Allan Meltzer on the Monetarist Counterrevolution and Economic Reforms

In this special episode recorded in front of a live audience, David interviews the renowned monetary economist, Allan Meltzer. Meltzer, a professor of political economy at Carnegie Mellon University and one of the founders of the monetarist school of thought discusses his long career in academia and policy. David and Allan also discuss current central bank policy, both in the United States and abroad, and how monetary policy can become more rules-based. Finally, Allan also argues many of our current economic problems are real, not nominal, and he hopes a Trump Administration can address some of these woes.

Read the full episode transcript

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Allan, welcome to the show.

Allan Meltzer: Thank you. Nice to be here.

Beckworth: We're glad to have you on, it's a real treat. Let's begin by asking, how did you get into macroeconomics? And particularly how did you become a monetarist?

Meltzer: Well, those are separate questions. I grew up in the 1930s. There was a period of the Great Depression, unemployment rates 20, 25% for part of that period, and never got down very low. So, I was not alone, but part of a generation. That said, we need to understand how things like that happen, and how they can be prevented. So, we went in with a very clear idea that, what we're interested in was, how do we make policies? And, at the time, and I think still, we believed that the way you made good policy was to have good theory.

Meltzer: So we began to work on monetary theory. And I became a monetarist. I started life on the left. I was a delegate to the political convention that nominated Henry Wallace for president.

Beckworth: Really?

Meltzer: So, that was far to the left. And I learned gradually and over time, that that was the wrong way to go, that people were a better judge of their own interests than anyone could be for them. And that got me interested in being a libertarian, and from libertarian to monetarist is a small step.

Beckworth: Okay. Well, you're a part of the Monetarist Counter-Revolution where they push back against the dominant view of Keynesianism at that time. And I was wondering if you could tell us about that experience, what was it like to go through the Counter-Revolution of Monetarism?

Monetarist Counter-Revolution

Meltzer: Well, paid to have a tough hide. Because, people said things about you that weren't always complimentary. But that was never a problem for me. I mean, like many people who have strong beliefs, I thought we were right. And you're right, you would eventually convince people that you were right. And they will do things for you.

Meltzer: And so, we tried to get them to do it. Carl Bruner and I, in the 1970s after the inflation was pretty well long. We're not just annoyed, put off, by the way in which the journalists discussed it on TV and radio, the time in the newspapers. They saw it as a problem between those people who thought we should have price and wage controls, and those people thought we should go back on the gold standard. And Bruner and I said, that isn't what economists think or do. So let's try to get people to understand what we do.

Meltzer: So we started the shadow Open Market Committee, and we pounded on them for the next few years. And we're gratified when Paul Volcker became chairman of the Fed and declared himself to be a quasar on monitors. I think he said a practical monitors, was what he called. And he set out to control money growth, and unlike so much of what goes on now and went on then, he was smart enough, and he is very smart. I parenthetically, have known him since I worked in the Kennedy administration Treasury in 1961. And he worked there as my boss. And we used to discuss fixed and floating exchange rates.

Meltzer: Anyway, he became chairman of the Fed, and he declared himself to be a practical monetarist. And he understood that, nothing about controlling inflation was going to take place in the next week. But it was a steady problem to convince the markets that you were going to persist in what you did. And finally, in April, I think the second year that he was chairman, in April of that year, with the unemployment rate is above 8%, he raised the interest rate. And that was a body blow to the inflation, because no one before him had ever done anything like that.

Meltzer: And the market said, this guy is really serious. He's going to stop inflation. And three, four months later, inflation rate was down to 3% or 4%. He convinced them. He was persistent. And that was just a great thing for the country, for the world, and for monetarism. And, the Fed has never liked the idea of controlling money and they got rid of the idea of monetarism as quickly as they could after that. And so they'd make terrible mistakes, and they're making terrible mistakes in this recovery.

Beckworth: Would you consider that the height of the monetarist counter revolution, and Volcker did the same?

Meltzer: That's the short run high. We'll be back.

Beckworth: You'll be back. Okay. Great to hear.

