INTERVIEWER: Tell us briefly how Paul Volcker set out to squeeze inflation out of the economy.
MILTON FRIEDMAN: Well, by the time Paul Volcker came along -- this was in 1968-69 [Volcker was undersecretary in the Treasury Department from 1969-74, president of the New York Federal Reseve Bank from 1975-79, and appointed chairman of the Board of Governors of the Federal Reserve Board from 1979-87] -- inflation had gotten very high and had gone up close to 20 percent. He was at a meeting of the International Monetary Fund in Yugoslavia in 1979, when the U.S. came under great criticism from the other people there for our inflationary policies. And he came back to the United States and had got the open market committee to announce that they would change their policy and shift from controlling interest rates to controlling the quantity of money. Now, this was mostly verbal rhetoric. What he really wanted to do was to have the interest rate go up very high, to reflect the amount of inflation. But he could do it better by professing that he wasn't controlling it and that he was controlling the quantity of money, and the right policy at that time was to limit what was happening to the quantity of money, and that meant the interest rate shot way up. This is a complex story. It isn't all one way, because in early 1980 President Carter introduced controls on installment spending, and that caused a very sharp collapse in the credit market and caused a very sharp downward spiral in the economy. To counter that, the Federal Reserve increased the money supply very rapidly. In the five months before the 1980 election, the money supply went up more rapidly than in any other five-month period in the postwar era. Immediately after him, Reagan was elected, and the money supply started going down. So that was a very political reaction during that period.
INTERVIEWER: How important was President Reagan's support for Volcker's policies?
MILTON FRIEDMAN: Enormously important. There is no other president in the postwar period who would have stood by without trying to interfere, to intervene with the Federal Reserve. The situation was this: The only way you could get the inflation down was by having monetary contraction. There was no way you could do that without having a temporary recession. The great error in the earlier period had been that whenever there was a little contraction there was a tendency to expand the money supply rapidly in order to avoid unemployment. That stop-and-go policy was really what bedeviled the Fed during the '60s and '70s. That was the situation in 1980, in '81 in particular. After Reagan came into office, the Fed did step on the money supply, did hold down its growth, and that did lead to a recession. At that point every other president would have immediately come in and tried to get the Federal Reserve to expand. Reagan knew what was happening. He understood very well that the only way he could get inflation down was by accepting a temporary recession, and he supported Volcker and did not try to intervene. Now, you know, there is a myth that Reagan was somehow simpleminded and didn't understand these things. That's a bunch of nonsense. He understood this issue very well. And I know -- I can speak with, I think, authority on this -- that he realized what he was doing, and he knew very well that he was risking his political standing in order to achieve a basic economic objective. And, as you know, his poll ratings went way down in 1982, and then, when the inflation seemed to be broken enough, the Fed reversed policy, started to expand the money supply, the economy recovered, and along with it, Reagan's poll ratings went back up.
INTERVIEWER: And the economy has been pretty solid ever since. [As of the year 2000.]
MILTON FRIEDMAN: Yes, absolutely. There is no doubt in my mind that that action of Reagan, plus his emphasis on lowering tax rates, plus his emphasis on deregulating ... I mentioned that the regulations had doubled, the number of pages in the Federal Register had doubled, during the Nixon regime; they almost halved during the Reagan regime. So those actions of Reagan unleashed the basic constructive forces of the free market and from 1983 on, it's been almost entirely up.
INTERVIEWER: What Reagan was doing is almost exactly mirrored in Britain by what Mrs. Thatcher was doing at about the same time. Are the two influencing to each other, or is it just a case of ideas coming into their own?
MILTON FRIEDMAN: Both of them faced similar situations. And both of them, fortunately, had exposure to similar ideas. And they reinforced one another. Each saw the success of the other. I think that the coincidence of Thatcher and Reagan having been in office at the same time was enormously important for the public acceptance, worldwide, of a different approach to economic and monetary policy.