39 - Allan Meltzer on the Monetarist Counterrevolution and Economic Reforms

Episode Summary

Executive Summary: Alan Meltzer traces his shift from left-wing activism to monetarism, argues that successful monetary regimes require rules and money control, and criticizes modern central banking for relying on discretionary, interest-rate-centric policy. He defends monetarism’s transmission mechanism via asset prices, rejects standard Keynesian interpretations, and says today’s economic problems are mostly real, not monetary.

Main Topics: Origins of Meltzer’s macroeconomics and monetarism (Priority: 5/5): Meltzer explains that growing up during the Great Depression pushed him toward macroeconomics and policy-focused monetary theory; his political evolution moved from left-wing activism to libertarianism and then monetarism. Monetarist counter-revolution and Volcker’s role (Priority: 5/5): He describes the 1970s monetarist pushback against Keynesian orthodoxy, the Shadow Open Market Committee, and Paul Volcker’s adoption of practical monetarism as the turning point in defeating inflation. Monetary transmission, asset prices, and why money matters (Priority: 5/5): Meltzer and Carl Brunner’s key contribution was a micro-founded channel: money growth raises asset prices, which lowers the cost of new investment and housing, stimulating real activity. Critique of Keynesianism and modern New Keynesian policy (Priority: 5/5): He argues Keynes has been misread by later Keynesians and rejects models that treat money and credit as incidental; he says central banks should not rely on the Phillips curve or Taylor-rule-style discretion alone. Fed policy since the Great Recession and QE (Priority: 4/5): Meltzer agrees the Fed helped create the mid-2000s boom and worsened the bust by being too slow, but says QE mostly altered exchange rates and asset prices rather than solving the economy’s real problems. Rules, sovereignty, and political economy (Priority: 4/5): He favors rules over discretion at the Fed, supports reform proposals like the FORM Act, and connects voter backlash in the U.S. and Europe to concerns about lost sovereignty and overreach by unelected institutions. Negative rates, ECB/Japan, and structural reform (Priority: 3/5): Meltzer says negative rates distort behavior, encourage cash hoarding, and cannot substitute for non-monetary reforms needed in Europe and Japan.

Key Arguments: Monetarism emerged from the need to explain and prevent Depression-style macroeconomic failure, not from ideology alone. Volcker’s willingness to raise rates despite high unemployment proved that persistent money control can break inflation expectations. The key monetary transmission mechanism is through asset prices and relative prices, not a simplistic money-to-output shortcut. Keynes was primarily concerned with uncertainty and capital formation; later Keynesianism overemphasized consumption and deficits. Modern central banks err by treating money and credit as unimportant and by relying too much on discretionary, day-to-day policy reactions. Inflation control requires a rule-like, predictable framework; the best Fed periods were when policy followed a clear rule or quasi-rule. QE did not create strong growth because the U.S. problem was not mainly monetary; reserves piled up while bank lending remained weak. Weak recovery reflected regulatory and business pessimism more than lack of monetary stimulus. Negative interest rates are a poor substitute for structural reform and can push people toward currency hoarding. Public discontent is partly a response to loss of sovereignty and policymaking by administrative elites rather than elected institutions.

Data Points: Great Depression unemployment: 20%–25% - Meltzer cites Depression-era labor market collapse as the formative macroeconomic problem that shaped his career. Majority of 1930s unemployment: Never got down very low - Used to emphasize persistent economic distress during his youth. Volcker-era unemployment: Above 8% - He says Volcker raised rates despite very high unemployment to convince markets he was serious about stopping inflation. Inflation after Volcker tightening: Three to four percent - Meltzer says inflation fell within months after Volcker’s decisive rate hike and policy persistence. Number of coauthored papers with Carl Brunner: Probably 25 - He describes a long collaboration with Brunner on monetarist research. Key paper year on transmission mechanism: 1961 - Brunner’s JPE essay introducing the asset-price channel for money growth. M2 growth during QE era: 5%–6% - Meltzer notes broad money growth stayed modest despite massive reserve expansion. Core PCE inflation average: About 1.5% - He says the Fed failed to reach its 2% target despite QE and other unconventional policies. Fed inflation target: 2% - Referenced as the Fed’s preferred goal that remained undershot. Best Fed period (Greenspan era): 1986–2002 - He identifies this as one of the two strongest Fed periods due to more rule-like behavior.

Pivotal Quotes: "Inflation is always and everywhere a monetary phenomenon." — Alan Meltzer: Used to defend Friedman’s framework and distinguish generalized inflation from relative price changes like oil shocks. "You want to keep inflation out, you want to control money." — Alan Meltzer: His core prescription for successful central banking and stable macroeconomic policy. "I know how you get in, but how do you get out?" — Kennedy-era general (as recounted by Meltzer): Illustrates his broader critique that policymakers often ignore exit strategy and long-term consequences.

Implications: Meltzer’s view implies central banks should return to rule-based policy, focus on money and credit, and stop using QE/negative rates as substitutes for structural reform. For markets, predictability and anti-inflation credibility matter more than constant discretion.