Meltzer: The Johnson, the great Harry Johnson said, monetarism is fashionable when there's inflation, and very unfashionable when there isn't. And I think that's a correct... I didn't like it when he said it, but I believe it's true.

Beckworth: So what were the pivotal moments, Volker is the highlight, leading up to that there is already momentum. Was it the 1970s experience? Was it your work with Carl Bruner? Was it Milton Friedman's work? What do you see as the pivotal moments in that revolution?

Meltzer: Well, I think Volker leaned heavily on the work that Friedman, Schwartz, Bruner and I and others had done. I mean, in a general way that is he understood that he had to get control of monetary aggregates, and keep them from rising rapidly. And, he did that. And as I said, when the time came to push up the interest rate in order to control money growth, he did it, and he did it with 8% unemployment. It's just, having watched the Federal Reserve policy since the 1960s, that was an unusual amount.

Beckworth: Yeah, I wonder today if the central banker could have the thick skin that he had, because he received a lot of blow back. A lot of resistance, from Congress, the media, you knew him then, what was it like for him to go through that?

Meltzer: Well, let me answer it in a slightly different way. If you compare what the Fed has done, to what they've done in countries which have basically monitors type policies, like Switzerland, the Bundesbank before there was the ECB, Singapore. Here's a comparison. The Swiss have had generally low inflation rates, and a rather steady policies, and not a lot of fiscal intervention.

Meltzer: Under Bretton Woods, Swiss franc was worth 20 cents. It's now $1, that series of events concern about inflation, a modest fiscal policy, series of referendum that the Swiss vote on all the time, to raise tax rates are cut tax rates of raise spending. Which usually get voted down. Does that standard policy hurt Switzerland? No, Switzerland was a poor country before World War II. It now has a per capita GDP larger than ours. It's been a blessing for the Swiss to have relatively stable, predictable policies.

Meltzer: Singapore fits that model very well. The Bundesbank, I mean, nothing was more monetarist than the Bundesbank. I mean, they were my friends, and we colonized, started the constant seminar. We helped to retrain the German economists, after World War II and the Hitler period. We brought over people like Barrow and Dawn Bush, and Moosa and young Americans, to show them how good economics was done. They now have some very good economists and constant seminar has gone on. Manford Norman took it over after Carl and I left and then some other people took it over after Manford Norman and it still goes on.

Meltzer: And it's had an impact on the way in which people think about and act on, and do research on monetary policy. So, I'm not disheartened by the fact that the current Fed is one of the worst Feds in its history and I know a fair amount of man's history.

Beckworth: You mentioned Carl Bruner, your colleague you worked a lot together-

Meltzer: My teacher also.

Beckworth: ... your teacher and you guys were labeled monetarist, Milton Friedman, Anna J. Schwartz are also considered monetarist. What was your contribution? What did you do that was different than Friedman and Schwartz?

Meltzer: Well, Carl Bruner was a wonderful person. I can tell you, he and I wrote probably 25 papers together. Not counting the introduction to all the volumes. And, we never argued about who did what, we never had an argument, we would talk on the phone, because we were really in the same place together. So we would talk on the phone, on Wednesday night, my teenage children hated that. Because the conversation would go on for over two hours.

Meltzer: So he would take ideas from me, and write them up in papers without my name. And I would take ideas from him and write them up in papers without his name on it. And we never argued about who was responsible for what, we just got along very well. We were interested in the ideas and so on. So that was a great working with relationship.

Meltzer: Now, what did we do that, that Milton Friedman didn't do? Milton Friedman brought money back. I mean, Keynes... There had been a strong monetary tradition in the 20s. And then Keynes, the way Keynesian was interpreted,, it put that aside. So, Milton Friedman brought it back. But Milton Friedman never explained how it was, that if you increase nominal money, you got real effects. The person who did that first, and that's a fundamental question was Carl Bruner, in an essay in the JPE, in 1961.

Meltzer: And he said something which, if you think about it, you'll see how clear it is. He said, what happens when you increase money growth is asset prices rise, stock market rises, housing prices of existing housing rise. And these rising asset prices make it cheap, relatively cheap to invest in new production of the same assets. So we get capital spending and house production. So that's a nice micro explanation of the transmission of monetary policy. It says we change the relative prices. And as the relative prices change, we get more spending on real output.

