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Allan Meltzerís Fed Ed

Funding for Think Tank is provided by:

At Pfizer weíre spending nearly five billion dollars looking for the cures of the future. We have twelve thousand scientists and health experts who firmly believe the only thing incurable is our passion. Pfizer. Life is our lifeís work.

Additional funding is provided by the Lynde and Harry Bradley Foundation, the John M. Olin Foundation, the Bernard and Irene Schwartz Foundation, and the Smith Richardson Foundation.

(opening animation)

Ben Wattenberg: Hello. Iím Ben Wattenberg. Today Think Tank is joined by Allan Meltzer, a renowned free market economist who has made a career out of following the money--a tangled topic we hope to clarify. He has chaired the Shadow Open Market Committee, a self-appointed watchdog for the Federal Reserves monetary policy. He is a professor of political economy at Carnegie Mellon University, visiting scholar at the American Enterprise Institute and the author of several books, most recently A History of the Federal Reserve, Volume One, Nineteen Thirteen to Nineteen Fifty-One. The topic before the house Allan Meltzerís Fed Ed this week on Think Tank.


Ben Wattenberg: Allan Meltzer welcome to Think Tank.

Ben Wattenberg: Okay. Now, you were known, I believe, as a free market monetarist. Is that right?

Allan Meltzer: Thatís the way people often describe it, yes.

Ben Wattenberg: Now if I were to call you a free market monetarist and somebody said what do you mean by that, what should I answer?

Allan Meltzer: One is that I believe that people make better judgments for themselves than other people make for them and so theyíre better off in most cases making judgements for themselves and not having the government do it. Thatís free market. The second part is the monetarist. I believe that, following from that, that the Government can help the economy. It needs to help the economy have a stable prices and the best way to do that is to have control over the rate of growth of the money stock and thatís the monitarist part.

Ben Wattenbeg: What was the Fed meant to do? What did it do? How does it affect you and me and the crew here and the people outside?

Allan Meltzer: What it does now is it tries to maintain price stability, the value of your money and reasonable steady growth in the economy and it does that by raising and lowering interest rates and when it changes an interest rate, it affects all the other interest rates in the system. That affects the money that you borrow on your credit card, the automobile loans. One of the reasons we have such a big automobile boom, why we have automobile companies saying weíll lend you the money at zero interest rates, as theyíve been doing for the last several years, is because interest rates are so low. The Fed is helping the economy through this rough period. It affects the mortgages. One of the reasons we have such a home buying boom is because mortgage rates are at the lowest that theyíve been since the nineteen sixties, and people see that there is a sale on money so they go out and borrow money to...

Ben Wattenberg: Money is a commodity like anything else.

Allan Meltzer: Anything else and they borrow money to buy a house.

Ben Wattenberg What....what....

Allan Meltzer: But it also also affects the job creation part. It affects investment. So it affects not only the creation of jobs but how fast the economy is going to grow because it requires investment to grow. We need to have an institution to control the money stock and the Federal Reserve is that institution.

Ben Wattenberg: You worked on this book, A History of the Federal Reserve, Volume One, Nineteen Thirteen to Nineteen Fifty-One. Allen Greenspan when he talked about you said you started in the nineteen sixties on that book?

Allan Meltzer: I was asked by Congressman Patman, who was the head of the Banking Committee at the time to do a study of something to do with the way in which the market functioned. I convinced him that the problems in the market were not in the market. They were at the Federal Reserve and so he said well go ahead, study whatís going on at the Federal Reserve and we, with a co-author the late Karl Brunner, we did a study at the time of how the Federal Reserve operated and what it did. That was the subject of hearings and some changes at the Federal Reserve, but unfortunately not major changes.

Ben Wattenberg: And then you actually single-handedly dug into the actual hold amongst the archives of the Federal Reserve from the beginning. Is that right?

Allan Meltzer: Thatís right. Thatís right. From the very beginning, in fact from a little before the beginning, and there were thousands of boxes, tens of thousands of pages, there was far more material then I knew that I was going to find when I started to do the background. And eventually realized that I would never finish the book and do the research myself, so I now have some assistants who do that but then I have the job of checking up and making sure that theyíre getting everything that needs to be gotten.

Ben Wattenberg: And Volume Two will come out when?

Allan Meltzer: One day.

Ben Wattenberg: One day.

Allan Meltzer: I think about three or four years.

Ben Wattenberg: Okay, when the Fed was formed in nineteen thirteen, this was following many years of great turbulence in the economy. Is that correct?

Allan Meltzer: Right. Yes.

Ben Wattenberg: Why donít you tell me about it. I mean and ....did the panic of this and the panic............

Allan Meltzer: Yes. There were a whole series of panics. Eighteen ninety-two, somewhere in the middle after that, nineteen-oh-seven was the big one. After nineteen-oh-seven, there was a whole coalition got together with different purposes in mind to try to do something so that we would have fewer panics and also solve some other problems that we had and thatís what led to the Federal Reserve.

Ben Wattenberg: Okay. Now itís your view, as I understand it, that as this Federal Reserve System, this central bank, grew during the twentieth century it made two monumental mistakes.

Allan Meltzer: Thatís right.

Ben Wattenberg: What are they?

Allan Meltzer: The first was the Great Depression and thatís divided into two parts. First they brought us or helped to bring us the Great Depression and then second they didnít do very much to get us out of the great depression and the second big mistake was the great inflation that came in the late nineteen sixties until sometime in the early nineteen eighties.

Ben Wattenberg: All right. Tell us about the first, the Great Depression, and what did they not do and what should they have done afterward?

Allan Meltzer: They were on something called the Gold Standard. Many people learn about the Gold Standard, at least the idea of the Gold Standard, where countries are supposed to allow when gold comes in, they expand the amount of money and lower interest rates and when gold flows out, they raise interest rates and reduce the amount of money in circulation. We had adopted, worked hard in the nineteen twenties to re-establish something like the pre-war Gold Standard. Everybody was in favor of it.

Ben Wattenberg: You mean World War I?

Allan Meltzer: Pre-World War I Gold Standard. Everyone was in favor of doing that. And when I say everyone, virtually all classes and people. They believed that was the right order for people to have, but they didnít want to follow the rules of the Gold Standard. So the Gold Standard had a problem...when countries got gold, they had to inflate. We didnít want to inflate so we didnít follow that rule. When countries lost gold, they had to deflate. They didnít have any choice.

Ben Wattenberg: When you say gained gold or lost gold, what does that mean? