of 1966. Again, the
behavior of interest rates is vital to proper interpretation
of monetary developments and guidance of monetary policy.
Interest rates are endogenous variables and cannot be used
alone— but neither can money stock. Either interest rates
or money stock, used alone, could seriously mislead us.
I really don’t understand how the scarcity of any com­
modity can be gauged without referring to its price— or,
more specifically, how the scarcity of money can be gauged
without referring to interest rates. It may, strictly speaking,
be wrong to identify any market interest rate as the price
of money. In the U. S., no interest is paid either on demand
deposits or on currency. But this is quibbling. The point
is that a change in the demand for money relative to the
supply, or a change in the supply relative to demand, results
generally in a change in interest rates.4 To insist that the
behavior of the price of money ( interest rates) conveys no
information about its scarcity is, as Tobin has noted, an
“odd heresy.”
Third, given the fluctuations in money velocity, that sup­
posedly inexorable link between money and economic ac­
tivity has yet to be established. We should not forget this,
however sweet the siren song of the monetarists may sound.
We should not forget the revealing passage from that monu­
mental Friedman-Schwartz volume, A Monetary History of
the United States, that makes my point:


Walter W. Heller

. . . the observed year-to-year change in velocity was
less than 10 per cent in 78 out of 91 year-to-year changes
from 1869, when our velocity figures start, to i960. Of
the 13 larger changes, more than half came during
either the Great Contraction or the two world wars,
and the largest change was 17 per cent. Expressed as
a percentage of a secular trend, velocity was within the
range of 90 to 110 in 53 years, 85 to 115 in 66 years,
of the remaining 26 years, 12 were during the first 15^
years, for which the income figures are seriously defec­
tive, and 17 during the Great Contraction and the two
Clearly, velocity has varied over time— some might say
“greatly,” others “moderately.” Let me sidestep a bit and
say, for purposes of this discussion, “sig n ifica n tly F o r I
would remind you that the income velocity of money rose
roughly 28 per cent during the 1960-68 period. Had velocity
been the same in 1968 as it was in i960, nominal GNP
would have been not some $860 billion, but only $675
What Friedman and Schwartz report, then, about the
beKavior of velocity suggests that there are other factors
— strangely, such fiscal actions as tax cuts or budget changes
come to mind— that influence the level of economic activity.
Velocity has changed, as it were, to accommodate these
other influences and will go on doing so, I have no doubt,
in the future.
The observed changes in velocity underscore the broader
point I was hinting at a moment ago: The FriedmanSchwartz study did not find anything like a near-perfect
correlation— a rigid link— between money and economic
activity. And such correlation as they did find was based
on complex and often quite arbitrary adjustments of their

Is Monetary Policy Being OversoldP


raw data. It was Tobin who noted that the regularities
which Professor Friedman claims to have detected in his
data are quite esoteric!
This reminds us again that Friedman and Schwartz use
an incomplete model of the U. S. economy in testing the
potency of money supply. Perhaps, had they used a more
complete model, they might have found not only less po­
tency but greater precision in the effects of changes in the
money supply ( and hence, by the way, less need for a rigid
monetary rule). Before succumbing to their massive and
impressive array of data, observers in general and policy
makers in particular should be clear that the FriedmanSchwartz findings neither prove that “only money matters
much” nor disprove that fiscal policy matters a great deal.6
Fourth, it would help us if the monetarists could narrow
the range on when money matters. How long are the lags
that have to be taken into account in managing monetary
policy? Here, I quote from Professor Friedman’s tour de
force, A Program for Monetary Stability:
In the National Bureau study on which I have bej>n
collaborating with Mrs. Schwartz we found that, on the
average of 18 cycles, peaks in the rate of change in the
stock of money tend to precede peaks in general busi­
ness by about 16 months and troughs in the rate of
change in the stock of money to precede troughs in gen­
eral business by about 12 months. . . . For individual
cycles, the recorded lag has varied between 6 and 29
months at peaks and between 4 and 22 months at
So the Friedman-Schwartz study found a long average lag,
and just as important it would seem, a highly variable lag.
But why this considerable variance? No doubt there are sev­


Walter W . H eller

eral possible answers. But again, the most natural one is
that the level of economic activity, or total demand for the
nation’s output, is influenced by variables other than the
stock of money— possibly even by tax rates and federal
spending and transfer payments!
Suppose I told you that I had checked and found that in
repeated trials, it required from 100 to 300 feet for a car
going so and so many miles an hour to stop. That is quite
a range. But would you be surprised? I think not. You would
simply remind me that the distance it takes a car to stop
depends, among other things, on the condition of the road
surface. If I had allowed for the condition of the road sur­
face, I would not have ended up with such a wide range
of stopping distances.
Just so. If Professor Friedman and Mrs. Schwartz had
taken account of other variables that influence total demand,
or if they had estimated the lag of monetary policy using a
complete model of the U. S. economy, they would not have
found the lag of monetary policy to be quite so variable.
Again, then, one correctly infers that their findings are quite
consistent with fiscal policy mattering, and mattering a great
deal. Nor is it necessarily relevant, as some have suggested,
that in the middle of the nineteenth century, the government
sector was relatively small. Variables other than changes in
tax rates and government expenditures and transfers can
"distort” the money-income lag.
Professor Friedman has also used this finding of (a ) a
long average lag and (b ) a highly variable lag in support
of his plea for steady growth of the money supply. With so
long an average lag, the argument goes, forecasters are help­
less; they cannot see twelve or fifteen months into the future
with any accuracy. And even if they could, they would be
at a loss to know how far ahead to appraise the economic

Is Monetary Policy Being Oversold?


outlook. But I doubt that he can properly draw this infer­
ence from his finding of a long and highly variable lag.
It seems to me misleading to estimate a discreet lag as
the Friedman-Schwartz team did. It’s reasonable to suppose,
given the research findings of other investigators, that the
effect of a change in monetary policy cumulates through
time. To begin, there’s a slight effect; and as time passes,
the effect becomes more pronounced. But insofar as the
feasibility of discretionary monetary policy is at issue, what
matters most is whether there is some near-term effect. If
there is, then the Federal Reserve can influence the econ­
omy one quarter or two quarters from now. That there are
subsequent, more pronounced, effects is not the key ques­
tion. These subsequent effects get caught, as it were, in sub­
sequent forecasts of the economic outlook, and current policy
is adjusted accordingly. At least this is what happens in a
non-Friedmanic world where one enjoys the benefits of dis­
cretionary policy changes.
Lest I leave any doubt about what I infer from this:
if there is a near-immediate effect from a change in policy,
then discretionary monetary policy does not impose an un­
bearable burden on forecasters. For six or nine months
ahead, they can do reasonably well. But given the toodiscreet way Friedman-Schwartz went about estimating the
lag of monetary policy, I see no way of determining the
shape of the monetary policy lag. Until they know more
about the shape of this lag, I don’t see how they can insist
on a monetary rule.
Fifth, I’d be happier if only I knew which of the two
Friedmans to believe. Should it be the Friedman we have
had in focus here— the Friedman of the close causal re­
lationship between money supply and income, who sees
changes in money balances worked off gradually, with long


Walter W . Heller

lags before interest rates, prices of financial and physical
assets, and, eventually, investment and consumption spend­
ing are affected? Or should it be the Friedman of the “permanent-income hypothesis,” who sees the demand for money
as quite unresponsive to changes in current income (since
current income has only a fractional weight in permanent
income), with the implied result that the monetary mul­
tiplier is very large in the short run, that there is an im­
mediate and strong response to a change in the money stock?
As Tobin has noted, he can t have it both ways. But which
is it to be?
Sixth, if Milton’s policy prescription were made in a frictionless Friedmanesque world without price, wage, and
exchange rigidities— a world of his own making— it would
be more admissible. But in the imperfect world in which we
actually operate, beset by all sorts of rigidities, the introduc­
tion of his fixed-throttle money-supply rule might, in fact,
be destabilizing. Or it could condemn us to long periods of
economic slack or inflation as the slow adjustment processes
in wages and prices, given strong market power, delayed the
economy’s reaction to the monetary rule while policy makers
stood helplessly by.
A seventh and closely related concern is that locking the
money supply into a rigid rule would jeopardize the U. S.
international position. It’s quite clear that capital flows are
interest-rate sensitive. Indeed, capital flows induced by interest-rate changes can increase alarmingly when speculators
take over. Under the Friedman rule, market interest rates
would be whatever they turned out to be. It would be be­
yond the pale for the Fed to adjust interest rates for balanceof-payments adjustment purposes. Nor is it clear that by
operating in the market for forward exchange (which in
any event Milton would presumably oppose) the system

Is Monetary Policy Being Oversold?


could altogether neutralize changes in domestic market
Milton has heard all of this before, and he always has an
answer— flexible exchange rates. Parenthetically, I fully un­
derstand that it’s much easier to debate Milton in absentia
than in person! Yet, suffice it to note that however vital they
are to the workings of his money-supply peg, floating ex­
change rates are not just around the corner.
As my heavenly reference suggested, then, in the real
world, Milton and the monetarists are quite safe. Their
theory and policy prescriptions won’t be put to the test of
application, so there will be no chance to disprove them.
Eighth, and finally, if the monetarists showed some small
willingness to recognize the impact of fiscal policy— which
has played such a large role in the policy thinking and
action underlying the great expansion of the 1960’s— one
might be a little more sympathetic to their views. This point
is, I must admit, not so much a condition as a plea for
symmetry. The “new economists,” having already given im­
portant and increasing weight to monetary factors in their
policy models, are still waiting for signs that the monetarists
will admit fiscal factors to theirs.
The 1964 tax cut pointedly illustrates what I mean. While
the "new economists” fully recognize the important role
monetary policy played in facilitating the success of the tax
cut, the monetarists go to elaborate lengths to "prove” that
the tax cut— which came close to removing a $13 billion
full-employment surplus that was overburdening and retard­
ing the economy— had nothing to do with the 1964-65
expansion. Money-supply growth did it all. Apparently, we
were just playing fiscal tiddlywinks in Washington.
It seems to me that the cause of balanced analysis and
rational policy would be served by redirecting some of the


Walter W. Heller

brilliance of Friedman and his followers from (a ) singleminded devotion to the money-supply thesis and unceasing
efforts to discredit fiscal policy and indeed all discretionary
policy to (b ) joint efforts to develop a more complete and
satisfactory model of how the real world works; ascertain
why it is working far better today than it did before active
and conscious fiscal-monetary policy came into play; and de­
termine how such policy can be improved to make it work
even better in the future.
In a related asymmetry, as I’ve already suggested in pass­
ing, some Friedmanites fail to recognize that if fiscal policy
actions like the 1964 tax cut can do no good, then fiscal
policy actions like the big budget increases and deficits as­
sociated with Vietnam can also do no harm. Again, they
should recognize that they can’t have it both ways.
Now, one could lengthen and elaborate this list. But
enough— let’s just round it off this way: if Milton Friedman
were saying that ( as part of an active discretionary policy)
we had better keep a closer eye on that important variable,
money supply, in one or more of its several incarnations
— I would say well and good, by all means. If the manifold
doubts can be reasonably resolved, let’s remedy any neglect
or underemphasis of money supply as a policy indicator
relative to interest rates, free reserves, and the like. But let’s
not lock the steering gear into place, knowing full well of
the twists and turns in the road ahead. That’s an invitation
to chaos.
Suppose for a moment that a conservative president, heed­
ing— as indeed the Republican candidate seemed to in 1964
— the counsel of the monetarists, (a ) persuaded the Fed­
eral Reserve Board to set monetary policy on a rigid path of
4 or 5 per cent annual increases in monetary supply, and
(b ) persuaded the Congress to freeze tax policy into a pat­

Is Monetary Policy Being Oversold?