Meltzer: And then for the next... that was in 61, it was not a model. It was just a couple of paragraphs in an essay. Over the next couple of years, Bruner and I worked out the model, and about six years after Bruner wrote his model, or his paragraphs, Jim Tobin, in the first issue of Carl's Journal of Money Credit Banking, Jim Tobin, wrote, the General Equilibrium theory of Money. And what was the transmission mechanism? What was something he called Q? What was Q, it was simply the relative price of assets to output. That is the same idea that we had, but that he developed independently of what we had done.

Meltzer: So the amazing thing for me is that the Fed has always ignored that, they have played with the Phillips Curve. And I'm not opposed to the Phillips Curve, but I have always pointed out to my students, that the Phillips Curve was developed by Philips, when there was a gold standard. So there was an anchor to the price, the future price level that made that work much better than it works in periods when there isn't that close anchor. And the Phillips Curve has been... there must be hundreds of papers on the Philips Curve by this time. Many of which are not very encouraging about its empirical relevance.

Meltzer: So we think that the... and here's an implication, which seems to me to be important. If you took the relative price theory, our way of thinking about it, you would say that after about 29, 2010, when you saw the excess reserves piling up on the balance sheets of the banks, you would have asked yourself, why is it that we're getting the asset price of X, and we're not getting the output? We're not getting investment, there's not much investment. And while there is some house building, it's not very great. And it's especially weak compared to the amount of reserves that we put into the system. So there must be something wrong, we're missing something. And what they were missing, of course, was that we have a government at that point, and still that was very anti business.

Meltzer: So businesses were not investing, they were being hit with new regulations all the time. And, I think it's interesting that, when the new election took place, one of the first things that happened in the stock market, was that shares that were being hindered by Dodd Frank went up, because markets think Dodd Frank will likely be modified or repealed. And the regulation will come down. And I believe that's true. And that is likely to happen under the new administration.

Beckworth: You mentioned just a minute ago, how Keynes was interpreted. And I find that interesting because you had a 1988 book titled “Keynes, Monetary Theory, a Different Interpretation.” And in that you argue the Keynesians actually got it wrong. Keynesianism as practiced was based on a false premise what Keynes actually said. So why don't you share that with us? What is your take on what Keynes actually meant in his general theory?

Did the Keynesians get Keynes Wrong?

Meltzer: To write that book, I read just about every paper he wrote, and book he wrote from about 1920 on. The first thing I would say is, you want to think of Keynes as a Cambridge economist, because that's what he was. So when he would think about what was the problem in the macro economy, he would begin by thinking, well, what is the externality that's being imposed? And he's decided that the externality is, that there's too much uncertainty in the system.

Meltzer: Uncertainly not risk, uncertainty. That is what later Don Webb so called the unknown unknowns. That's the uncertainty. And as a result of at people he said, held more money and less capital. So the problem was too little capital. What should you do? Well, you should obviously have public investment to try to get more capital. What about the Keynesian view that you want to do more consumption? Well, there is absolutely clear that no, that isn't what you want to do. He wrote to Mid, who was his colleague from Cambridge, when he was in the government. And he told him, Mid was proposing to increase consumer spending during wartime Britain.

Meltzer: And Keynes wrote as if he had written, or had read the Permanent Income Theory. He said people have long practice habits of consumption. You don't want to interfere with them. You don't want to make a temporary change in those habits. You want to concentrate on investment. He was in Washington during the war, when Abba Lerner, who wrote the Economics of Control, was giving one of his first seminars on, deficits and the need for big deficits. The kind of junk that Paul Krugman writes.

Meltzer: What did Keynes say, well, he was wrong and what he said but what he said is, that's a bad idea. No government will ever do that. He didn't believe in large, permanent deficits. He believed in the opposite. I mean, he developed the Bretton Woods system. And what is the Bretton Woods system was a fixed exchange rate system. So you can't have a fixed exchange rate system and health, willing, really expensive fiscal policies all the time because you're going to have to devalue.

