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Thursday, May 11, 2017

Remembering All of Allan Meltzer's Work

Allan Meltzer passed away this week. He is probably best known for his multi-volume history of the Federal Reserve, the 'Meltzer Commission' that aimed to reform the IMF, and most recently his critique of Fed policy since the Great Recession. There was, however, much more to Allan Meltzer than just these developments.

One of the most important contributions, in my view, was his work with Karl Brunner during the 'Monetarist Counterrevolution'. This counterrevolution took place in the 1960s and 1970s and pushed backed against the dominant view of the time that monetary policy did not matter. Milton Friedman and Anna J. Schwartz spearheaded this movement, but it was Meltzer and Brunner who did the most to show why money mattered. They worked hard to show the mechanism through which monetary policy could actually affect the economy. This was no small feat since at the time many economists did not believe in monetary policy. Their insights now permeate modern macroeconomics.

Sadly, however, I suspect many observers will only remember Allan for his critique of Fed policy since 2008. While I disagreed with him on this issue, he was so much more than that one issue. So I hope readers will look at his entire life's work when judging him.

My appreciation for him grew over the past few years for several reasons. First, I got to the chance to interview him before a live audience for my podcast. It was a great interview. He was incredibly sharp, witty, and funny. I can only hope I am that lucid and spry when I hit my late 80s. 

Second, I came to appreciate his work with Karl Brunner on the monetary transmission mechanism as I was working a recent paper. As an example, below is an excerpt from a 1987 article. Read it and see if you can find any relevance for Fed's QE programs (my bold):
The adjustment of reserve positions to transitory change by buying and selling Federal funds (or by borrowing or repaying loans at the central bank) has negligible effects on the interest rates and asset prices relevant for household and business decisions.  A perceived permanent change in the monetary base initiates very different responses and has different costs.  The banks' balance sheet adjustments involve all portfolio items.  The responses by the banks change the money stock, affect interest rates on a variety of assets and the prices of real assets.  The public responds to changing relative costs and returns between loan liabilities and real assets.  The adjustment to a perceived permanent change is reinforced by changes in price expectations or adjustment of the current expected return to capital whenever permanent increase in the base are sufficiently large or persistent.
Meltzer and Brunner, in short, are saying that expected changes in the monetary base have to be permanent to have any meaningful effect.  This is a widely understood point now, one that if ignored leads to the QE "irrelevance results" of Krugman (1998) and Eggertson and Woodford (2003). This understanding explains why the Fed's QE programs failed to generate a robust recovery.  The monetary base injections under them were always meant to be temporary and this limited how much kick they could generate. Put differently, the Fed's temporary monetary injections were never going to create a fast escape from a ZLB environment. (For those interested, I further explain this point in a recent working paper.)

What is remarkable to me is that Meltzer and Brunner understood this principle long before QE was tried in Japan, the United States, the United Kingdom, the Eurozone, and Japan again. His work continues to shed light on current policy debates.

Examples like this one is why Allan Meltzer's life work deserves to be remembered. He is a giant and will be missed. Rest in Peace Allan.   

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