tern of once-a-year income tax cuts as Senator Goldwater
proposed in ’64 and as Arthur Bums seemed to be suggest­
ing last week.
With the controls thus locked into place— I started to say,
“with the controls thus on automatic pilot,” but that’s the
wrong figure of speech because the automatic pilot adjusts
for changes in the wind and other atmospheric conditions
— one can imagine what would happen when the economy
encountered the turbulence of recession with its downdrafts
in jobs, profits, and incomes. How long could Bichard Nixon,
for example, stand idly by and deny himself and the coun­
try the proven tonic of tax cuts, spending speedups, and
easier money? Economic common sense and political sagac­
ity— and he has both— would soon win out, I am sure, over
the rigid and static rules that so ill befit an ever changing
and dynamic economy. So as a practical matter, I don’t ex­
pect the country to fall into the trap of lockstep economics
in the Nixon Administration or any other administration of
the foreseeable future. I fully expect the new Administration
to practice active discretionary fiscal and monetary policy.
This may put me, I realize, in the strange position of
defending the Nixon Administration against one of its own
advisors. But, as the lady psychiatrist at a convention of
psychiatrists said to herself when she was about to slap a
male colleague sitting next to her who was taking certain
liberties— “Why should I? That’s his problem!”
Having paid my debt to the title of this talk, let me turn
now to the more positive side of my assignment. Two im­
portant tasks remain. The first is to remind you of the po­
tency and effectiveness of fiscal policy. The second is to
restate the case for continued and expanded use of discre­
tionary, man-made policy in preference to rigid monetary

Walter W. Heller


and fiscal rules.
Again, we need to stop, look, and listen lest we let sim­
plistic or captious criticism operate to deny us the benefits
of past experience and thwart the promise of future dis­
cretionary action on the monetary and fiscal fronts.
Perhaps the best way to begin is to move back from a
day-by-day or month-by-month perspective to ask this broad
question: What has been the course of the American econ­
omy during the postwar period of an increasingly active
and self-conscious fiscal-monetary policy for economic sta­
bilization? Or, for that matter, let’s broaden it: what has
been the course of the world’s advanced industrial econo­
mies during this period? The correlation is unmistakable:
the more active, informed, and self-conscious fiscal and mon­
etary policies have become, by and large, the more fully
employed and stable the affected economies have become.
Casual empiricism? Perhaps— yet a powerful and persuasive
observation. ^
Witness the conclusion of the two-and-a-half-year study
for the OECD by a group of fiscal experts from eight indus­
trial countries:
The postwar economic performance of most Western
countries in respect of employment, production and
growth has been vastly superior to that of the pre-war
years. This, in our view, has not been accidental. Gov­
ernments have increasingly accepted responsibility for
the promotion and maintenance of high employment
and steady economic growth. The more conscious use
of economic policies has undoubtedly played a crucial
role in the better performance achieved— an achieve­
ment which, from the point of view of the ultimate so­
cial objectives of policy, is of paramount importance.8
Perhaps an even more telling testament to the effective­
ness of active modem stabilization-policy is the change in

Is Monetary Policy Being Oversold?


private investment thinking and planning not only in the
financial sense of sustained confidence in the future of cor­
porate earnings and stock market values, even in the face
of temporary slowdowns in the economy— but more impor­
tant, in the physical sense of sustained high levels of plant
and equipment investment which seem to be replacing the
sickening swings that used to be the order of the day.
Why? In good part, I take it to be the result of a con­
stantly deepening conviction in the business and financial
community that alert and active fiscal-monetary policy will
keep the economy operating at a higher proportion of its
potential in the future than in the past; that beyond short
and temporary slowdowns, or perhaps even a recession—
that’s not ruled out in this vast and dynamic economy of
ours— lies the prospect of sustained growth in that narrow
band around full employment.
Going beyond these general observations, we have to look
at specific economic experience for cause-and-effect se­
quences that demonstrate the potency of fiscal policy. Don’t
expect me to assert that we have proof, absolute proof, of
this causal sequence. But quibbles about exact timing aside,
the potency of fiscal policy— both good and bad— has been
demonstrated time and again in the past couple of decades.
First, the contrast between the fiscal record and economic
consequences of the Vietnam and Korean wars is particu­
larly instructive. In 1950-5.1, three tax bills that, in today’s
GNP terms, boosted taxes by $35^40 billion paved the way
for some four years of price stability ( after an initial spurt
that ended by m id-1951) without resort to excessively tight
money. In 1966-68, Vietnam escalation coupled with initial
Presidential hesitation to ask for a tax boost and later Con­
gressional delay in enacting one led to the opposite result:
growing deficits and an accelerating inflation (interrupted
only by the late-1966 and early-1967 slowdown after the


Walter W. Heller

monetary brakes were slammed on and some fiscal restraints
were imposed).
Second, in 1959-60, a growing full-employment surplus
which reached a level of more than $10 billion, reinforced
by rising interest rates, pushed the economy back into reces­
sion after only twenty-five months of expansion. Here we
have another prime example of the penalty for failure to
act, a penalty that was widely predicted by economists, both
liberal and conservative, outside the Eisenhower Adminis­
Third, the great expansion of the 1960^ is another case
in point. Deliberate tax cuts and both deliberate and nondeliberate expenditure increases played the key role in the
thinking of economic policy makers, in official forecasts of
changes in the level of economic activity, and in the actual
GNP developments that materialized. And when urgentlyrecommended steps to increase taxes were not taken, the
predicted consequences of overheating and inflation and
undue burdens on monetary policy were amply and pain­
fully borne out. Both in the breach and in the observance,
fiscal policy demonstrated its potency during the lgCx/s.
The capstone of postwar policy for putting the U. S. econ­
omy more or less permanently into the full-employment
orbit was, of course, the great tax cut of 1964. Coupled with
the 1962 tax measures to stimulate investment, it reduced
both individual and corporate income tax liabilities by one
fifth. As for its economic impact: (1 ) as already noted, it
virtually cleared away the last great obstacle to full em­
ployment, that $12 to $13 billion full-employment surplus
under whose crushing weight we were simply unable to
struggle to full employment. Put more starkly, to get full
employment without the tax cut would have required $12
to $13 billion of additional private investment to offset a

Is Monetary Policy Being OversoldP


like amount of government saving. (2) Monetary policy
played an important supporting role in accommodating the
expansionary thrust of the tax cut. The Fed did not permit
rising interest rates or tightening credit to choke off its
stimulative impact. (3 ) The pace of economic advance ac­
celerated as expected. By mid-1965, just before Vietnam
escalation undid us, the old peacetime record for duration
of U.S. expansions, fifty-one months, toppled, and rapidly
expanding employment had brought the jobless rate to 4%
per cent. (4 ) In this process, the tax cut cleared away many
of the obstacles of economic myth and misunderstanding
that had long blocked the path to full use of our monetary
and fiscal tools.
As we near a five-year perspective on the tax cut, we
begin to see it as an economic watershed, the end of one
era and the beginning of another. It ended an era in which
the country felt it could afford to tolerate— or, given the
available economic tools and understanding, needed to tol­
erate— chronic unemployment and underutilization of its
resources (which characterized eight of the ten years be­
tween 1955 and 1965). It ushered in a new era in which
the avowed and active use of tax, budget, and monetary
instruments would keep the economy operating in the vicin­
ity of full employment, with all the pleasures and pains that
the management of prosperity involves ( a state that most of
our partners in the industrial world have enjoyed and suf­
fered for some time).
But great as its contribution was in removing barriers to
full employment and public understanding— and in bear­
ing out the analysis and forecasts in which the tax cut was
anchored— it has relatively little to offer us in the manage­
ment of policy in the narrow band (aside from serving as
further confirming evidence on such economic relationships


Walter W . Heller

as those reflected in the multiplier). Why ?
Primarily, because the requirement today is for much
more nimble and faster action than a chronically or re­
peatedly underemployed economy typically requires. It was
a semantic misfortune that this requirement was put in terms
of “fine tuning” in 1967. What we were referring to was
simply the need to shift from stimulus to restraint at about
mid-year. But given the glee with which the term is being
attacked— the critics imply that it means constant fiddling
with the fiscal-monetary dials— Tm afraid that "fine tuning”
is about to join “the Puritan ethic” in the gallery of gaffes
in economic-policy semantics.
Yet, lampooning aside, the term “fine tuning” brings an
important issue into focus. For policy tolerances become
much narrower in the high-employment economic zone. Fis­
cal and monetary actions must not only pack a punch, but
that punch has to be delivered with greater speed and pre­
cision— and with greater courage as well, since inflation is so
often the foe in a high-employment, high-growth economy.
That throws the issue of man versus rules, discretion ver­
sus automaticity, into bold relief. The monetarists tell the
policy maker, in effect, “Don’t do something, just stand
there.” They doubt that we have the economic wisdom, the
strength of character, and the institutional capability to op­
erate a successful discretionary policy. In their view, rigid
rules would outperform mortal man.
Time and space do not permit a full review here of the
case for discretionary and flexible policy.9 Quite apart from
the basic flaw in the concept of living by rules alone—
namely, that there is no escape from discretion, if only in
setting the rules and changing them from time to time— I
have already suggested a couple of practical defects. (1 )
In anything but a world of flexible price, cost, and exchange

Is Monetary Policy Being Oversold?


adjustments, fixed rates of change in the money stock and
tax levels are more likely to be destabilizing than stabilizing.
(2 ) It offends common sense to say that policy should (or
would) deny itself the increasingly broad, prompt, and reli­
able current economic information available to us, let alone,
the forecasts grounded in this growing fund of information
and knowledge of economic relationships.
Yet, doubts about the limits of discretion persist. In terms
of the economic policies of the 6o’s, they center on ( a ) the
halting performance in dealing with Vietnam-induced infla­
tion in the past three years; (b ) the slow response of GNP
to last June’s tax hike and budget cutback; and (c ) occa­
sional errors in official economic forecasts. Close inspection
of experience in all three cases offers, I submit, solid reasons
for pushing ahead along the path of discretionary policy
rather than taking refuge in rigid rules.
First, then, we turn to the lessons of 1966-68. The ten­
dency is to say that we did so poorly in coping with inflation
that it bodes ill for the future of discretionary and monetary
policy. One can join the chorus of critics of 1966-68 policy
without accepting the gloomy inference for the future. A
more hopeful inference about our ability and will to cope
with excess demand in the future can be drawn from the
following facts:
(1 )
The Economic Advisers’ diagnosis of the economy’s
ills was, in general, correct, and their prescription was apt.
As President Johnson recently revealed, his advisers unani­
mously recommended a tax increase early in 1966 as part
of their prescription for what ailed the economy. But Drs.
Johnson and Mills were slow to fill the prescription and
apply it to the patient. One might add that Dr. Ford and a
few others on the other side of the aisle were even slower
to accept the diagnosis and prescription.


Walter W . Heller

(2 ) Some of the difficulties that plagued economic policy
were sui generis. Can you imagine a repeat of the situation
in the second half of 1965 when the Council of Economic
Advisers and the Treasury— judging by the speeches of
their top men— were not aware of the Pentagon’s expendi­
ture plans? Or a period when a block of expenditures as
large as those for Vietnam were underestimated again and
again to the point where one agency in Washington foot­
noted an “official” estimate of military expenditures as fol­
lows: “For internal use only, but dangerous if swallowed!”
(3 ) Just as we moved from fiscal fiction and fallacy to fis­
cal fact and understanding in the course of debate and ac­
tion on the 1964 tax cut, so it seems to me we learned a great
deal in the two-and-a-half-year hassle over the tax increase.
The newspaper headline last spring, “Market Rallies on
Hope of Tax Boost,” is a case in point. Failure to act on
taxes was, as predicted, so costly in terms of higher prices,
higher interest rates, higher imports, and higher deficits,
that the lesson for the future was inescapable. Never again,
I should judge, would a President hesitate so long or a Con­
gress sit idly by while inflation takes us by the throat as it
did in 1966-68.
(4 ) Congress did, after all, pass the tax surcharge and
the budget cutback. After that unconscionable and costly
delay, it was still an act of political courage— coming as it
did, just five months before a national election. And judging
by the high ratio of incumbents who voted for the surtax
in June and won reelection in November, it didn’t involve
nearly the political penalties that had been feared. That,
too, is a good portent for the future.
(5 ) In the future, the fiscal fight against inflation can
ordinarily be fought without resort to the grueling and
gruesome process of wringing a tax increase out of Congress

Is Monetary Policy Being Oversold?


For revenues from existing taxes (the surtax aside) will
grow by some $15 billion a year, as an automatic by-product
of growth in GNP. It should be a lot easier to exercise fiscal
restraint by holding back some of this revenue bounty (i.e.,
by not declaring “fiscal dividends” through program in­
creases or tax cuts) than it has been to ram a tax increase
through a reluctant Congress.
Second, after the long executive and legislative lags on
the 10 per cent surtax, how does the advocate of discre­
tionary fiscal action deal with the lag in economic response
to this measure after its enactment last June?
(1 ) By confessing that many, if not most, of us who make
specific forecasts have a bit of egg on our face. We expected
a cooling off of the economy to be well under way by now,
but the overall advance in GNP seems to be holding up
better than expected.
(2 ) By reminding you that the surcharge is doing some
of the work expected of it, not just in the sense of "think
of how much worse off we would be if we hadn’t acted,”
but in the performance of retail sales, which peaked at $29
billion in August ( after rising more than $2)2 billion during
1968) and have not reached that level since; of real GNP,
which forged ahead at an annual rate of nearly 6/2 per cent
in the first couple of quarters, slowed to 4.9 per cent in the
third quarter, seems headed down to about 3M per cent in
the current quarter, and perhaps 1 to 2 per cent in the first
couple of quarters next year.
(3 ) By noting that during the long delay in enacting the
fiscal package, cost and price pressures became more in­
tense, and inflationary expectations became more embedded
in investment thinking, than most observers realized. Cou­
pled with growing confidence in sustained expansion, this
has lessened the risks associated with capital spending and


Walter W . Heller

debt. Advances in plant and equipment spending, housing,
and durable goods purchases have all exceeded expec­
I should add that if the expected healthy easing of the
economy does occur early next year, it wont provide any
clear-cut decision after all on the relative impacts of fiscal
and monetary policy. The recent slowdown in the growth
of the money supply (at least in its Mi version) deprives
us of what might have been a reasonably clear-cut con­
frontation. What a sad day for those who had so eagerly
awaited a test-tube experiment!
Finally, this brings us to the prickly area of economic
forecasting. One of Milton Friedman’s main charges against
discretionary policy is that economic forecasting is a weak
reed on which to lean in guiding policy action. The
contrary view, which I hold, is that we cannot operate
intelligent economic policies— public or private— without
forecasts. We have to make the most reasonable forecast
of the future and then be as nimble and flexible as possible
in adjusting to unforeseen events and forces.
Official forecasters have, as you know, been leading a
mighty exposed life ever since the beginning of President
Kennedy’s Administration, when we reversed previous prac­
tice by laying forecasts on the line publicly. I hope and
assume that future administrations will not change this
What’s the right test to apply in judging whether fore­
casting can carry the burden that is required for discre­
tionary policy? The right test, I submit, is not whether
annual GNP forecasts are accurate to the nearest $5 or $10
billion, but whether they are sufficiently right in predicting
the direction and intensity of change, first, to avoid wrong
policy advice (for if they do no more than that, they have

Is Monetary Policy Being Oversold?


already at least matched automatic, or lockstep, policy);
second, to lead to the right policy advice, if not every time,
at least a very high proportion of the time.
Now by that reasonable standard, I submit that official
forecasts since i960 have fallen from grace for only four
brief periods: early 1962, when we thought the economy
was going to be a lot more exuberant than it turned out
to be, and we didn’t switch our forecast until May of that
year; late 1965 and early 1966, when the economic force of
Vietnam was at best dimly perceived; the fall of 1966, when
economic softness crept up on us unawares and was not
recognized for about six weeks; the well known 1968 exam­
ple we are still experiencing.
But the rest of the time, official economic forecasts have
correctly led the President’s economic advisers to urge ex­
pansionary action from early 1961 to the first half of 1965;
to urge restrictive fiscal-monetary policy in 1966; to urge
a roller-coaster policy in 1967, consisting of (a ) fiscalmonetary ease early in the year to avert recession and
then (b ) a call for the surtax after mid-year to help ward
off resurgent inflation; and to urge, with ever greater in­
tensity, prompt enactment of the surtax in 1968.
That inevitably moves us from the alleged weakness of
forecasting to the weakness of the flesh. For what shall it
profit us if we can correctly forecast overheating and pre­
scribe the right policy medicine, but Wilbur Mills heedeth
us not? Or, as some other wit dimly suggested, that the tax
Mills grind exceeding fine, or may even grind to a halt?
That is a none-too-subtle way of bringing me to the point
that we need to bend every effort to make fiscal policy— and
particularly tax policy— more responsive and flexible. In­
deed, if tax rates can be adjusted quickly and flexibly to
ebbs and flows of aggregate demand, the penalties for


Walter W. Heller

errors in forecasting would be correspondingly reduced. We
must find a way to make tax rates more adaptable to eco­
nomic circumstances, either by granting the President stand­
by power to make temporary cuts and increases in the
income tax (subject to Congressional veto); or by setting
up speedier Congressional procedures to respond to Presi­
dential requests for quick tax changes to head off recession
or inflation; or by developing the executive practice (pro­
posed by a Nixon task force) under which the President
would, as part of his budget message each January, propose
a positive or negative income surtax (for stabilization pur­
poses ).
In winding up these comments, let me say that just as the
monetarists have a great deal still to clarify, establish, and
correct before they can lay claim to an only-money-mattersmuch economic policy, so the economic activists— I won’t
say “fiscalists,” because economic activism implies a bal­
anced policy of fiscal and monetary discretion— still have a
great deal to learn about operating in the narrow band
around full employment; a great deal more to do in im­
proving forecasting; and important worlds to conquer in
speeding up the executive and legislative processes and
developing the skills to manage the fiscal dividend so as not
to let it retard normal expansion, and yet, when the econ­
omy overheats, to let it become a welcome fiscal drag.
In my comments today, I referred to the brilliance of the
Chicago School. I should also comment on their great con­
sistency over the years. The rest of us— responding to new
analysis and evidence, observing basic changes in the econ­
omy, and conditioned (or perhaps “burned”) by experience
and on-the-job training— adapt and modify our views from
time to time on such key issues as (a ) the role and desir­
ability of government tax incentives for investments; (b )

Is Monetary Policy Being Oversold?


the independence of the Fed; (c ) the proper mix of tax
cuts, government budget increases, and tax sharing; and
(d ) yes, even the relative roles of fiscal and monetary pol­
icy. In short, we have yet to encounter the revealed and
immutable truth.
But the Chicago school just goes rolling along. Miracu­
lously, all the evidence— I really mean, all the admissible
evidence— strengthens their conviction, held for decades,
that to err is human, and to live by rules is divine. In spite
of vast improvements in the promptness, breadth, and ac­
curacy of economic statistics, in spite of important advances
in forecasting techniques and performance, in spite of vast
strides in public understanding and acceptance of positive
economic policy, in spite of encouraging signs of greater
responsiveness of executive and legislative officials to in­
formed economic policy advice, the Chicago School still ad­
heres to the proposition that we should put our trust in
stable formulas, not in unstable men and institutions.
That’s a bit of a caricature, but only a bit. The mone­
tarists have taught us much. We are far richer for their
analyses and painstaking research. But we would be far
poorer, I believe, for following their policy prescription. It
is high time that they stop trying to establish a single varia­
ble— money supply— as all-powerful, or nearly so, and stop
striving to disestablish another variable— fiscal policy— as
impotent, or nearly so. The path to progress in economic
policy lies, instead, in a mutual undertaking to work out the
best possible combination of fiscal, monetary, and wageprice policies— coupled with measures to speed the rise in
productivity— for reconciling sustained high employment
with reasonable price stability.


Has Fiscal Policy
Been Oversold?



I am delighted to share the platform with Walter Heller
today. Walter and I have been friends for a long time, and
disagreement is part of the spice of friendship. I am de­
lighted also to agree with him on some of the rules of to­
day’s game: for example, that we are not engaging in a
debate, but are simply evaluating the substantive issues of
monetary and fiscal policy, and, more seriously, that our
discussion has no political element whatsoever because I,
at least, shall speak not for any mythical Chicago School,
not for any administration or candidate, but for myself. It
is one of the great virtues and one of the great advantages
of being a professor at a university, which those among you
who are so unfortunate as to have to earn your living in
the business world do not share, that we can be completely
independent and irresponsible, and say what we really


Milton Friedman

Let me start by saying that Walter has set up something
of a straw man when he says that the issue is not whether
money matters, but whether only money matters. I have
never myself been able to accept that way of putting the
issue. I do not think that it is a meaningful statement. Only
money matters for what? If you want to have happiness
in your home, the kind of money that matters is not the
kind we’re talking about now. It isn’t Federal Reserve pol­
icy; it’s income that matters.
More generally, there are many, many different things
that matter for many, many different purposes. The key
source of misunderstanding about the issue of monetary
policy, in my opinion, has been the failure to distinguish
clearly what it is that money matters for. What I and those
who share my views have emphasized is that the quantity
of money is extremely important for nominal magnitudes,
for nominal income, for the level of income in dollars—
important for what happens to prices. It is not important at
all, or, if that’s perhaps an exaggeration, not very impor­
tant, for what happens to real output over the long period.
I have been increasingly impressed that much of the dis­
agreement about this issue stems from the fact that an im­
portant element in the Keynesian revolution in economics
was the notion that prices are an institutional datum de­
termined outside the system. Once you take that view, once
you say that prices are somehow determined elsewhere,
then the distinction between nominal magnitudes and real
magnitudes disappears. The distinction between magnitudes
in dollars and magnitudes in terms of goods and services
is no longer important.
That is why the qualifications we have always attached
to our statements about the importance of money tend
to be overlooked. We have always stressed that money

Has Fiscal Policy Been Oversold P


matters a great deal for the development of nominal mag­
nitudes, but not over the long run for real magnitudes. That
qualification has tended to be dropped and a straw man
has been set up to the effect that we say that money is the
only thing that matters for the development of the econ­
omy. That’s an absurd position, of course, and one that I
have never held. The real wealth of a society depends much
more on the kind of institutional structure it has, on the
abilities, initiative, driving force of its people, on invest­
ment potentialities, on technology— on all of those things.
That’s what really matters from the point of view of the
level of output. But, how many dollars will that be valued
at? When you ask that question, that’s where money matters.
Let me turn more directly to the topics assigned for this
session. Is fiscal policy being oversold? Is monetary policy
being oversold? I want to stress that my answer is yes to
both of those questions. I believe monetary policy is being
oversold; I believe fiscal policy is being oversold. What I
believe is that fine tuning has been oversold. And this is
not a new conclusion. I am delighted to attest to the cor­
rectness of Walter’s statement that many of our views have
not changed over time. It so happens that the facts haven’t
been inconsistent with them, and, therefore, we haven’t had
to change them over time.
Just this past week I was reading proof on a collection
of technical essays of mine written much earlier that is go­
ing to appear next year (1969), and I came across a paper
I gave to the Joint Economic Committee in 1958. I would
like to quote from that paper, written ten years ago, some
sentences which expressed my view at that time, and which
still express my view today, on the issue of fine tuning,
rather than on the separate issues of monetary and fiscal