Meltzer: And they will allowed countries to devalue, but they didn't make it easy for them to value. So Keynes was not a believer in what is now called Keynesianism. He was a believer in Keynesian economics, which were, try to reduce uncertainty and try to increase the capital stock, because that's what standards of living depend upon. And that's just the opposite of what these people do. It's hard to believe that they've ever read the book. They probably haven't.

Beckworth: Well, moving forward to the present. The standard approach to monetary economics today is a New Keynesian model. And that central banks, they adjust short term interest rates, they respond to output gaps to inflation, the Taylor rule kind of embodies that. There is no money in monetary policy. Does that break your heart as monetarists? Do you think there's still a need for monetary aggregates in monetary policy?

Role of Monetary Aggregates in Monetary Policy

Meltzer: I think my attitude towards Michael Woods work, which is the foundation of the idea that, money and credit just don't belong in the model. He latter modified that and so that they have a little effect but not much. You have to be as smart as Michael Woodford to come up with the idea that the principal product of central banks, which have money in credit, has nothing to do with central banking. I mean, it has always seemed to me to be an insane idea.

Meltzer: The successful central bank's Switzerland, Germany before joined ECB, the Volcker period in the United States, countless others, control money. You want to keep inflation out. You want to control money. Milton said it correctly, inflation is always in everywhere a monetary phenomenon. Now, people scoff at that idea, but it's because they don't understand what it meant. What he meant was, the aggregate price level as opposed to something like an oil shock. Prices rise because of an oil shock. But that's not inflation, in the sense that Friedman talked about it. That's a change in relative prices.

Meltzer: And the Shadow Committee, my Shadow Committee, in 1974, said you got it wrong, Arthur Burns. This is a change in the relative price. There's no reason why you want to kill the economy by tightening money. There's no reason why you want to do that. What you want to do is you want to let the increase in relative prices pass through. But they didn't do that. So they tightened the economy. And then they did the same thing again, later in that decade.

Meltzer: And then by 2000, they finally got it right. And they said, well, it's a relative price change. So we don't have to do anything about that. We'll let it pass through. And that's the right answer. So when Milton said, inflation is always in everywhere, a monetary phenomenon, he meant, generalized increase in purchasing power, not increases in relative prices.

Beckworth: So the last central bank to have money in its target was the ECB. They had the dual pillars. And they recently dropped that. So you're probably disappointed to see them do away with their dual pillars?

Meltzer: Well, I've learned not to be disappointed by things that central bankers do.

Beckworth: All right.

Meltzer: I mean, here's an example where congressman Hansley, student of economics, was a student of Phil Grams in Texas, comes up with a monetary rule, and he says to the Fed, adopt the monetary rule of your own choosing and implement it. And what do they say? No. Why did they say that? I mean, is there any evidence that discretionary policy is effective, more effective than a rule. No, the best period in monetary history of 100 years of the Fed, the two best periods are one, was the period in the 1920s, when they followed a rule, the modified gold standard. Not a rule I would pick, but that was the rule that they picked.

Meltzer: And then the second period which they followed a rule was, more or less followed a rule, was the years 1986 to 2002 when Allan Greenspan had a medium term strategy, more or less, and I emphasize more or less following a rule. And, that was a period where we had low inflation, stable growth, short recessions, quick recoveries, and very little variability. Why? Well, people could look at what he was doing, and could estimate or guess as best they'll ever be able to guess, what the interest rate would be a year or two years from now.

Meltzer: Compare that to what they do now. They look at the daily data, and they respond to it. And so you don't have any idea what monetary policy is going to do. They've been talking about, they're going to raise the interest rate now for damn near a year. And they finally are probably going to do it in December. So what we're going to have, we're going to have a big quarter point increase in interest rates.

Meltzer: We should be way above that. What's going to happen when they finally, if they ever do, get out of this. I mean, we have a problem in the economy that we should be aware of, and worry about. A lot of retirees used to finance themselves by buying CDs at the banks and rolling them over from period to period and earning enough to live on. Well, with a low interest rate policy. They can't do that. So they've been buying bonds. Boy, how many of them are sophisticated enough to know the simple fact that when interest rate rise, bond prices sink, and that they're going to lose some of their money, and they're going to be prepared to do that, because they retirees? They can't replace it.

