Allan Meltzer’s great advice for the Federal Reserve

Here is Allan Meltzer’s great advice on US monetary policy:

“Repeatedly, the message has been to reduce tax rates permanently… A permanent tax cut was supposed to do what previous fiscal efforts had failed to do — generate sustained expansion of the American economy. 

No one should doubt that an expansion is desirable for US… and the rest of the world…The US government has watched the economy stagnate much too long. A policy change is long overdue. 

The problem with the advice (about fiscal easing) is that few would, and none should, believe that the US can reduce tax rates permanently. US has run big budget deficits for the past five years and accumulated a large debt that must be serviced at considerably higher interest rates in the future … And the US must soon start to finance large prospective deficits for old age pensions and health care. There is no way to finance these current and future liabilities that will not involve higher future tax rates… 

It is wrong when somebody tells the American to maintain the value of the dollar…The fluctuating rate system should work both ways. Strong economies appreciate; weak economies depreciate. 

What is the alternative? Deregulation is desirable, but it will do its work slowly. If temporary tax cuts are saved, not spent, and permanent tax cuts are impossible, the US choice is between devaluation and renewed deflation. The deflationary solution runs grave risks. Asset prices would continue to fall. Investors anticipating further asset price declines would have every reason to hold cash and wait for better prices. The fragile banking system would face larger losses as asset prices fell. 

Monetary expansion and devaluation is a much better solution. An announcement by the Federal Reserve and the government that the aim of policy is to prevent deflation and restore growth by providing enough money to raise asset prices would change beliefs and anticipations. Rising asset prices, including land and property prices, would revive markets for these assets once the public became convinced that the policy would be sustained. 

The volume of “bad loans” at US banks is not a fixed sum. Rising asset prices would change some loans from bad to good, thereby improving the position of the banking system. Faster money growth would add to the banks’ ability to make new loans, encouraging business expansion.

This program can work only if the exchange rate is allowed to depreciate. Five years of lowering interest rates has shown that there is no way to maintain the exchange rate and generate monetary expansion…

…Some will see devaluation as an attempt by the US to expand through exporting. This is a half-truth. Devaluation will initially increase US exports and reduce imports. As the economy recovers, incomes will rise. Rising incomes are the surest way of generating imports of raw materials and sub-assemblies from US trading partners.

Let money growth increase until asset prices start to rise.”

I think Allan Meltzer as a true monetarist presents a very strong case for US monetary easing and at the same time acknowledges that fiscal policy is irrelevant. Furthermore, Meltzer makes a forceful argument that if monetary policy is eased then that would significantly ease financial sector distress. The readers of my blog should not be surprised that Allan Meltzer always have been one of my favourite economists.

Meltzer indirectly hints that he wants the Federal Reserve to target asset prices. I am not sure how good an idea that is. After all what asset prices are we talking about? Stock prices? Bond prices? Or property prices? Much better to target the nominal GDP target level, but ok stock prices do indeed tend to forecast the future NGDP level pretty well.

OK, I admit it…I have been cheating! Allan Meltzer did indeed write this (or most of it), but he as not writing about the US. He was writing about Japan in 1999 (So I changed the text a little). It would be very interesting hearing why Dr. Meltzer thinks monetary easing is wrong for the US today, but right for Japan in 1999. Why would Allan Meltzer be against a NGDP target rule that would bring the US NGDP level back to the pre-crisis trend and then there after target a 3%, 4% or 5% growth path as suggested by US Market Monetarists such as Scott Sumner, Bill Woolsey and David Beckworth?


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  1. Lars
    There´s a pattern here. You get Meltzer, Taylor and Bernanke at different times all giving advice to Japan. The general direction of the advice is to adopt some level target.
    So what´s good for Japan is not good for the US?

  2. Marcus, very good point. Maybe we should make a collection of clever economists’ comments on Japan.

  3. That would certainly make a good compilation of the kind “I know what you said last summer”!

  4. dwb

     /  January 23, 2012

    “targeting assets” is likely a poor choice, however investments and assets being the the present value of future cash flows, a higher nominal gdp growth path leads to higher asset values. For example, loan delinquencies and defaults are a direct function of nominal gdp, so higher ngdp leads to lower defaults/deliquencies and higher loan/asset values values. higher ngdp also implies higher consumption and therefore more investment and higher stock prices, and so on. Let the market do the work of appropriately allocating the necessary capital along the ngdp path once the central bank has appropriately adjusted ngdp. Productivity-enhancing deregulation (especially in export sectors) would be good on top of this, so that potential output is also higher. Strange as it may seem, the U.S. can be cost-competitive in manufacturing (low labor costs are not the only ingredient!) with the right productivity. I do not necessarily wish for a higher or lower exhange rate as long as its detemined at market and as long as we encourage productivity to maintain cost-competitiveness.

  5. Dwb, I totally agree with you. The role of the central bank should basically be to be “neutral” in the sense that it should NOT distort the allocation of capital and labour. A NGDP level targeting regime best ensures this.

  6. Benjamin Cole

     /  January 23, 2012

    A cruel joke on us devout Market Monetarists! I was hoping we had a convert.

    I tik Meltzer will advocate for aggressive monetarism as soon as Romney replaces Obama. Taylor too. Possibly even Bernanke.

    • Benjamin, I think that is an interesting idea – that think public attitude US conservative/right-wing (whatever…) economists dependent on who is in the White House. I wonder whether the markets have the same idea. If so then we should expect the markets to start to price in monetary easing if it is becoming more likely that Romney will win.

      But I tend to agree – I think at least Bernanke will feel much less pressure with a Republican in the White House.

  7. Benjamin Cole

     /  January 24, 2012

    In other words, we have a long wait in America for prosperity. Obama would win also.

  8. dwb: investments and assets being the the present value of future cash flows Gold? Works of art?

    That people see (some) assets as stores of value is absolutely basic to understanding the price movements of such assets. For example, housing prices surge when people see them as inflation-beating assets.

    Not that this is any sort of argument for central banks to “target” asset prices.

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