Milton Friedman

I said: "A steady rate of growth in the money supply will
not mean perfect stability even though it would prevent
the kind of wide fluctuations that we have experienced
from time to time in the past. It is tempting to try to go
farther and to use monetary changes to offset other factors
making for expansion and contraction. . . . The available
evidence . . . casts grave doubts on the possibility of pro­
ducing any fine adjustments in economic activity by fine
adjustments in monetary policy— at least in the present state
of knowledge. . . . There are thus serious limitations to the
possibility of a discretionary monetary policy and much
danger that such a policy may make matters worse rather
than better.”
I went on: "To avoid misunderstanding, it should be
emphasized that the problems just discussed are in no way
peculiar to monetary policy. . . . The basic difficulties and
limitations of monetary policy apply with equal force to
fiscal policy.”
And then I went on, "Political pressures to ‘do something’
in the face of either relatively mild price rises or relatively
mild price and employment declines are clearly very strong
indeed in the existing state of public attitudes. The main
moral to be drawn from the two preceding points is that
yielding to these pressures may frequently do more harm
than good. There is a saying that the best is often the enemy
of the good, which seems highly relevant. The goal of an
extremely high degree of economic stability is certainly a
splendid one. Our ability to attain it, however, is limited;
we can surely avoid extreme fluctuations; we do not know
enough to avoid minor fluctuations; the attempt to do more
than we can will itself be a disturbance that may increase
rather than reduce instability. But like all such injunctions,
this one too must be taken in moderation. It is a plea for a

Has Fiscal Policy Been Oversold?


sense of perspective and balance, not for irresponsibility in
the face of major problems or for failure to correct past
mistakes.” 1
Well, that was a view that I expressed ten years ago,
and I do not believe that the evidence of the past ten years
gives the lie to that view. I think that the evidence of the
past ten years rather reinforces it, rather shows the diffi­
culties of trying to engage in a very fine tuning of economic
policy. I would emphasize today even more than I did then
my qualifications with respect to monetary policy because
thanks fundamentally, I think, to the difficulties that have
been experienced with fiscal policy and to the experience of
other countries, there has been an enormous shift in opinion.
Walter says we all know that money matters; it’s only
a question of whether it matters very much. His saying
that is, in itself, evidence of the shift in opinion. Before
coming up here today I reread the reports of the Council of
Economic Advisers that were published when he was chair­
man of the Council.2 1 do not believe that anybody can read
those reports and come out with the conclusion that they
say that money matters significantly. While there was some
attention paid to money in those reports, it was very limited.
There has been a tremendous change in opinion on this
subject since then. And I am afraid that change may go too
far. I share very much the doubts that Walter expressed
about the closeness of the monetary relations. There is a
very good relation on the average. But the relation is not
close enough, it is not precise enough, so that you can,
with enormous confidence, predict from the changes in the
money supply in one quarter precisely what’s going to hap­
pen in the next quarter or two quarters later.
Indeed, that's the major reason why I’m in favor of a rule.
If I thought I could predict precisely, well then, to go back


Milton Friedman

to the statement I quoted from, I would be prepared to
make fine adjustments to offset other forces making for
change. It’s precisely because we don’t know how to predict
precisely that you cannot in fact use monetary policy effec­
tively for this purpose. So I emphasize that my basic view
is that what has been oversold is the notion of fine tuning.
Yet, fiscal policy has, in my view, been oversold in a very
different and more basic sense than monetary policy— to
turn to the main subject assigned to me. I believe that the
rate of change of the money supply by itself— and I’m going
to come back to those two words "by itself”— has a very
important effect on nominal income and prices in the long
run. It has a very important effect on fluctuations in nominal
and real income in the short run. That’s my basic conclusion
about changes in the stock of money.
Now let’s turn to fiscal policy. I believe that the state of
the government budget matters; matters a great deal— for
some things. The state of the government budget determines
what fraction of the nation’s income is spent through the
government and what fraction is spent by individuals pri­
vately. The state of the government budget determines what
the level of our taxes is, how much of our income we turn
over to the government. The state of the government budget
has a considerable effect on interest rates. If the federal
government runs a large deficit, that means the government
has to borrow in the market, which raises the demand for
loanable funds and so tends to raise interest rates.
If the government budget shifts to a surplus, that adds
to the supply of loanable funds, which tends to lower in­
terest rates. It was no surprise to those of us who stress
money that enactment of the surtax was followed by a
decline in interest rates. That’s precisely what we had pre­
dicted and what our analysis leads us to predict. But— and

Has Fiscal Policy Been Oversold?

I come to the main point— in my opinion, the state of the
budget by itself has no significant effect on the course of
nominal income, on inflation, on deflation, or on cyclical
The crucial words in these statements are “by itself” be­
cause the whole problem of interpretation is precisely
that you are always having changes in monetary policy and
that you are always having changes in fiscal policy. And if
you want to think clearly about the two separately, you
must somehow try to separate the influence of fiscal policy
from the influence of monetary policy. The question you
want to ask yourself is, “Is what happened to the govern­
ment budget the major factor that produced a particular
change, or is it what happened to monetary variables?”
I recognize, of course, that there is no unique way to
separate monetary policy from fiscal policy, but I think there
would be wide agreement on the part of most people that
by fiscal policy we mean changes in the relation of taxes
to spending, and that by monetary policy, we mean changes
in certain monetary totals. Some people might want to use
as the relevant monetary total the monetary base; some
people might want to use the money supply in the sense of
currency and demand deposits; some people might want
to use a broader money supply.
For the moment, those differences do not matter. What
matters is that we ask the question, “What happens if you
hold monetary policy constant and you change fiscal policy?”
Or, “What happens if you hold fiscal policy constant and you
change monetary policy?” Analytically— I’m going to discuss
the statistical evidence later— we can separate monetary
and fiscal policy by considering a situation in which mone­
tary policy proceeds in a certain way, and we hypothetically
consider a big tax increase or a big tax cut. What differ­


Milton Friedm an

ence would that make?
In talking about fiscal policy, when I discuss the relation
of taxes and expenditures, I don’t mean current tax receipts
and current payments, because all of us would agree that
that’s not solely a question of policy, but partly a result of
what happens to the economy. Currently, about the best
measure of fiscal policy is to be found in something like
the high-employment budget, in the notion of what taxes
and expenditures would be at high levels of employment.
I was delighted to see the Council of Economic Advisers,
under Walter Heller’s chairmanship, follow up the sugges­
tion which had been made in 1947 by the Committee for
Economic Development, and independently by me, that we
look at fiscal policy in terms of the high-employment bud­
get.3 The Council provided for the first time some very use­
ful and interesting figures on fiscal policy by itself, namely,
on the state of the high-employment budget.
Now it’s perfectly clear that fiscal policy can change by
itself without a change in monetary policy. You can have a
tax cut, let us say, and finance the resulting deficit by bor­
rowing from the market. If you do that, that will have an
effect on interest rates, but the money supply need not be
affected. Alternatively, the change in fiscal policy can be
accompanied by a change in monetary policy. You can have
a tax cut and finance the deficit by printing money.
The essence of the pure fiscal position is that it doesn’t
make any difference which of those you do. The essence of
the monetary position that I’m presenting is that it makes
an enormous difference which of those you do, that those
two kinds of tax cut will have very different effects. That’s
what I mean by separating the effect of fiscal policy by
itself, from the effect of monetary policy by itself.
The fascinating thing to me is that the widespread faith

Has Fiscal Policy Been Oversold?


in the potency of fiscal policy— this is flying straight in the
face of some words that Walter Heller spoke a few moments
ago when he talked about the proven effectiveness of fiscal
policy— rests on no evidence whatsoever. It’s based on pure
assumption. It’s based on a priori reasoning.
I’ll come back to that point of available evidence a little
later and document it more fully. But it is worth dealing
briefly with the a priori argument, I think— the argument
from first principles— because at first it seems so persuasive.
And the question is, “What’s wrong with it?” It certainly
seems obvious that if you raise taxes, as you did with the
surtax, that clearly reduces the disposable income of the
people who pay the taxes, leaves them with less to spend,
and reduces spending. Surely, that is anti-inflationary. What
could be clearer and simpler? How could any fool in his
right mind deny so obvious a chain of events?
The trouble is that what I’ve said so far is only half the
story. There’s another half to it which is typically left out.
If the federal government imposes a surtax, as it did, but
keeps on spending roughly the same amount of money, as it
did, then that reduces the amount it has to borrow. If it
raises $10 billion more in taxes, it now has to borrow $10 bil­
lion less. The taxpayers have less money, but the people who
would have loaned the government the funds with which to
finance their spending have more.
So, you have to ask, “What happens to that $10 billion
which the government otherwise would have borrowed?”
The answer is that that $10 billion is now available for peo­
ple to use to pay their taxes with or for people to lend to
others. That’s why the interest rate can be predicted to fall.
The tax increase does reduce the demand for loanable funds
on the part of the government. That lowers the interest
rate. But the reduction in the interest rate induces somebody


Milton Friedman

else to come and borrow those funds that otherwise would
have been available for the government.
It provides the possibility of greater private investment,
expenditure on housing, whatever it may be that people are
borrowing it for. And so, if you take both sides of the pic­
ture to a first approximation, there’s a standoff. Taxpayers
have $10 billion less, and the people who would have loaned
that money to the government have $10 billion more. If
there is going to be any net effect, it has to be on a more
sophisticated level; it has to be the indirect effect of the
reduction in interest rates on other variables. In particular,
it has to be a willingness on the part of the populace to
hold more money, more nominal money, when the interest
rate goes down.
I only sketch this— it isn’t intended to be a full analysis—
to show that on a purely theoretical level, you cannot come
out with a clean case. It could be that fiscal policy is still
potent. I don’t mean to say that, in abstract theory, these
indirect effects could not be strong. Keynes thought they
were. And you can perfectly well establish an entirely cor­
rect theoretical chain of reasoning whereby those indirect
effects would be strong. It is possible, but it’s not obvious.
And so you have to look at facts. When you look at facts,
there’s a strong tendency to be anecdotal. After all, it’s
much more appealing to look at particular episodes. They
are more dramatic. They are more immediately accessible.
And, especially, when we talk rather than write, they fit
into the mode of discourse much better.
There’s nothing wrong with doing that. Those individual
episodes are relevant evidence, and they are useful to look
at— I’m going to look at some— but they are a very small
part of the evidence. If we are really going to examine the
evidence, we want to look at experience over a long period

Has Fiscal Policy Been Oversold?


we want to look at all the experience, we want to look at
the average effect. One swallow doesn’t make a spring; one
case of confirmation or disconfirmation doesn’t settle any­
I think it will be interesting if you have an experiment
in 1969 on the effects of fiscal versus monetary policy. But
whichever way it goes, it’s only going to be a small part
of the total body of accumulated evidence that is avail­
able. But let me turn to a couple of episodes.
The one that is most dramatic and that Walter Heller
emphasized most is, of course, the 1964 tax cut. Now let me
point out to you that, so far as I know, there has been no
empirical demonstration that that tax cut had any effect
on the total flow of income in the U. S. There has been
no demonstration that if monetary policies had been main­
tained unchanged— I’ll come back to that in a moment— the
tax cut would have been really expansionary on nominal in­
come. It clearly made interest rates higher than they other­
wise would have been. But there is no evidence that by itself
it was expansionary on income.
Arthur Okun wrote a paper in the summer of 1965 that
he presented at the Statistical Association Meeting that fall
which gave a statistical analysis of the effect of the tax cut.4
It’s a very interesting paper; it’s a fine thing to have done.
I think we ought to have more such examinations. But if
you examine what he did, you will find that what he has
is an illustrative calculation of, not evidence on, the impor­
tance of the tax cut.
What Okun did was to assume away the whole problem
because he looked only at the effect of fiscal policy without
asking what role monetary policy played during that period.
What he did was to say that we could put monetary policy
aside, because interest rates didn’t change during the period


Milton Friedman

and that, therefore, we could suppose that monetary policy
was neutral. As I’ve just made clear, that really begs the
fundamental issue. If monetary policy were really neutral,
you would have expected interest rates to go up, not stay
constant. You had a tax cut. That meant the government
had to borrow more, which would have raised interest rates.
If, despite that effect, interest rates didn’t go up, monetary
policy must have been doing something.
What Art Okun did in that paper was to say: Let us
assume that the theory underlying fiscal policy is correct.
Then what do the figures say about the numerical value
of the multiplier in this episode. He did not present evi­
dence on whether that theory is correct.
To do that, you need to see what happened to money
separately. If you look at what happened to money, you
will find that the temporal pattern of money supply con­
forms much better to the temporal pattern of nominal in­
come than does the tax cut. There was a decided tapering
off in the growth of money supply in early 1962 through
about the first three-quarters of ’62. This was reflected in
the last part of ’62 and early ’63 by a tapering off in the
economy. You then had a switch in monetary policy. It
became more expansive— the quantity of money started
growing— and lo and behold, about six or nine or ten
months later, before the tax cut had taken effect, income
started to rise at a more rapid rate.
In order to make the tax cut responsible for that, you
have to argue that anticipation of the tax cut produced an
increase in income, and that then, after you had the tax
cut, despite the fact that it had been anticipated, it had its
full effect all over again. So that episode, while it’s a nice
dramatic episode, does not, as it has so far been analyzed,
provide much evidence.

