Chairman: Are there any questions from the audience not having
to do with hints at how to evade....
Answer: Let me say first, that I don’t think governments are
evil. Not at all. Governments do a great deal of harm, which is
a very different thing. The people who run governments are generally
decent people who are trying to do their best, but they have an
impossible assignment. I don’t for a moment in any way want
to impugn the personal character or personal motives of any of the
The Brazilian system is certainly an improvement over a system in
which you keep the exchange rate pegged for long stretches of time.
But I do not believe that there is any incompatibility between the
existence of a government and of a central bank on the one hand,
and freely floating exchange rates on the other. You don’t
have to have the Brazilian system. The Brazilian system seems to
me better than no attempt to change the exchange rate, but less
good than an exchange rate that changes more rapidly. I have never
been in Brazil but I have been in Korea for one day, which makes
me an expert, and Korea also had a system very similar to Brazil’s.
They justified it on the grounds that their commercial and financial
markets were so poorly developed that they couldn’t expect
an effective market rate to prevail. That’s not true for Israel.
Canada is a good example of a highly developed country that has
a central bank, that has a government, and that for most of the
last twenty years has had a freely floating exchange rate. So there’s
no reason why Israel could not have one. Indeed, you do have a freely
floating exchange rate. What are you kidding yourselves about? The
only question is whether you have it in the open or whether you
have it under the table. Surely it’s better to have it in
Question expressing disagreement with the statement in the lecture
that something like a 15 or 20 per cent annual rate of monetary
growth would be consistent with stable prices on the grounds that
velocity had not been declining in Israel.
Answer: I haven’t studied the detailed data for Israel in
this period, so it may well be that my number is wrong. I didn’t
mean to state that number as a definitive judgment on the appropriate
rate of monetary growth for price stability. Let me take a different
example for a moment.
I have looked in much greater detail into the data for Japan. Japan
is a country that at the moment is on roughly the same economic
level per capita as Israel. Like Israel it has been having a very
rapid development for the past 10 to 15 years. For Japan, I have
a good deal of confidence that a number like 20 per cent is right,
because it is perfectly clear that during the period when they had
relatively stable prices, velocity was declining fairly sharply.
It may be that that is not the case for Israel, and before a policy
is adopted, one should of course examine the evidence carefully.
However, there remains the question of whether the period you are
speaking of is not a period in which the rate of inflation accelerated.
If it was, the relatively stable velocity may conceal a tendency
for velocity at stable prices to decline. You may be right—as
I say, I haven’t studied those data and I don’t really
want to offer any firm judgment.
Question on same general issue.
Prof. Friedman: Mr. Horowitz was saying that the actual rate of
monetary growth in Israel has been considerably less than the 15
to 20 per cent mentioned for much of the period when you did have
inflation. That would certainly suggest that my figure may well
be an over-estimate. There’s a further problem of making sure
that you define your money supply correctly. It’s a shame
that so much of the ingenuity of the Jewish people in Israel has
gone into devising the most complicated banking regulations in the
world. As I understand it, the reserve requirements against deposits,
the kind of interest rates that can be paid and so on, have much
of the time been very elaborate and subject to frequent change.
As a result, it is not clear that the usual monetary stock figures
have a consistent meaning. In many ways, it may well be better for
Israel to look at what happens to currency alone, rather than at
currency plus deposits, whose precise meaning changes very rapidly
Chairman: I have a question. I’d like to proceed with that
comment—I wish the tape were off. To correct the last point
you made—I think it is not correct that Israel really has
a fluctuating exchange rate. It is common knowledge, although it
may not be true, that the Bank of Israel frequently pegs the rate
on Lilienblum Street, so that’s not necessarily a completely
Prof. Friedman: I wasn’t referring to Lilienblum Street at
all. I was referring to my understanding that the standard life
history of an exchange episode in Israel is that you have a devaluation,
that the devaluation is accompanied by a liberalising of exchange
controls and the narrowing of the multiple exchange rates, then
inflation proceeds and the currency becomes over-valued, and then,
in a perfectly legal manner, the multiple exchange rate system expands
and special provisions are made for various groups. If I were therefore
to calculate not the exchange rate that is posted on the board as
the official rate but the average of the exchange rates at which
dollars are in fact converted into pounds, I would find that that
was a fluctuating rate.
You people in the audience know Israel far better than I do. Is
what I have said an inaccurate description?
Chairman: My question was a different one. To me it wasn’t
100 per cent clear why a unified currency with a major developing
country was a first step and a flexible rate a second step. The
precise reason for the preference of the first over the second was
not completely obvious to me. Let me state that there might, in
the context of your presentation, be an argument in reverse—that
is that government has more freedom under a flexible rate to use
inflation as a tax, which for a country like Israel, or for an under-developed
country in general, might be considered part of an advantage—you
might not agree.
Prof. Friedman: Let me put aside for a moment the special problem
of defence for Israel. If we postpone that and consider the problem
of development, then my judgment from observing developing countries
is that the less power the government has to tax the better. Government
taxation tends to slow down development because it goes into the
wrong kinds of programs.