Meltzer: That's a problem. It's a problem that is so typical of the US government. That is, you take the first step, you never think about what are the longer term consequences of what you're doing. That's the biggest weakness of our government is that, and it shows up and beginning wars without knowing how you're going to get out of them. I remember way back in the 60s when John F. Kennedy was President and I was working in the Treasury, and he brought in a general who would replace MacArthur in Korea. And he asked him about going into Vietnam. And the general said to him, exactly the right thing. He said, "Mr. President, I know how you get in. But how do you get out?" Think about the consequences of what you're doing that you can see.

Meltzer: Our government doesn't do that. The Fed doesn't do that. They look at the day to day numbers. The day to day numbers are mixtures of permanent and transitory changes. You can't tell from looking at them, whether they're permanent or transitory changes. You got to see at least two and maybe more, to be able to get a clear path for that. So that is a foolish policy. And it has bad results.

Beckworth: Well, let's look at some of the Fed’s actions more recently. John Taylor argued in 2007, that one of the reasons we had a great recession is because the Fed kept rates too low for too long, so it facilitated a boom, other forces were at work, but that bed definitely played a role. Robert Hensel, would also be considered a monetarist, he argued and Scott is as well, that, their bust was also facilitated by the Fed. The Fed was too slow to react in 2008. They were overly cautious, that things got worse. I like to hear your take, did the Fed contribute both to the boom and the bust during the Great Recession?

The Fed’s Culpability for the Great Recession

Meltzer: Yes, I agree with those criticisms. And when you say the Fed was too slow to act, the reason we have inflation in this country, not just now or not just in the prospect of the future, but in general over the last 40 years, is because the Fed is always too slow to act against inflation. That's why we have inflations. Because it takes a while, you're not going to stop the inflation, by suddenly raising the interest rate from a quarter to a half a point. Half a percent, or even from a half` to 1%. It's going to take more than that, and it's going to take time, before it happen.

Meltzer: In the Volcker period, the markets just didn't believe that he was going to persist. So it took until they became convinced that he would persist. That was more than a year of suffering by the public as unemployment rates rose. That's just a fact. And there's nothing we can do to change that fact. I mean, monetary policy works, in part by changing relative prices, but in part by changing people's expectations. And we have no model of how that connection to expectations works.

Beckworth: I want to move on into the recovery stage. We've talked about the boom the bust and the recovery period. The Fed tried unconventional monetary policy, new experiments, QE, QE One, two and three. And yet we had a very tepid recovery. It was by historical standards, one of the weakest on record of slow, it was anemic, credit anks may explain the selection to some extent. Why didn't the Fed's QE programs do more?

Meltzer: The reason the QE programs didn't do more is because we don't have a monetary problem. I mean, neither we... first of all, let me say QE. I think QE is an artifice that hides what was something which is shameful. And that is, we had an agreement at the time of Bretton Woods, the start of Bretton Woods. Which was that, because of the bad experience in 1930s, we would not have competitive devaluations. Bernanke broke that agreement. QE was the way of hiding the fact that... calling it QE was a way of hiding the fact that he was attempting to have a relative devaluation of the dollar.

Meltzer: That, of course, was soon followed by other countries, the ECB, Japan, that also called what they were doing QE, but were also efforts to change the relative price of their currency. So now the dollar instead of being weak, is strong. Who gets benefit from that? Certainly not us. Who gets hurt by it? Well, as you can imagine, the countries that can engage in that game, the weak or developing countries, as former governor Rajan, of the Bank of India, pointed out, they are the people who take the heat, because of the changes in the relative prices of currency. And I don't think that any model is going to tell you that it's optimal to put the costs of these things onto them without getting any much benefit for it ourselves.

Beckworth: Even nominal measures like inflation, for example, are the feds own preferred inflation target, which is the core PCE deflator, has averaged about one and a half percent in their target 42%. So despite all these programs, the Fed itself hasn't been able to generate the inflation at once? What's the explanation behind that?