Has Fiscal Policy Been Oversold?


From what I’ve said so far, I haven’t proved that the tax
cut didn’t have an expansionary effect. I’m not trying to
argue that it has been established conclusively that fiscal
policy had no effect in that episode alone. I’m only saying
that so far, there is no persuasive statistical, empirical evalu­
ation which gives you reason to say that it had an effect.
1966-1967 is a nice episode. It is a nice controlled ex­
periment. Nature happened to turn one out. In early 1966,
April 1966, the Federal Reserve stepped very hard on the
monetary brake. The quantity of money, however you mea­
sure it, slowed down its rate of growth very sharply. The
narrow definition actually declined; the broader definition
increased from April to December, but at a much slower
pace than it had before. During that same period, the highemployment budget moved toward a larger and larger
If you were to look at the high-employment budget
alone, you would say that we should have had a boom in
the early part of 1967. If you were to look at monetary
policy alone, you would say that we should have had a
slowdown in the early part of 1067. Well, as Walter testified
in his talk, we did have a slowdown in the early part of
1967, as you would have expected from the monetary in­
fluence, in contrast to what you would have expected from
the fiscal influence.
Early in 1967, the Fed turned around, and it is true, as
Walter pointed out, that 1967— I guess he was saying ’68,
but ’67 too— comes pretty close to being a record year of
monetary expansion. And about six to nine months after
the Fed turned around, the economy turned around. We
started 16 have an expanded growth in nominal income.
As for the 1969 possible experiment, it’s too soon to say
because I do not think that you ought to judge fiscal policy,


Milton Friedman

as you ought not to judge monetary policy, on whether it
has an Overnight influence of major magnitude. There are
lags involved in fiscal policy, as there are in monetary
policy. Whether you have an experiment or not depends
on how the Federal Reserve behaves. The various monetary
totals have been behaving in very different ways, for rea­
sons about which maybe YU have a chance to say something
later. At the moment 111 put it to one side. If the Fed should
continue with a very easy policy, of the kind that it had
prior to the past two months, that is, if the rate of growth
of the money supply defined broadly should continue at its
present pace, and if the rate of growth of the narrow
money supply should step up and come closer to its usual
relation with the rate of growth of the broader money sup­
ply, then that would suggest that you would not have a
slowdown in the early part of ’69.
On the other hand, the fiscal effect would suggest that
you would. So you might have another experiment. But
whether you do or not, depends on what the Fed does. If
the Fed should repeat its behavior of early 1966, if it should
step on the brake very hard, then both fiscal and monetary
policy will be going in the same direction and you will
not have an experiment. But, as I said before, none of this
is very satisfactory. This is all episodic. What you need is
systematic evidence that takes account of other factors at
work, that tries to examine what happens not only at cer­
tain critical points of time, but throughout a longer period.
The interesting thing is that those people who speak
most loudly about the potency of fiscal policy have pro­
duced no such evidence. But there is a great deal of evi­
dence which has been produced primarily by those of us
who have argued for the potency of monetary policy. You
know, it is always being said that we are unrealistic, that we

Has Fiscal Policy Been Oversold?


are abstract and so on. But I think that there is no one who
can deny that we have, in the course of the past fifteen
years, accumulated an enormous amount of empirical evi­
dence on the questions that are at issue. I’d like to call your
attention to some items in that list which are relevant to
the particular issue of the potency of fiscal and monetary
I’m going to run over them very hastily. Some sixteen
years ago, I wrote an article that compared the Civil War
to World War I and World War II. The particular question
I asked was, “Do you get a better understanding of what
happened to prices during those three wars by looking at
what was happening to monetary magnitudes, or by look­
ing at what was happening to fiscal magnitudes?” 5 The
answer was completely unambiguous. And nobody has since
produced any evidence contradicting that analysis. It turns
out that you get a very clear, straight-forward interpreta­
tion of price behavior in those three wars by looking at
monetary magnitudes; you do not get an explanation by
looking at fiscal magnitudes.
Second, Walter Heller was kind enough to comment on
the studies that Anna Schwartz and I have done under the
auspices of the National Bureau of Economic Research. We
have studied the relation between monetary magnitude and
economic magnitudes over the course of a hundred years,
roughly a century. During that period, fiscal policy changed
enormously. At the beginning of that period, the govern­
ment budget was negligible. In the period since World War
II, the government budget has been mammoth. And yet
we found roughly the same kind of a relationship between
monetary and economic magnitudes over the whole of that
one-hundred-year period.
If fiscal policy were playing a dominant influence, it


Milton Friedman

should have introduced more variability, as Walter properly
said it should have, into the relation between money and
income in the later part than in the earlier; but as far as
we can see, it’s a homogeneous universe.
Third, some years back David Meiselman and I pub­
lished a study directed specifically at the question, “Do
monetary magnitudes or autonomous expenditure magni­
tudes give you a better interpretation of the movements
in nominal income over short periods of time?” 6 That article
produced a great controversy and a large number of replies
and counterreplies.7 It’s a matter of biblical exegesis to trace
through the thrusts and counterthrusts of that controversy
though I am sure it would be good for all your souls to
do so.
But one thing that came out of that controversy is that
everybody agreed that the monetary magnitudes did have
an important and systematic influence. The complaint that
was made against us was the one that Walter makes tonight,
that we had gone too far in denying that the autonomous
magnitudes exerted an influence.
The most recent study is one by the Federal Reserve Bank
of St. Louis,8 which Walter was good enough to refer to as
an unofficial arm of the Chicago School— well, we ought to
have one out of twelve anyway. It is an extremely thorough
and very fascinating study in which they have related
quarter-to-quarter changes in GNP to changes in monetary
totals over prior quarters and also to changes in governmen­
tal expenditures and taxes. They have been very thorough.
Anything that anybody suggested to them which might be
wrong with what they initially did, they have tried out. As
a result, they have tried out many of the possible permuta­
tions and combinations. They have tried the high-employment
budget and they have tried other budget concepts. But I’ll

Has Fiscal Policy Been Oversold?


refer to their findings about the high-employment budget.
What they have done is to try to see whether the mone­
tary or the fiscal magnitudes play a more consistent and
systematic role in explaining the course of GNP change
over the period 1952 to 1968. That is the right period be­
cause Walter Heller is right in pointing to the Federal Reserve-Treasury Accord of 1951 as marking a distinct change
in the role of monetary policy and its possibility.
Let me quote their summary conclusion. They say, “This
section tested the propositions that the response of economic
activity to fiscal actions relative to monetary actions is ( I )
larger, ( I I ) more predictable, and ( I I I ) faster.” 9
Let me repeat this more explicitly. The proposition they
tested was that the response of economic activity to fiscal
action was larger, more predictable, and faster than the re­
sponse of the economy to monetary action. “The results of
the tests,” they say, “were not consistent with any of these
propositions. Consequently, either the commonly used mea­
sures of fiscal influence do not correctly indicate the degree
and the direction of such influence, or there was no mea­
surable net fiscal influence on total spending in the test
period.” 10 To put it in simpler terms, what they found—
far from there being a proven efficiency of fiscal policy— was
that, as a statistical matter, the regression coefficients of the
high-employment budget surplus or deficit, if the monetary
variables are held constant, were not statistically significant.
They found that if you separated expenditures from taxes
and treated them separately, expenditures did have some
effect but taxes had none. An expenditure increase tended
to have a positive influence on income in the first two quar­
ters after the increase, but it had a negative influence in the
next two quarters.
Apparently, the expenditure increase had had a short-term


Milton Friedman

influence before it started to work its way through the credit
market. Then there was the delayed effect of the half of the
picture that, as I mentioned before, is generally not dis­
That’s another piece of evidence. Maybe it’s my myopia
that leads me not to know the empirical studies the other
way around. I would like to have some references to careful,
systematic, empirical studies which have analyzed the in­
fluence of fiscal policy along with the influence of monetary
policy, and which provide some evidence that, for a given
quantity of money, or a given monetary-supply policy de­
fined in some other way, fiscal policy has a significant in­
fluence on nominal national income and prices.12
Surely, I think the time has come to utter the usual poker
challenge to those who maintain that fiscal effects are im­
portant for inflation and the price level. It seems to me that
it is time they put up and gave us some evidence to support
the repeated assertions to that effect.




I t is difficult to work up anger or even indignation in a
discussion or debate with Milton Friedman. He is always
so charming and disarming, even when he’s dead wrong!
Listening to Milton, I was reminded of a postcard I got in
Washington from a Montana observer, whose message was,
"Don’t you go getting reasonable with me while I’m busy
getting mad at you.”
I’d be the first to admit that not enough has been done
to isolate and measure the impact of fiscal policy. So far
as I know, we have no evidence consisting of a simple ( or,
for that matter, esoteric) one-equation correlation between
fiscal actions and the level of economic activity. Yet, even
apart from the impressive correlation between fiscal activism
and high employment, we have also had a series of expe­
riences on the firing line in which the predicted conse­
quences of specific fiscal actions— or failures to act— became


