Agreeing to Disagree

RK: You have obviously had the enormous satisfaction of seeing your ideas influence a revolution, both in the thinking of economists and in the premises of politics and the role of government. Does this make you any more optimistic about the ability of the political process to work, and of government to learn over time?

MF: I've always been realistic about this. I do not think you can change [government].

RK: Well at least it seems to prove that ideas have influence.

MF: There is no question that they have influence. You know, I agree very much with the famous quotation from Keynes. Sooner or later, ideas matter.

RK: Right. Let me get down to some specifics. You were the progenitor of the notion that we ought to move to floating exchange rates.

MF: I was a promoter of that idea. I was in favor of it, but I was by no
means the inventor it. That was an old idea.

RK: Well, I guess I meant in the context of the Bretton-Woods system breaking down.

MF: Well, sure I wrote and spoke about the desirability of that proposal at a fairly early time.

RK: I guess my question is: are there times when, because of the unique role of the dollar and the ability of the United States to borrow dollars from sovereign countries, exchange rates can get dangerously out of alignment, and not correct as quickly as one might hope? Is that of concern?

MF: It is not. Any policy that seeks to adjust exchange rates more quickly will in practice adjust them more slowly. How often does the government ever beat the market in terms of getting things done better and more quickly?

RK: So if &.

MF: Of course there are periods when the exchange rate gets out of line-- the question is what is the best way to adjust. The market will adjust faster than the government would.

RK: Are there structural things in the way markets are structured that can reduce the risk of bubbles?

MF: I'm not an expert on bubbles I think bubbles are something that you can only know after the fact and obviously the more flexible the market, the more information you have going, the more likely it is that you will get the right price.

RK: So there's nothing that can be done in the rules of the regime to make it less likely that you'll have prolonged bubbles and then prolonged crashes, or dangerous deep crashes.

MF: Yes of course there is. You will not have any deep crashes if you have a stable monetary policy. After all we have not had any crashes after the 1999-2000 bubble.

RK: Well that was the next thing I wanted to ask you about. I was reviewing your history with Anna Schwartz [A Monetary History of The United States, 1963], which of course changed the thinking about the causes and dynamics of the Depression. So, if I read you right, it wasn't that the government had no role to play, it was that the government, in the person of the Federal Reserve, needed to provide the system with more liquidity than it was providing, but the government did a poor job that time. My question is, do you think the Fed has learned a few things since 1929?

MF: Oh, there is no doubt. I have a paper coming out in the Journal of Economic Perspectives on a natural experiment. You have bull markets in the 20's in the United States, the 80's in Japan, and the 90's in United States, followed in each case by a stock market crash and recession. If you plot the money supply, national income, and a stock market price index , they behave very similarly in the three bull decades. All rise fairly steadily and at much the same rates in the 20's, the. 80's and the 90's,On the other hand, if you look at what happens after the bull markets, you have an almost perfect experiment. Money supply plummeted in the United States after 1929. Money supply was horizontal in Japan in the early 90's except for a couple of negative quarters. Money supply grew at a steady and fairly rapid rate in the United States after the stock market crash of 2001. That's what happened to the money supply. Much the same happened to national income and the stock market. Both plummeted in the United States after 1929. In Japan, both stagnated. In the United States after 2001, both paused briefly after the market crash and then resumed fairly steady growth. The Fed is very much aware of that history.

RK: The Greenspan Fed has probably intervened by my count at least five times. There was the

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