Milton Friedman @ Rest
January 22, 2007

In July last year, the late Milton Friedman, Nobel laureate in economics in 1976, granted an interview to The Wall Street Journal. Today we publish material from a question-and-answer exchange he had by email -- shortly after their meeting -- with his interviewer, Tunku Varadarajan, the Journal's editorial features editor.

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Should China float the yuan?

Milton Friedman: Yes. Pegging the Chinese currency to the U.S. dollar requires that China follow a policy which over time yields an inflation rate that is compatible with, though not necessarily equal to, the U.S. inflation rate. When that is not the case, maintaining the peg will require control over foreign exchange transactions both current and capital. But China's future depends on their eliminating such exchange controls, on their opening the market as much as they can and as having essentially a free price system. Hence it is in their own interest to move to institutions which enable them to have as free a market as possible both internally and externally.

If they do insist on pegging the yuan, they will sooner or later run into a situation in which they are either accumulating an excessive amount of U.S. dollars or they are in debt for an excessive amount of U.S. dollars and they will have a foreign exchange crisis. Far better to have a floating exchange rate and let the market do the adjusting that is necessary to render developments in China economically compatible with those in the rest of the world.

Are you still a strong supporter of flexible exchange rates, even for developing countries?

Friedman: Yes. Economic forces affecting different countries are not always the same. The right exchange rate for a country in general may be one thing one time and another thing another time. A country that pegs the exchange rate is essentially committing itself to adopt the economic policies of the country whose currency it is pegged to. If it does that by pegging the exchange rate, it will always be under pressure as circumstances change to take advantage of the pegged exchange rate when they can and get into a position which is untenable.

The case of Argentina is the most dramatic and clearest case about that. Either a country should explicitly become part of the economic system of another country, as it could by dollarizing its currency as Panama has done, or else it seems to me it is best off by allowing the market to determine the value of its currency and in that way adjust to changes in the relative economic pressures on different countries. But flexible exchange rates are not a panacea for all evils. Governments can follow bad economic policies with either flexible or fixed exchange rates.

Do you still think it would be a good idea to have a computer run monetary policy?

Friedman: Yes. Of course it depends very much on how the computer is programmed. I am not saying that any computer program would do. In speaking of that, I have had in mind the idea that a computer would produce, for example, a constant rate of growth in the quantity of money as defined, let us say, by M2, something like 3% to 5% per year. There are certainly occasions in which discretionary changes in policy guided by a wise and talented manager of monetary policy would do better than the fixed rate, but they would be rare.

In any event, the computer program would certainly prevent any major disasters either way, any major inflation or any major depressions. One of the great defects of our kind of monetary system is that its performance depends so much on the quality of the people who are put in charge. We have seen that in the history of our own Federal Reserve System. Surely a computer would have produced far better results during the 1930s and during both world wars.

That raises a question about the desirability of our present monetary system. It is one in which a group of unelected people have enormous power, power which can lead to a great depression or which can lead to a great inflation. Is it wise to have that power in those hands?

An alternative would be to eliminate the Federal Reserve System; to reduce the monetary activities of the federal government to the provision of high-powered money, that is, currency and bank reserves, and to constitutionalize, as it were, what is to be done with high-powered money. My preference is simply to hold it constant and let financial developments produce the growth in the quantity of money in the form of bank deposits, a process that has been going on for many decades. But that is, of course, politically impossible.

Do tax cuts pay for themselves?

Friedman: Occasionally. But revenue loss is almost always less than static prediction.

Do you have any favorite candidates for president in 2008?

Friedman: No.

Is inflation-targeting the right medicine for monetary policy? If so, how would you do it?

Friedman: It is a good medicine with the present institutions. And recent experience suggests that it is doable. Targeting central banks have been able to hit their targets. Basic way to do it is to keep quantity of money growing at a rate equal to target plus trend rate of real growth. Full discussion beyond the scope of email.

What is the biggest risk to the world economy: America's deficits? Energy insecurity? Environment? Terrorism? None of the above?

Friedman: Islamofascism, with terrorism as its weapon.

What are your thoughts on the low U.S. savings rate?

Friedman: The right saving rate is whatever satisfies the tastes and preferences of the public in a free and unbiased capital market. Market can adjust to any rate. This is a very complicated question. Present estimates probably understate actual savings because of treatment of capital gains. In any event, the present situation does not raise any problems for the economy.

India -- how do you assess its prospects?

Friedman: Fifty years ago, as a consultant to the Indian minister of finance, I wrote a memo in which I said that India had a great potential but was stagnating because of collectivist economic policies. India has finally started to disband those collectivist policies and is reaping its reward. If they can continue dismantling the collectivist policies, their prospects are very bright.

Any thoughts on a China versus India comparison?

Friedman: Yes. Note the contrast. China has maintained political and human collectivism while gradually freeing the economic market. This has so far been very successful but is heading for a clash, since economic freedom and political collectivism are not compatible. India maintained political democracy while running a collectivist economy. It is now unwinding the latter, which will strengthen freedom of all kinds, so in that respect it is in a better position than China.

Milton Friedman died on Nov. 16, 2006, age 94. There is a memorial for him today at Stanford University.

link: http://online.wsj.com/