Walter W. Heller

the actual consequences (within quite tolerable margins of
error). Not, mind you, a perfect record, but a very respect­
able batting average.
But beyond this, Milton’s complaint that fiscal policy is
pure theory that has never been tested would certainly
come as a surprise to the many top-notch econometricians
who have, in one way or another, been doing that ever
since the Keynesian revolution started three decades ago.
Again, it’s true that they may not have asked, in their
research, the exact question in the exact way that Milton
Friedman has in mind. Indeed, those who are doing this
work— especially those who are using complete models of
the economy as in the Brookings-SSRC model and the Fed­
eral Reserve-MIT model— are persuaded that one needs to
go far beyond a one-equation system to get reasonably
reliable and balanced results.
They are testing what they regard as more advanced,
better formulated, and more interesting questions than the
simple one of whether fiscal or monetary policy is para­
mount. Yet, along the way, they have been substantiating
the importance of both fiscal and monetary policy. And
they are devoting a lot of time to refining the specification
of the fiscal and monetary policy sectors on the sensible
grounds that one cannot test and measure the effects of
policy on the economy without a very carefully and cor­
rectly specified model. I hardly need add that these studies
all show that fiscal policy matters a great deal.
Turning from defense to attack, I also think that one
should be aware of the very interesting “hindcasts” or
“backcasts” that have been made using the monetarists’
demand-for-money equation. Ex post correlations, after all,
are not enough. A key test of any given theory and set of
findings is a reasonable ability to forecast on the basis of



the variables identified as critical by such theory and re­
search. Comparing actual changes in nominal income with
those predicted by, say, Milton’s money-demand equation
does not lead to impressive results. Though I don’t have the
details at hand, I recall that comparisons made on this basis
demonstrate that the monetarists have no corner on good
(or bad) forecasting.1
Further, I suppose I shouldn’t let the 1964 tax cut go
entirely unmentioned in these comments even though the
gulf between us is so obvious, so wide, that there is no real
possibility of reconciling our positions. First, let me repeat
that I don’t see how the economy could have climbed to
full employment under the incubus of a $12 to $13 billion
full-employment surplus. Given the balance of payments
and other constraints of the real world, the idea that mone­
tary policy would have been capable of generating a match­
ing amount of private investment— in order to reach a
savings-investment relationship consistent with full employ­
ment— is next to inconceivable. And surely, the monetary
policy prevailing at the time ( which allegedly did the whole
jo b ) had no such power. The tax cut was the critical motive
The tax-cut issue is so important that I can’t just leave
it at that. I have to take a closer look at the record, since
Professor Friedman has not done it justice.
It is true that GNP started accelerating in the second
half of 1963, before the tax cut took effect. It is also true
that this surge was mainly fueled by sharp increases in
business-capital spending— by the way, both casual observa­
tion and penetrating study have shown this surge to be
related to the tax incentives provided in 1962. Monetary
policy also helped— without the credit expansion that oc­
curred, the rising demand from the investment-goods sector


Walter W. Heller

could not have been as fully met.
But it is in consumption behavior— the most directly and
immediately responsive spending sector in any fiscal policy
model— that one can most readily identify tax-cut effects.
In the three quarters preceding the tax cut, consumption
spending grew an average of $4.4 billion per quarter. For
the three quarters following the cut, the average jumped to
$8.4 billion per quarter— not a bad response (and close to
The relationships between the tax cut and the ensuing
jump in economic activity are examined in some detail in
the paper by Arthur Okun, the present Chairman of the
Council of Economic Advisers, to which Milton referred.
Surprisingly enough, my view of it differs from Milton’s.
As I see it, Okun’s appraisal provides further impressive,
even if not conclusive, evidence of the expansionary impact
of the tax cut.2
Now, what about 1966-67? Milton says that by our lights
— that is, by the lights of the “new economists”— we should
have forecast a continuing boom throughout 1967. But he'
is wide of the mark. I cannot agree that one of my per­
suasion— however Friedman describes it— would have pre­
dicted a boom in 1967. I’m widely on record (through my
Bank Letter for the National City Bank of Minneapolis)
with a forecast of a $42-billion GNP gain for 1967. The
actual increase turned out to be $42 billion. Professor Fried­
man is widely on record, through such instruments as his
Newsweek articles and his NET telecast early in 1967, with
dark ( and qualitative) forebodings of recession. Unemploy­
ment in 1967 averaged 3.8 per cent, the same as in 1966,
and was narrowly above 4 per cent only in September and
October— an unlikely picture of recession. But I have yet
to see the monetarists admit to their error in reading the



monetary tea leaves for 1967. After all, there was a slow­
down, and one could ( and they did) call it a mini-recession
— and so, in retrospect, although their widely predicted
recession failed to materialize, somehow, they see the moneysupply theory as calling the shots rather nicely.
Just as there was no occasion for predicting a recession,
surely, the developments in the full-employment surplus in
1966-67 provided no occasion for predicting a boom. Read­
ing from a table published by the Federal Reserve Bank
of St. Louis, I find that the full-employment surplus was
hovering near zero in the first three quarters of 1966. Cou­
pling that with the fact that the Fed had slammed on the
brakes in the absence of appropriate fiscal action, I find it
entirely reasonable that the forecaster taking a balanced
fiscal and monetary view would foresee a slowdown in the
first half of 1967. At the same time, with the full-employment
deficit leaping upward late in 1966, at the same time that
the Federal Reserve moved its foot from the brake to the
accelerator, it was quite reasonable to forecast, as we cor­
rectly did, a sharp upswing later in 1967.
Further, a realistic forecaster had to plug policy— per­
sonified by President Lyndon Johnson— into his forecast. I
have sometimes said that the U. S. economy would not have
a recession while Lyndon Johnson was President. It wouldn’t
dare! In the face of the early 1967 slowdown, he released
budget funds he had impounded; he called for restoration
of the investment credit; he released mortgage moneys; and
so on. It was reasonable— and right— to plug Lyndon John­
son into the forecast. Now I don’t know what Milton will
do with that.
Another point on which Milton jousts with caricature is
in asserting that those who lean towards the fiscal approach
make the mistake of assuming that the way in which a


Milton Friedman

deficit is financed will not alter the consequences of the
fiscal action that produces the deficit. Breathes there a fiscalist so pure as to take this illogical position, long since
exposed in even the most elementary of economics text­
books? I doubt it.3
Let me say again that what we apparently need is an
“economists’ disarmament agreement,” a recognition by each
side of the potential merit in the other side’s position rather
than a continuation of the divisive and counterproductive
indoor sport of sniping at each other’s conclusions. It would
hardly be a happy upshot of the debate if Friedman and
the monetarists convinced you that fiscal policy and discre­
tion won’t work while Heller and the “new economists” per­
suaded you that the money-supply thesis and rigid rules are
the road to ruin.
Yet, I must confess that in this attempt at de-escalation,
we’ve sent a number of notes to Hanoi, spelled Chicago,
offering to stop the bombing and negotiate a settlement,
looking to a working coalition with the Viet Cong. But the
reply has been stem and stony: stop the bombing in the
North and withdraw completely from the South, and then
we’ll negotiate.





am delighted to have the Johnson theory of the busi­
ness cycle added to monetary theories, real theories, “x”
theories, and so on. I want to comment on some of the
points that Walter made initially and try to answer some of
the questions he raised. I think that I might very well start
with a point he made before and which he repeated now.
He said that he would like us to stop being asymmetrical
about tax increases or tax cuts on the one hand, and ex­
penditure decreases on the other.
I want to make it clear that I have never favored expendi­
ture decreases as a stabilization device. I agree with Walter
that it would be inconsistent, completely inconsistent, for
me to argue that tax increases and decreases are ineffective
in stemming inflation or promoting expansion, but that
spending decreases or increases are effective. That would be
a silly position and, as far as I know, I have never taken it,


Milton Friedman

though maybe I’ve been careless in what I have written and
have given a misleading impression. I have been in favor of
tax decreases and expenditure decreases in 1964, in 1966,
and in 1968, but not for stabilization purposes. I am in favor
of expenditure decreases from a long-range point of view
because I think that the U. S. federal budget is too large
compared to what we’re getting for it. We’re not getting our
money’s worth out of it. And, therefore, I would like to see
government spending brought down. I have not argued—
at least, if I have, I will immediately admit that I should
not have and I don’t know of any quotation in which I have
(if Walter has any, I hope he will give them to m e)— that
expenditure decreases are a way to achieve stabilization at
a time of inflationary pressure.
I have said something different. I have said that, from
the point of view of the fiscalists, a tax increase or expendi­
ture decrease are equivalent. And, therefore, I have often
said that if you are going to adopt the policy of the fiscalist,
I would rather see you adopt it through expenditure de­
creases than through tax increases. But I personally have
never argued that that is an effective stabilization device,
and I don’t believe that it is.
Let me turn to some of the specific issues that Walter
raised in his first discussion and see if I can clarify a few
points that came up.
First of all, the question is, Why do we look only at the
money stock? Why don’t we also look at interest rates?
Don’t you have to look at both quantity and price? The
answer is yes, but the interest rate is not the price of money
in the sense of the money stock. The interest rate is the
price of credit. The price of money is how much goods and
services you have to give up to get a dollar. You can have



big changes in the quantity of money without any changes
in credit. Consider for a moment the 1848-58 period in the
United States. We had a big increase in the quantity of
money because of the discovery of gold. This increase didn’t,
in the first instance, impinge on the credit markets at all.
You must sharply distinguish between money in the sense
of the money or credit market, and money in the sense of the
quantity of money. And the price of money in that second
sense is the inverse of the price level— not the interest rate.
The interest rate is the price of credit. As I mentioned earlier,
the tax increase we had would tend to reduce the price of
credit because it reduces the demand for credit, even though
it didn’t affect the money supply at all.
So I do think you have to look at both price and quantity.
But the price you have to look at from this point of view
is the price level, not the interest rate.
Next, he said that 1967 was the easiest money year since
1962. Yet there was a big rise in interest rates. In other con­
nections, I have argued that our researches show that a
rapid increase in the quantity of money tends to lower
interest rates only for a brief period— about six months.
After that, it tends to raise interest rates. Conversely, a slow
rate of increase in the quantity of money tends to raise
interest rates only for about six months, and after that, it
tends to lower them.1
If you ask where in the world interest rates are highest,
the answer is in Brazil, Chile, places like that where the
quantity of money has been going up like mad. Interest
rates in the U. S. fell dramatically from 1929 to 1933. The
quantity of money declined by a third. So it’s not a surprise
to us that you could have the quantity of money easy in the
sense of quantity, and interest rates rise or fall or do almost


Milton Friedman

anything else.
Next, he asks, “Which of the Friedmans do you believe—
the one who stresses permanent-income relationships or the
one who stresses the close causal connection?” Well, belive both of them if you take them at what they said. The
permanent-income analysis has to do with the demand for
real money balances, and it was an analysis that was based
on annual data covering decades. There is no Friedman who
has argued that there is an immediate, mechanical, causal
connection between changes in the quantity of money and
changes in income.
What I have always argued is that there is a connection
which is, on the average, close but which may be quite
variable in an individual episode. I have emphasized that
the inability to pin down the lag means that there are lots
of factors about which I’m ignorant. That doesn’t mean that
money doesn’t have a systematic influence. But it does mean
that there is a good deal of variability in the influence.
The data support the view that a 1 per cent change in
the rate of expansion of the quantity of money tends to pro­
duce, on the average, a 2 per cent change in the rate of
growth of nominal income. There is a big multiplier, as the
permanent income analysis would lead you to expect. And
there is a cyclical relation. I’m sorry, but I really don’t see
any inconsistency between the position I’ve taken on these
two points.
Next, Walter Heller asks, Which of the money supplies
do you want?
or M2? Which quantity of money do you
want to use? A perfectly reasonable and appropriate and
proper question and I’m glad to answer it. In almost all
cases, it makes no difference. The only time it makes a dif­
ference is when our silly Regulation Q gets in the way. We



have a Regulation Q that pegs the maximum rate that com­
mercial banks can pay on time deposits. Whenever you
either hit that Regulation-Q limit or you come through from
the other side, the two monetary totals diverge and tell you
different stories, and you cannot trust either one.
At all other times, you will very seldom find that the mes­
sage told to you by Mi is much different than the message
told to you by M2. So what I say in answer to this is that
if we can only get rid of that silly Regulation Q, which is
introducing all the noise into the system, then I will let you
choose: you take whichever one of those monetary totals
you want and I will be willing to accept that choice. Of
course, it would be even better if you also abolished the
prohibition of payment of interest on demand deposits, be­
cause that also has been a factor that has produced a dis­
crepancy between these two monetary totals.
Then there was all this talk about being locked into a
rigid rule. You know, I have always found it a good rule of
thumb that when somebody starts resorting to metaphors,
there is something wrong with his argument.
When you start talking about cars driving along a road,
and whether you want to lock the steering wheel, well that’s
a good image; the automatic pilot, I agree, is a good one.
But metaphors or similes are to remind you of arguments;
they are not a substitute for an argument.
The reason I believe that you would do better with a
fixed rule, with a constant rate of increase in the quantity of
money, is because I have examined U. S. experience with
discretionary monetary policy. I have gone back and have
asked, as I reexamine this period, “Would the U. S. have
been better off or worse off if we had had a fixed rule?” I
challenge anybody to go back over the monetary history of