The great advantage of a unified currency is that it limits the
possibility of governmental intervention. The reason why I regard
a floating rate as second best for such a country is because it
leaves a much larger scope for governmental intervention.
In Israel, you have the special problem of defence. For that problem,
it’s obvious that you have to have a very high rate of taxation.
Nonetheless, it seems to me healthier for the society, both politically
and economically, to face up to that problem explicitly, to have
taxation be open and aboveboard, to have taxes be those that are
legislated by the Knesset, rather than to have taxes imposed implicitly
without legislative enactment by the rate of money creation. So
even in that case I would say you should have a unified currency
as the best solution, with a floating rate as a second-best solution
and a pegged rate as very much worse than either.
I may say, in talking to many people around Israel about a floating
rate, I have been impressed with one argument that is repeatedly
offered as an argument against a floating rate yet that seems to
be an argument for a floating rate. The argument that always comes
up is the following. Israel, it is said, is a nation besieged. From
time to time there will be great uncertainties. There might be a
war. The outbreak of fears of a war would lead everybody to try
to take his capital out of the country. That would be terrible.
We must, it is concluded, have exchange control and a pegged rate
to prevent such a development.
Let’s stop and consider that a bit more carefully. Suppose
there is a rumour that there’s going to be a war and as a
result widespread fear of war. Nobody can take his capital out in
a physical sense. Nobody can pick up a factory that is in Israel
and transport it across the border. Nobody can pick up a house and
take it out. Hence, when you say that some people are trying to
get capital out, you mean that some people in Israel are trying
to sell pounds for dollars. How can they do it? They can do it only
if they can find other people, in Israel or outside, who will accept
pounds and sell them dollars. The way in which they try to persuade
other people to sell them dollars is by offering a high price for
the dollar. As an extreme assumption, the price of the dollar might
go from 4 to 20 pounds a dollar.
Let us assume—because if we don’t, the whole issue is
irrelevant—that either war does not occur or that Israel,
as in the Six Day War, wins the war. When that happens, the exchange
rate will return to roughly its earlier level.
Now I want you to ask yourself, who lost and who gained in this
hypothetical episode? The people who sold their pounds for dollars—and
hence lost—are people who had little faith in Israel. The
people who bought the pounds for dollars—and hence gained—are
people who had much faith in Israel. So this is an episode in which
those people who have little faith in Israel lose, and those people
who have much faith in Israel, gain. What is wrong with that? Why
should you have an elaborate structure of exchange controls involving
major economic inefficiencies and a major interference with human
freedom, to prevent such an outcome?
Note that the episode I’ve described is a temporary phenomenon.
The rate’s going to shoot up and it’s going to come
down again. What Israel needs to bolster its strength and its ability
to meet the threat of war is not a fixed exchange rate but a stock
of foreign exchange. It is eminently sensible and desirable that
for defence purposes the government should hold, as it now does,
a substantial stock of dollars in order to be able to assure itself
that it can buy munitions and other supplies outside the country
in such an emergency.
So far as prices within the country are concerned, they will not
be affected by the hypothetical episode I have described because
those prices can only be affected as quantities are affected. What
we are talking about is a situation of a temporary nature in which
the price of a dollar is terms of pounds is driven up. Of course,
in practise it would in fact not go up anything like the amount
I envisaged because what would actually happen is that as the price
of the dollar went up people would get discouraged and desist from
trying to convert pounds to dollars.
I took an extreme case to show that even then flexible rates are
a good thing and not a bad thing. In order for prices internally
to be affected, you must have a high exchange rate persist for a
long time. How can that be? If the pound price of the dollar goes
up for a couple of weeks and then down again, it isn’t going
to affect prices internally.
Comment that the abnormally high exchange rate would raise prices
of imported goods.
Prof. Friedman: It is desirable that you should pay more for foreign
goods under those circumstances, because under those circumstances
it is essential that you reserve your foreign exchange for urgent
purposes. There’s nothing wrong with that. Domestic prices
cannot go up under those circumstances unless the government spends
much more money.
Question whether I favour a multiple exchange rate system.
Prof. Friedman: Not at all. I favour a completely free exchange
rate with a single rate.
Question about effect of the high exchange rate lasting for a long
Prof. Friedman: Of course, it will then have effects on the prices
of foreign goods, and under those circumstances it is desirable
that it should have those effects. But it will only stay up for
a long time if there is a great demand for foreign exchange relative
to domestic exchange. In that case you want to conserve your foreign
change. You want to make imported goods expensive. On the other
hand, the people who cite this argument always refer to the speculators
as causing the exchange crisis. If it’s the speculators, it’s
only going to last a week, it’s not going to last three months.
Under those circumstances it will have negligible effects on the
prices of imports. So you have to decide whether there is a real,
underlying shortage of foreign exchange, in which case it’s
desirable that the rate move, or whether you have a speculative
attempt by some people to get their capital out of the country,
in which case a free rate enables those who have faith in Israel
to buy up the capital of those who don’t, at a cheap price.
Chairman: I think we should nominate Professor Friedman as our emissary
to the next United Jewish Appeal, and with that I would like to
thank you very much.