From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm. “Flexible Exchange Rates For Israel” by Milton Friedman Lecture, Hebrew University of Jerusalem, 5 July 1977 CHAIRMAN, Professor Giora Hanoch: Ladies and gentlemen, on behalf of the Department of Economics I would like to greet the great scholar and our warm friend for a long time, Professor Milton Friedman. The usual chairman will say that Friedman does not need an introduction, and then go on to introduce him. I will try not to do that. We all are Professor Friedman’s students: those who had the privilege to study under him directly as well as those who studied his scholarly writing and have seen him in his previous visits here and elsewhere. This evening he’s going to talk about the subject of flexible exchange rates for Israel. As you all know, it is a great pleasure and stimulus to disagree with Professor Friedman. Even if we disagree, it’s always a great pleasure to hear him about any topic. I think he chose this particular topic tonight as an example . We all know what is his stand on flexible rates and abolition of controls on foreign exchange. And I’m sure he will go tonight beyond that and try to tell us more specifically how to do it, and not only why to do it. Professor Friedman has been a friend of the Hebrew University and of the Israeli economy for a long time. I remember, I missed his first visit in Israel. I was in Chicago when he visited here. He came back and told me all about the Israeli economy. So I’m sure by now, after his recent one-day visit here, he can tell us all many things which we ourselves do not know. I would add only that what I learned most from Professor Friedman— who is always very confident, a great believer of what he preaches and what he says—and his analyses is to put a question mark on all these other statements that we tend to take as given and self-evident. After listening to his side, we always, if we don’t completely agree, at least put the question mark. So I hope that this discussion tonight will help to put some question marks around topics related to foreign exchange control and flexible or non-flexible exchange rates which have been so much in recent political news as well. MILTON FRIEDMAN: Thank you. You know it’s the custom in most academic institutions that before an individual acquires a doctorate, he has to give a public lecture. In the Hebrew University of Jerusalem, you naturally do things in a different way. You first give a man a doctorate and then he has to give a public lecture. I’m glad that you will not be able to determine the appropriateness of the doctorate that I received yesterday on the basis of what I say today. I am very happy indeed to be an alumnus of this University. I had felt a member of it for many years, both because of my appearances here, but even more because of the steady stream of students from Israel—many from the Hebrew University—whom we have had at the University of Chicago. They have consistently been among the ablest, most effective and most active of our students, and I hope the flow continues. I chose the topic about flexible exchange rates for Israel not because I’m going to tell you how to do it—despite Giora’s leading introduction—but because the topic is suddenly lively here. Moreover, you suddenly have a fresh opportunity to do something about it. 1 From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm. It therefore seemed to me that it might be appropriate to consider not the general case for flexible exchange rates, but the special case for flexible exchange rates in the particular circumstances of Israel—not those of the year 1977, but more generally because I believe that the circumstances of Israel have been especially suited for many years to the introduction of flexible exchange rates. Indeed, much of what I shall say today, I have said before here in Israel, particularly in 1972, when I had the great honor of delivering the David Horowitz Lecture in Israel. With respect to flexible exchange rates in general, there is an enormous contrast, as you are all well aware, between the situation when I first began to write on the subject, and the situation as it is now. I was first led to write on the subject of flexible exchange rates in 1950. That was twenty-seven years ago, before many of you in this room had seen the light of day. At that time, we were in the immediate postwar period of the Bretton Woods Agreement. It was taken for granted around the world that the only appropriate regime was rigidly fixed exchange rates among countries. The idea of flexible exchange rates was a heresy that received little attention. A historical accident led me to look into the question. I spent a few months in Paris with the U.S. Marshall Plan agency and I was asked to look into the economics of the so-called Shuman Plan for an “Iron and Steel” community, what later developed into the Common Market. I became persuaded that a common market would never be a viable economic entity, unless the countries of the Common Market introduced flexible exchange rates among themselves. That was what led me to write the essay which I later published under the title of The Case for Flexible Exchange Rates. As you all know, there is no longer any question whether exchange rates should be flexible. They are. That is the existing system. The fixed rate system broke down, as it inevitably had to. Its final demise came in 1973, after several preliminary demises. Since then, essentially all the countries of the world have adopted a flexible exchange rate system. The only question that remains is the form that flexibility should take. The Israeli experience is an exaggerated version of what has happened around the rest of the world. Israel, as you will recall, started with an exchange rate of $3.00 to the Israeli pound—you have now progressed very greatly so that you now have 9.5 pounds to the U.S. dollar. (9.47! I was just rounding off to the nearest half. Because after all I don’t want this talk to be very dated and next week it will be something else.) If you look at the way the changes have taken place, you will see the gradual transition that has been taking place—not only in Israel but throughout the world. Originally, the system was one of temporarily fixed exchange rates subject to wide changes from time to time. The pattern for Israel was that every once in a while, when you couldn’t hold the official exchange rate any longer, you had a big devaluation. Of course, in between, Israel didn’t really have a fixed exchange rate. In between, you had a multiple exchange rate system, which concealed devaluations of one form or another. It is not possible for any country, least of all for Israel, to disregard completely market forces and to keep the price of your currency different from the price that the market dictates. But to some extent you can conceal what’s happening, and that’s what Israel did. It concealed devaluation in the form of subsidies to exports and restrictions on imports. You still do that to a very large extent. I was told today that there are sixty-three effective exchange rates in Israel and someone else said that that was a gross understatement, that there are literally thousands of exchange rates, which I well believe. And then you moved from occasional massive changes in the official rate to so-called “creeping 2 From The Collected Works of Milton Friedman, compiled and edited by Robert Leeson and Charles G. Palm. devaluation” at fixed stated times, and then to “creeping devaluation,” at unstated times. And sooner or later, and the only question is how soon, you will move to unstated devaluations at unstated times, by adopting essentially a freely floating exchange rate. Change has occurred not only in Israel but throughout the world. I was very much impressed by the change in the world attitude as reflected in two meetings that I happened to attend three years apart of the so-called “International Monetary Conference.” The first one that I attended was held in Copenhagen, I believe in 1969, at the late stages of the fixed exchange rate regime. The then Secretary of the International Monetary Fund gave the usual speech, the essence of which was that the only possible system was fixed exchange rates. He blasted the idea of flexible or floating exchange rates as a dangerous heresy that had to be extirpated from humankind if the world was going to last. Three years later, I attended a meeting of the same group in Montreal, Canada, in 1972, some nine months after President Nixon had opened the new era by closing the U.S. gold window. The then Secretary General of the International Monetary Fund’s speech was very different. Everybody, he said, knows that the only possible system of exchange rates is a flexible exchange rate system. What the IMF did reminded me of an old story of a great teacher of mine.