Milton Friedman

the United States, and come out with any other conclusion
than that for the great bulk of the time, you would have
been better off with the fixed rule. You would clearly have
avoided all the major mistakes.
The reason why that doesn’t rigidly lock you in, in the
sense in which Walter was speaking, is that I don’t believe
that money is all that matters. The automatic pilot is the
price system. It isn’t perfectly flexible, it isn’t perfectly free,
but it has a good deal of capacity to adjust. If you look at
what happened to this country when we adjusted to postWorld War II, to the enormous decline in our expenditures,
and the shift in the direction of resources, you have to say
that we did an extraordinarily effective job of adjusting, and
that this is because there is an automatic pilot.
But if an automatic pilot is going to work, if you’re going
to have the market system work, it has to have some basic,
stable framework. It has to have something it can count on.
And the virtue of a fixed rule, of a constant rate of increase
in the quantity of money, is that it would provide such a
stable monetary framework. I have discussed that many
times in many different ways, and I really have nothing to
Let me only say two additional things. I meant to say
earlier, with reference to putting yourself down on paper
as far as predictions are concerned— I will give Walter
Heller a bibliographical note and he can check— that Prentice-Hall recently brought out (this is a free advertisement)
a collection of some essays of mine called Dollars and
Deficits.2 These are papers directed at a general audience
and contain more popular things including a couple of
memoranda that I wrote at various times for meetings of
the Federal Reserve Board. I think that if you look through



these, you will find that they contain a considerable num­
ber of forecasts.
I have some footnotes at various points indicating what
did happen later. Some of the forecasts are pretty good,
some aren’t; but you can judge for yourself whether you
think that, on the whole, the record is good or bad.
The final thing I want to talk about is the statement that
Walter made at the end of his initial talk, when he said,
Look at the world economy; hasn’t it been far healthier dur­
ing post-World War II than it was between the Wars? Of
course. It certainly has been enormously healthier. Why?
Well, again, I’m sorry to have to be consistent, but in 1953,
I gave a talk in Stockholm, which is also reprinted in that
collection of papers, under the title of “Why the American
Economy is Depression Proof.”
I think that I was right, that as of that time and as of
today, the American economy is depression proof. The rea­
sons I gave at that time did not include the fact that dis­
cretionary monetary and fiscal policy was going to keep
things on an even keel. I believe that the reason why the
world has done so much better, the reason why we haven’t
had any depressions in that period, is not because of the
positive virtue of the fine tuning that has been followed,
but because we have avoided the major mistakes of the
interwar period. Those major mistakes were the occasionally
severe deflations of the money stock.
We did learn something from the Great Depression. We
learned that you do not have to cut the quantity of money
by a third over three or four years. We learned that you
ought to have numbers on the quantity of money. If the
Federal Reserve System in 1929 to 1933 had been publish­
ing statistics on the quantity of money, I don’t believe that


Milton Friedman

the Great Depression could have taken the course it did.
There were no numbers. And we have not since then, and
we will not in the foreseeable future, permit a monetary
authority to make the kind of mistake that our monetary
authorities made in the 30’s.
That, in my opinion, is the major reason why we have
had such a different experience in post-World War II.




Is M o n e ta r y P o lic y B ein g O v erso ld ?
W alter W . Heller
1. Anyone interested in the ongoing debate about monetary
policy should read Professor Tobin’s piece in The Washington
Post for April 16, 1967 (which, in the best journalistic tradition,
was printed under the headline, “Tobin Attacks Friedman’s Theo­
ries of Money Supply” ), and Dr. Gramley’s article, “The Infor­
mational Content of Interest Rates as Indicators of Monetary
Policy,” in Proceedings: 19 6 8 Money and Banking Workshop,
Federal Reserve Bank of Minneapolis (May, 1968). (A com­
panion article, “Interest Rates Versus the Quantity of Money:
The Policy Issues,” by Professor Phillip Cagan, is also well worth
reading.) More technical criticisms of Professor Friedman’s posi­
tion will be found in two papers, the first by Professor Tobin:
“Money and Income: Post Hoc Propter Hoc,” which is available
in mimeograph. The second is by Professors Michael Lovell and
Edward Prescott: “Money, Multiplier-Accelerator Interaction and
the Business Cycle,” Southern Journal of Economics , July, 1968.
2. “U.S. Financial Data, week ending November 6, 1968,”
Federal Reserve Bank of St. Louis, p. 1.
3. Gramley, op. cit.f p. 23.
4. This was not only Keynes’s view; it is, I believe, Milton
Friedman’s. Indeed, his formulation of the monetary process—
of the process whereby a change in the supply of money works
its potent magic— reads remarkably like Tobin’s, or for that mat­
ter, like Keynes’s. See, for example, his “Money and Business
Cycles,” p. 60. This paper was written with Mrs. Schwartz, and
appeared in the February, 1963 issue of the Review of E co­
nomics and Statistics.
5. Milton Friedman and Anna Jacobson Schwartz, A Monetary
(Princeton, N.J.:
Princeton University Press, 1963), p. 682.
History of the United States: 18 6 7 -1 9 6 0

6. An unpublished paper by the staff of the St. Louis Federal
Reserve Bank cited by Professor Friedman in support of the
contrary position (see pp. 60-62) was not available to me at



the time of this debate, but has since been published. (Leonall
Anderson and Jerry Jordan, “Monetary and Fiscal Actions: A
Test of Their Relative Importance in Economic Stabilization,”
St. Louis Federal Reserve Bank Review, November, 1968.) It
calls for comment, especially since it has been much praised by
the monetarists. It concludes, in effect, that monetary policy
matters greatly and fiscal policy little, if at all. But a faulty
specification of the world cannot lead to correct conclusions. And
the Anderson-Jordan specification is faulty in pursuing strictly
one-way economics:
• They make no allowance for reverse causation, for the in­
fluence of economic activity on the money supply. Yet such
causation was clearly at work in the 1952-68 period they
• Similarly, they do not allow for the influence of economic
activity on government spending. Yet where demand expan­
sion generates inflation, real government spending may be
treated as an exogenous variable, but nominal spending surely
On the first point, suffice it to note that during much of the
1952-68 period, the Federal Reserve adhered to what has been
called the “free-reserves doctrine.” Under this decision rule,
money supply became, in part, a dependent variable, for ex­
• When the level of interest rates had to be fixed with an eye
to our external position so that changes in the level of eco­
nomic activity had to be “taken up,” so to speak, in the stock
of money.
• When the level of interest rates had to be held down to
avoid thwarting the stimulus of the 1964 tax cut so that, here
also, the money supply had to follow the lead of nominal GNP,
i.e., had to respond to changes in economic activity rather
than vice versa.

7. Milton Friedman, A Program for Monetary Stability (New
York: Fordham University Press, 1959), p. 87.
8. Organization for Economic Cooperation and Development,
Fiscal Policy for a Balanced Economy, Paris, 1968, p. 23. This
report reviews and appraises the fiscal policy experiences of
Belgium, France, Germany, Italy, Sweden, the United Kingdom,



and the United States since 1955 and makes recommendations
for improving the operation of fiscal policy. See also the com­
panion volume by Bent Hansen, Fiscal Policy in Seven Coun­
tries, OECD, Paris, 1969, which presents in detail the results of
the econometric studies underlying some of the conclusions of
the experts’ report.
9. I reviewed a number of the issues involved in this contro­
versy in my article, “CED’s Stabilizing Budget Policy After Ten
Years,” The American Economic Review, September, 1957, pp.

H as F iscal P olicy B e e n O versold ?

Milton Friedman
1. Milton Friedman, “The Supply of Money and Changes in
Prices and Output,” The Relationship of Prices to Economic
Stability and Growth, 85th Cong., 2nd Sess., Joint Committee
Print (Washington, D. C., U. S. Government Printing Office,
3.958), pp. 241-256, quotation from pp. 255-256. To be reprinted
in Milton Friedman, The Optimum Quantity of Money and
Other Essays (Chicago, 111.: Aldine Publishing Co., 1969).
2. Contained in the 1962, 1963, and 1964 Economic Report of
the President, (Washington, D. C.: U. S. Government Printing
Office, 1962, 1963, 1964).
3. Taxes and the Budget: A Program for Prosperity in a Free
Economy, a statement by the Research and Policy Committee of
the Committee for Economic Development (November, 1947);
Milton Friedman, “A Monetary and Fiscal Framework for
Economic Stability,” American Economic Review, XXXVIII
(June, 1948), p. 249 (originally presented before Econometric
Society in September, 1947). The concept that has come to be
called the high-employment budget, I labelled, in my paper,
the “stable” budget, and the council first labelled, in its 1962
Report, the “full-employment” budget (op. cit., p. 80).
4. Arthur M. Okun, “Measuring the Impact of the 1964 Tax
Reduction,” in Walter W. Heller (ed.), Perspectives on Economic
Growth (New York: Random House, 1968).



5. "Price, Income, and Monetary Changes in Three Wartime
Periods,” American Economic Review (May, 1952), pp. 612625. To be reprinted in The Optimum Quantity of Money and

Other Essays, op. cit.
6. Milton Friedman and David Meiselman, "The Relative Sta­
bility of Monetary Velocity and the Investment Multiplier in
the United States, 1897-1958,” Stabilization Policies (Com­
mission on Money and Credit, Englewood Cliffs, N. J.: PrenticeHall, 1963), pp. 165-268.
7. Donald D. Hester, "Keynes and the Quantity Theory: A Com­
ment on the Friedman-Meiselman CMC Paper,” and Milton
Friedman and David Meiselman, "Reply to Donald Hester,”
The Review of Economics and Statistics, XLVI (November,
1964), pp. 364-377; Albert Ando and Franco Modigliani, "The
Relative Stability of Monetary Velocity and the Investment
Multiplier,” Michael De Prano and Thomas Mayer, "Tests of the
Relative Importance of Autonomous Expenditures and Money,”
and Milton Friedman and David Meiselman, "Reply to Ando
and Modigliani and to De Prano and Mayer,” American Eco­
nomic Review, LV (September, 1965), pp. 693—792.
8. Leonall C. Anderson and Jerry L. Jordan, "Monetary and
Fiscal Actions: A Test of Their Relative Importance in Economic
Stabilization,” Review, Federal Reserve Bank of St. Louis, No­
vember, 1968, pp. 11-23.
9. Ibid., p. 22.
10. Ibid., p. 22
11. In a footnote to his paper added after our interchange (note
6, p. 83- above), Professor Heller criticizes the St. Louis study
for making no allowance for "reverse causation,” i.e., for the
influence of economic activity on the money supply and on
government spending. The reader of the paper by Anderson
and Jordan will find that they anticipate this possible criticism,
discuss it explicitly, and show it to be invalid for their computa­
tions and conclusions. The key issue is to assure that, so far as
possible, the variables defining monetary policy and fiscal policy
are autonomous, not partly autonomous, partly induced. For



money, they achieve this by using a number of different mone­
tary totals: the monetary base, currency plus demand deposits,
currency plus all commercial bank deposits. For the government
budget they do so by using high employment expenditures and
receipts. For both, autonomy is reinforced by using lagged
values of monetary and fiscal policy variables with different
methods of allowing for lags. All variants yield essentially the
same results.
Of course, no study can "prove” anything finally. Proof is re­
served for logical, not empirical, propositions. What a study can
do is to contradict or fail to contradict hypotheses, and even
then, of course, any findings are always tentative because the
evidence is necessarily incomplete and there is always the possi­
bility that the hypothesis contradicted can be reformulated so
as to be consistent with the initially contradictory evidence.
However, as a veteran of many years’ standing of the kind
of smoke-screen criticism levelled by Heller against the Ander­
son-Jordan study, I would take it far more seriously if the as­
sertion that something may be wrong were accompanied by
some evidence, empirical or analytical, that something is wrong.
12. The references added by Professor Heller in footnote 1 of
his paper do not meet this challenge. They are criticisms of my
work of the same kind as, though naturally more elaborate and
developed than, his brief criticisms of the Anderson-Jordan
article discussed in the preceding footnote. None of the criticisms
gives any systematic evidence supporting the hypothesis that
fiscal policy by itself has a significant influence on nominal in­
come. To complement the references in his footnote, I should
note an article of mine, “Taxes, Money and Stabilization,” Wash­
ington Post, November 5, 1967, because it is partly in answer
to several critical pieces by Tobin in the Washington Post,
including the one referred to by Heller.
His footnote 8 gives two other references to OECD docu­
ments. Since I have not yet seen these I cannot judge whether
they provide relevant empirical evidence.