Meltzer: Yes, way back when they started all that stuff, I said, we're going to have inflation. I was wrong. And the reason I was wrong because, like the Fed, I missed the fact that the reserves were piling up on the bank's balance sheet in that M2, or whatever monetary growth measure you prefer. None of them were rising very rapidly, M2 growth stayed between 5% and 6%, throughout the thing, it's picking up now. But, I was wrong about that. And I recognize that when I saw the reserves piling up, instead of going into creating money. So why do we have the slow recovery? The answer is because we have, as I said, real problems in the American economy, but they're not monetary problems. And the same is true with the ECB. They have real problems and the same is true of Japan. Japan has real problems. And that-

Beckworth: Are you worried that any of these experiments will go all right? Like Japan's balance sheet is growing so much, that they might lose control the monetary base?

Meltzer: No, Japan has increased its debt enormously. But then it's all bought by the Central Bank. So net, isn't increasing all that much.

Impacts of the 2016 Election on Monetary Policy

Beckworth: Okay. Well, let's move forward to the election. Talk about that just a bit. So President Elect Donald Trump is now with us. You mentioned earlier the market response to his election, bond yields have shot up, which suggest more spending, higher inflation, possibly maybe higher real growth, stock prices are up. So, do you see the market saying that he may be a net plus for the economy or what do you think the market's saying about him?

Meltzer: I think just what you said, they see it as a net plus. What seems to me to be the lesson that the democrats and the elites refuse to learn is, what this election was about. For the last four or five, seven years maybe, I've been working on something called regulation on the rule of law. And out of that experience, I learned that there's a great deal of unhappiness in the country, because they believe that their sovereignty has been taken away. That they have nothing to say about the regulations and the rules, and the policies that affect them. That all those things are done by the administrative agencies and the courts.

Meltzer: That our government, the US government, the American Revolution, was founded on the idea of popular sovereignty. Lincoln, you just have to read the history of that period. You'll see that just comes popping out at you, popular sovereignty, who was going to rule, it wasn't going to be an elite. It wasn't going to be the administrative agency. It was going to be the public. And that's what Lincoln said. He described in the Gettysburg Address. He said, government, of the people, by the people, by the people. Popular sovereignty, the public elected to Congress, the Congress made the laws.

Meltzer: That doesn't describe the beginnings of what we do in this country. What happens is the rules are made by the administrative agencies, and Congress doesn't do anything about them. And Congress doesn't even have a veto power over those rules. And it's discussed something called the REINS Act over and over again, and never passed it. So they abdicate responsibility, and that's what the public here is objecting to. And it's what the public that voted for Brexit was objecting to, they didn't like the idea that their rules were made by unelected individuals in Brussels.

Meltzer: And that's what people in Germany who are part of the alternative for Deutschland. That's what people all over Europe are complaining about. That they do not have sovereignty, and they want to get back is sovereignty. And that's what they voted for, when they voted for Trump. You may like Trump, you may not like Trump. But you have to recognize that that is a fundamental issue in our country. And he was on the side which said, I'm going to give you back to sovereignty. We'll see whether he does.

Beckworth: Well. It will be interesting to see who he appoints to the Fed. So we've got several board positions that are open as well as Janet Yellen, term as chair is coming to an end in 2017.

Meltzer: But he has a couple before that.

Beckworth: Yes. So what is your forecast for the shape of the board to come?

Meltzer: Oh, he's going to appoint more people who are going to be, in favor of rules.

Beckworth: Alright, so maybe John Taylor?

Meltzer: Well, John Taylor will probably be a candidate for chairman?

Beckworth: Okay. Yes, you mentioned a minute ago, the prospects of new legislation coming out that would make the Fed adopt some rule, this is the benchmark. So that's the form act, and I think you're referring to... So it sounds like your favorite part is something like the former, which just to be clear, it would require the Fed to pick a benchmark rule. And the Fed could violate that rule as long as it explained itself. It's not truly a binding constraints, it's just a benchmark to facilitate conversation and understanding. But you're sympathetic towards that legislation?

