Tuesday, July 10, 2012

Meltzer: monetary policy is not the problem

Allan Meltzer has always been one of my favorite economists, perhaps because we think alike on so many issues. His op-ed in today's WSJ ("What's Wrong With the Federal Reserve") is a good example of his clear-thinking approach to complex issues:

Consider the response to last week's employment report for June—a meager 80,000 net new jobs created, and an unemployment rate stuck at 8.2%. Day traders and speculators immediately clamored for additional monetary easing. Even the president of the Federal Reserve Bank of Chicago joined in.
To his credit, Mr. Bernanke did not immediately agree. 
But he failed utterly to state the obvious: The country's sluggish growth and stubbornly high unemployment rate was not caused by, nor could it be cured by, monetary policy. Market interest rates on all maturities of government bonds are the lowest since the founding of the republic. Banks have $1.5 trillion in cash on their balance sheet in excess of their legally required reserves—far more than enough to meet any unsatisfied demand for loans that bankers regard as prudent. 

For those that missed it, this echoes my thoughts in a post last week. 


Benjamin Cole said...

Meltzer is also a GOP solon. That is fine; I voted for Reagan and Bush Jr. (only the first time). Meltzer wants Obama out (I am sympathetic to the view, especially if a better option emerges).

How partisan is Meltzer? Meltzer has written a history of the Fed that incorrectly ascribes 1970s inflation to US domestic spending and welfare policies, failing to even mention the Vietnam War, but also confusing the effects of fiscal policy with monetary policy. This is an astounding shortcoming for an economist.

He also writes that Carter wanted Volcker out (Volcker was a Carter appointee) failing to mention the Reaganaut's ire with Volcker, or that Reagan Treasury Secy Don Regan gave speeches suggesting moving Fed powers to the Treasury Department as Volcker was being too tight. The Reaganauts wanted Volcker out, and the WSJ was writing editorials that money policy was too tight---when inflation was running in the 4 percent to 5 percent range.

Today we simply have a hysteria about inflation, in some ways similar to other hysterias about communism; hunger in the USA (in a nation of fatties), or the spread of HIV (which never got into the general population).

Today monetary policy is the problem; and again Meltzer is wrong (not surprisingly; when one resolutely views the world through partisan blinders and party-colored lenses, that is often the result).

By the reasoning of Meltzer and other GOP partisans, Japan has had an "easy" money policy since 1992. Their interest rates have been near zero for decades.

But when you hit the "zero bound" then monetary policy needs to take steps that incorrectly are regarded as "unconventional," such as QE.

We have seen GOP thinkers such as John Taylor and Milton Friedman visit Japan and advise QE, Ben Bernanke (a GOP appointee) and Frederic Mishkin did too. But in the USA, in the GOP today, you have to drink the Kool-Aid, at least until Obama is out. You have to be seen as for "tight money." Remember Texan Gubbie Perry's proclamation that Bernanke should be executed if he loosens up on the money supply before the election?

If Romney wins, look for GOP economists to talk about the need to get the economy going again, and for the GOP to say that "deficits don't matter, steve the beast).

For this reason, it may be better if Romney wins (egads, i hope we can avoid endless wars, an ever-growing security state, and gushers of rural subsidies).

In short, Meltzer is hardline GOP partisan, and what he writes must be viewed in that light. More important to Meltzer is beating Obama---later we can get the economy going.


Benjamin Cole said...

BTW, here is Allan Meltzer telling Japan what to do:

"A Policy for Japanese Recovery, from Meltzer (h/t Market Monetarist) on what to do for the weak economy in Japan (stuck in a similar situation to the United States today), as it addresses all that directly. I’m going to add some bolded numbers:

Meltzer: "Repeatedly, the message has been to reduce tax rates permanently and maintain the exchange rate for the yen in its recent range…A permanent tax cut was supposed to do what previous fiscal efforts had failed to do — generate sustained expansion of the Japanese economy.

No one should doubt that Japanese expansion is desirable for Japan, its neighbors, and the rest of the world…The Japanese government has watched the economy stagnate much too long. [1] A policy change is long overdue.

The problem with the U.S. Treasury’s advice is that few would, and none should, believe
that Japan can reduce tax rates permanently. [2] Japan 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 Japan must soon start to finance large prospective deficits for old age pensions and health care. [3] There is no way to finance these current and future liabilities that will not involve higher future tax rates…

What is the alternative? Deregulation is desirable, but it will do its work slowly. [4] If temporary tax cuts are saved, not spent, and permanent tax cuts are impossible, Japan’s choice is between devaluation and renewed deflation. The deflationary solution runs grave risks…

Monetary expansion and devaluation is a much better solution. [5] An announcement by the Bank of Japan 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…"

This is amazing. Meltzer advises Japan to engage in monetary stimulus and forget about tax rates.

Meltzer is undoubtably a smart guy. But his present agenda is very suspect.