REPLY/Walter W. Heller
1. Gramley, who may know more about Professor Friedman's
work than anyone other than Friedman himself, has compared
actual yearly changes in nominal Net National Product (NNP)
with those predicted by the Friedman equation as reported in
“Interest Rates and the Demand for Money,” Journal of Law
and Economics, October, 1966. For the period 1948-60, the
average yearly change in nominal NNP was $18.6 billion. Gram­
ley found the average predicted changes to be $5.5 billion. It is
quite true that for the period 1960-67, the two average changes
are nearly identical ($37.2 billion versus $36.8 billion). But
this does not contradict the point that a fixed rule ought to
allow for trend changes in velocity. And if trend changes are
allowed for, why not shorter run changes?
2. See Arthur M. Okun, “Measuring the Impact of the 1964
Tax Reduction,” in Walter W. Heller, (ed.), Perspectives on
Economic Growth, (New York: Random House, 1968).
3. Subsequent to our discourse in New York, I’ve gone over
the debate Friedman and Meiselman touched off in the pro­
fessional journals, which Milton summed up in his comments
by indicating that everyone agreed that monetary magni­
tudes did have an important and systematic influence. But I
find that he rather slides over the fact that, to the satisfaction
of many— indeed, I think it’s safe to say most— members of the
profession, his own work concluding that monetary magnitudes
were far more important than fiscal was effectively rebuffed.

R e p l y / Milton Friedman
1. For a summary of these results, see my paper “Factors Af­
fecting the Level of Interest Rates,” 1968 Proceedings, Confer­
ence on Savings and Residential Financing (Chicago, 111.: U. S.
Savings and Loan League, 1968), pp. 11-27.
2. Milton Friedman, Dollars and Deficits (Englewood Cliffs,
N.J.: Prentice-Hall, 1968).
3. Ibid., pp. 72-96.

Glossary of Terms and



This glossary is intended to present simple definitions and ex­
planations of terms used by Professors Friedman and Heller in
their debate. Words or phrases in italics also appear as separate

Automated policy. The reliance on fixed rates of change in money and
tax rates rather than frequent discretionary changes in monetary or
fiscal policy to affect the level of economic activity. An example of
automated policy is the setting of a growth rate for the money supply
to be followed for long periods independent of current economic
Autonomous expenditures. Expenditures exogenous to the particular model
used to forecast GNP. Generally regarded as autonomous are private
investment, exports or net foreign balance, expenditures by the fed­
eral government or the federal deficit or the federal full- (or high-)
employment deficit, and expenditures attributed to changes in the
federal government’s tax rates.
Chicago School. A name applied to a group of economists who, among
other things, believe that changes in the money supply are a major
determinant of short-run changes in the level of economic activity


Glossary of Terms and R eferences

and the most important of the policy instruments available to the fed­
eral government for affecting short-run changes in economic activity.
The members of this school generally advocate reliance upon auto­
mated policy.

Classical real-wage doctrine. A doctrine which holds that, in the longrun, there is no trade off between unemployment and price increases as
is implied by the Phillips curve. It has been taken to indicate that a
rising price level will not affect permanently the level of unemploy­
Committee for Economic Development (CED). A nonpartisan organiza­
tion, composed of leading businessmen and educators, which issues fre­
quent policy statements on economic matters.
Council of Economic Advisers. Three members, assisted by a professional
staff of economists, who are appointed by the President to advise him
on economic matters, as provided by the Employment Act of 1946.
Credit. See Loanable Funds.
Currency. Paper money and coins.
Demand deposits. Bank deposits legally payable upon demand and gen­
erally transferable by check.
Discretionary policy. The deliberate introduction by administrative
agencies of changes in monetary and fiscal policy to serve national
economic goals.

Easy money. A monetary policy regarded as stimulating economic ac­
tivity. Defined by some as a policy of promoting low interest rates;
by others, falling interest rates; by others, a rapid rate of growth of the
quantity of money; by others an acceleration in the rate of growth
of the quantity of money.
Endogenous variable. A variable whose value is determined by the values
of other variables within the particular model used to explain events.
Exogenous variable. A variable whose value is determined outside the
particular model used to explain events.
Federal Reserve System (Fed). The organization responsible for mone­
tary policy in the United States. There are twelve regional federal
reserve banks. The Board of Governors of the Federal Reserve Sys­
tem, consisting of seven governors, appointed by the President for
fourteen-year terms, is the major policy-formulating group. Since 1951,
its Chairman has been William McChesney Martin, Jr.
Federal Reserve-Treasury Accord. See Monetary Accord of 1951.
Fine tuning. The active use of discretionary monetary and fiscal policy
in the attempt to offset fluctuations in the level of economic activity.
Fiscal dividend. The increase in federal revenues which results from a
rise in GNP at any given level of tax rates.
Fiscal drag. The possible restrictive effect on the economy of the auto­

Glossary of Term s and References


matic growth in federal revenues arising out of the growth in GNP ,
where such revenue growth is not matched by corresponding expendi­
ture increases and/or tax reductions. (Alternatively, fiscal drag may
be defined as the growth in the potential full- (or high-) employ­
ment surplus.)

Fiscal policy. The use of changes in the level of taxes and expenditures
(either transfer payments or other budget expenditures) to serve
national economic goals.

Fiscalists. Those who believe that fiscal policy is the most important
means available to the government for affecting the level of economic
Flexible exchange rates. A situation in which exchange rates among na­
tional currencies would be free to vary in response to supply-anddemand conditions, without government attempts to maintain a fixed
rate at which one currency is exchanged for another.
Forward exchange. Foreign exchange transacted for delivery at some
future date.
Free reserves. The excess of member-hank reserves over borrowings from
the Federal Reserve System plus reserves legally required against bank
Full (or high) employment. A situation in which all looking for jobs at
the going wage rate would be able to obtain employment. For pur­
poses of policy, because of job turnover and other frictions, full (or
high) employment is currently considered to be a situation where the
unemployed are only 3 or 4 per cent of the labor force.
Full- (or high-) employment surplus (deficit). A measure of the size
of the surplus (deficit) which would occur in the federal government
budget if the economy were at full (or high) employment. This con­
cept is used because the actual amount of tax collections (and certain
expenditures like unemployment compensation) is dependent upon the
level of economic activity, once the government has set the tax and
expenditure rates.
Gross National Product (GNP). The total value of goods and services
produced in the economy within a given time period before allowance
for depreciation of capital goods.
Income velocity of money. The ratio of income to the money supply.
Interest-rate peg. The monetary policy followed from 1942 to 1951 under
which the Federal Reserve System adjusted the quantity of money
so as to hold the interest rate on Treasury securities constant.
Investment tax credit. The reduction of taxes through a 7 per cent tax
credit for firms purchasing new plant and equipment. First passed in
1962, it was suspended for several months in 1966-67 in an attempt
to reduce such investment.


Glossary of Terms and R eferences

Joint Economic Committee. A Congressional committee composed of ten
Senators and ten Representatives which holds hearings and issues re­
ports on economic matters.
Liquidity preference. The desire on the part of firms and individuals to
hold money.
Loanable funds. Funds that lenders are willing to make available to
borrowers at a specified rate of interest.
Member-bank reserves. Currency held by banks who are members of
the Federal Reserve System, plus their deposits at federal reserve
Monetarists. Those who believe that monetary policy is the most im­
portant means available to the federal government for affecting the
level of economic activity.
Monetary Accord of 1951. An agreement between the Treasury and the
Federal Reserve System which ended the interest-rate peg, permitting
monetary policy to respond to other objectives.
Monetary base. The sum of member-bank reserves and currency held
outside banks. This is under the direct control of the Federal Reserve
System. Between January and November 1968, the monetary base rose
from $72.2 billion to $76.2 billion.
Monetary multiplier. A number giving the expected change in income
per unit change in the money supply.
Monetary policy. The use of changes in the money supply and the cost
and availability of credit to serve national economic goals.
Money supply. The total quantity of money held by the public. Two
measures of the money supply are generally used. Mx is the sum of
currency held outside banks and demand deposits. M2 is the sum of
Mx and time deposits held in commercial banks. Between January and
November 1968, Mx rose from $ 182.3 billion to $ 192.0 billion; M2
from $366.4 billion to $393.9 billion (seasonally adjusted data).
Multiplier. A relationship giving the expected change in GNP for given
changes in autonomous expenditures.
National economic goals. High or full employment, a satisfactory growth
rate, reasonable price stability, and equilibrium in the international
balance of payments. These goals are sought within a framework of
economic freedom of choice and growing equality of opportunity.
New economics. A term applied to the active use of discretionary fiscal
and monetary policy to serve national economic goals.
Nominal income. The dollar value of income. Changes in nominal income
may be due to either changes in real income or changes in the level of
Organization for Economic Cooperation and Development (OECD).
An organization of twenty-two nations (from noncommunist Europe,
Canada, Japan, and the United States) which was established to

Glossary of Terms and R eferences


coordinate and advise on economic and financial policies of the
member nations.
Permanent income. The average income expected to be received over a
period of years.
Permanent-income hypothesis. The hypothesis that household-consumption expenditures are related to permanent income and not affected
by deviations from this amount.
Phillips curve. A relationship between the level of unemployment and
the rate of change of wages. It has been taken to indicate that it
is possible to reduce unemployment only at the expense of a rising
price level, so that it is necessary to trade off between reducing un­
employment and holding the price level stable.
Real income. A measure of goods and services produced within a given
time period. Changes in real income are computed by adjusting changes
in nominal income for changes in the level of prices.
Real money balances. The quantity of goods and services which can be
purchased from a given stock of money held by individuals. Changes
in real-money balances are computed by adjusting changes in the
quantity of money held for changes in the level of prices.
Real output. See Real income.
Regression coefficient. A statistically determined measure of the quantita­
tive effect of a change in one factor upon another.
Regulation Q. The regulation providing the Federal Reserve Board with
the power to control the interest rate paid on time deposits held in
member commercial banks.
Surtax. A 10 per cent surcharge placed on personal and corporation in­
come taxes passed by Congress in June 1968 and which was to be in
effect for one year. It was intended to contract the level of economic
Tax cut of 1964. A broad-based reduction in the personal and corpora­
tion income-tax rates passed by Congress in 1964 to reduce the size
of the full-employment surplus. It was designed to expand the level
of economic activity.
Tax sharing. The proposal that the federal government grant some part
of its tax collections to state and local governments.
Tight money. A monetary policy regarded as retarding economic ac­
tivity. The opposite of easy money.
Time deposits. Bank deposits subject to prior notice of withdrawal and
not transferable by check.
Transfer payments. Payments made by the federal government to indi­
viduals, not as payments for currently productive services. These in­
clude welfare payments, unemployment compensation, and social
security payments.