Meltzer: I worked on that. I mean, Carl Bruner and I, way back, began to talk about uncertainty and I tell you a little story. We wrote a paper called, Targets and Indicators of Monetary Policy, in which it said, no matter what model you have, that model may make mistakes. So you want to have an idea as to something else, like the money growth rate or something credit growth rate, real GDP. Something which tells you why you want track or is something happening, the models' giving you bad advice.

Meltzer: So, we had a conference, and Franco Modigliani, Larry Klein, a lot of model builders came to the conference. They had absolutely refused to believe there was anything like uncertainty. They said, no, when we have a model, we will have a model, the right model will be exactly right. Well, we're ready for that. I don't think anyone would say that anymore. So the author, the person who's taking notes and wrote them up, build the wall. Bruner and I, and half a dozen of the people who were at the conference accepted the idea that there was uncertainty in the world. And that uncertainty meant that you just could never have a model that was going to tell you what happened. There were always going to be events that you can't forecast. And that, Modigliani, and Klein, others just didn't believe that.

Meltzer: Well, I think now, economists have finally gotten on to the idea that there is such a thing as uncertainty. And Tom Sergeant, people like that are working diligently on trying to build models in which uncertainty is an important element.

Beckworth: You've mentioned some recent writings, you'd also like to reform the structure of the Fed. I believe I've read that you would like to see all 12 Regional president's vote at the FOMC. Can you speak about that proposal?

Meltzer: Yes. From the very first of the Fed, it was considered sort of truth, unalterable truth that the Washington Fed was political. And that the regional Fed represented economic ideas, and then at that time bankers. They're no longer bankers, but the banks are run by economists and business people. So I think the perspective of the bankers and the business people, is much better than the political pressures, which come up on the board. So I would like to see more of that view in the deliberations, and in the policy making.

Meltzer: So I've said, originally, all the open market decisions were made by the regional banks. The 1933 and 1935 Act, transferred the power to Washington. One of the anomalies of the time was, one of the authors of the Federal Reserve Act was the chairman of the committee in 1935, that changed the rules and strengthen, and he was against the idea of having a central bank. He never wanted a central bank. But somehow he got hoodwinked or buffaloed into creating one.

Q&A Session

Beckworth: All right, that ends the interview part of the podcast. We're now going to turn to our Q&A, and as was mentioned before, please raise your hand, please state a question not a strong view, just a question for Professor Meltzer, but keep it brief. Just please stand up and share with us.

Audience member: Professor, could you comment on the folly of negative interest rates in Japan, in Europe?

Meltzer: Yes. Let me preface my remark about that, because I want to say, that well, it guides me in thinking and doing these things is that I'm an economist. So I try to think about the economics of the problem. I am certainly very much aware that politics plays a role. And I've certainly done my bit to create models of political economy.

Meltzer: But I'm an economist first and foremost. So I try to think about what does the economics tell us? When, it comes to negative interest rates. Here's what it boils down to, in my mind. People, you see this in Europe, watch the whole currency. In Germany, they buy safes to store the currency at home. So the currency has a fixed price. So if you really want negative interest rates, you want to loosen that restriction. You want to float the value of the currency.

Meltzer: Now, if you fought the value of the currency, you put uncertainty risk right into the consumers market basket. Do you really want to do that? I don't think that's a very good idea. But that's what seems to me to be involved. Otherwise, you get the present business with negative interest rates, as this interesting result. The Swiss have very negative interest rates. That's because they want to discourage the movement of European Currency into Switzerland, because they want to control inflation. So they have very negative interest rates applied to these inflows. The idea is, that slows down the Swiss economy because the exchange rate has gone up.

Beckworth: Okay, that's-

Meltzer: Wait. In ECB, they want negative interest rates because they think it's going to be expensive. They don't walk across the border and say, the Swiss are doing this to slow their economy. They say, we're going to do it to expand ours. We can't do both, my guess is the ECB is probably right. That it would be a mildly expansive thing. But how many people are going to land on the supply side? Where they have to pay the borrower for the privilege of taking a loan from them? I don't think you're going to get much increasing credit under those circumstances. And I believe that the increases in credit, what we need to see, to see recovery.

Meltzer: So what would I do instead? I would do what they need to do badly, which is to make non-monetary reforms in their countries. That's what's hurting them. It's what's hurting us. We have taken a step, which I believe will move us in that direction. And the market seems to think that's the case. The Europeans cannot or don't seem to be capable of doing similar things. The Japanese, my old friend, Governor Kuroda, tells me that the Government of Japan has agreed that it will change the rules and the labor and commodity market. And we'll see whether they finally do that.

Beckworth: All right, Will.

Audience member: Dr. Meltzer, if I'm not mistaken, earlier David characterized the... he said that expansionary monetary policy in the mid 2000s fueled the boom and contractionary monetary policy, shortly thereafter exacerbated the economic downturn, and I believe you agreed with that. And in late 2008, early 2009, Anna Schwartz expressed a similar position. And Dr. Sumner described her as breaking from her monetarist position as stated in her work with Friedman. And referred to her instead as a neo-Austrian, and so I'm curious whether you would characterize yourself as a monetarist or a neo-Austrian?

Meltzer: I don't really care about those titles. People have called me many things.

Audience member: Very recently I heard Larry Summers saying that monetary policy applies to people whose savings is a choice. Now, in Us, with this acute income inequality and savings is no longer a choice. He's trying to say that, only fiscal ways we can reach these people. Do you agree with this?

Meltzer: Do I agree with them about what?

Audience member: About that, fiscal policy, the monetary policy is losing its shine because a lot of people savings is not a choice. So interest rate movements really does not affect them?

Meltzer: No, I don't agree with them. The reason monetary policy is said to be losing its power, is because we don't have a monetary problem. So you can print money, from now to Doomsday and not get much effect from it, if the bank's just hold the excess reserves. In order to get monetary policy to work, you have to have a monetary problem that you're solving, and the monetary problem we're solving, isn't there. The problems that we have are, we get the first effect of monetary expansion, namely, asset prices rise. So the stock market booms. And that creates a large constituency, that is a big clack for continuing that policy even though it doesn't have much effect on the output.

Meltzer: I mean, if you asked me, do I think that that policy of the Fed has had important increases in output? My answer is, I don't see it. Why I don't see it. Because I don't see the increasing credit that would be required, the demand for credit would have to increase. The fact that we're getting recovery, probably has very little to do with what the Fed has done. Because the asset prices rose, but there hasn't been a follow through on the real side. And that is very important. As far as I'm concerned, that's where the transmission takes place. So and the reason I given for why there isn't a follow through is because, the businessmen are very pessimistic, and rightly so.

Meltzer: How do I know they're pessimistic? Well, I look at what they do. What they do is they make profits and they use them to buy back this stock at very high as equity prices. I can't think of anything that is more discouraging than that. They don't want to invest. So the only thing that they do these days is, they buy up their competitors and reduce competition, which is, is that great? What's happened to the insurance industry? Look what this administration has allowed to happen to hospitals. You go to almost any city now. There's only one or at most two hospitals, competition is really being reduced. Is that good? I don't consider it good. I consider it bad. We will be much better off if we didn't allow all those merges.

Beckworth: All right. One last question. And is, in the back there.

Audience member: Earlier this evening, Professor Sumner gave a very conciliatory address on the relationship between market monetarism and classical monetarism. But at other times, he's emphasized the differences. So I wonder if, as somebody who has been instrumental in the development of both strands, do you see market monetarism as the rightful heir to monetarism, as far as monetary theory goes? Or do you think there's some reason to it here still to classical monetarism?

Meltzer: I worry very little about those distinctions. I mean, if they do the right thing, which is, have a rule controlling money growth, I really don't care what they call it. Or rule controlling monetary policy, just like the Taylor Rule, I don't care what they call it.

Beckworth: Alright, our guest today has been Allan Meltzer. Allan, thank you for being on the show.

Meltzer: Thank you. And thank all of you, it's been a pleasure to be with you. And, I spent almost 60 years working as an economist. I love economics. And I have enjoyed having the privilege of doing what I did.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.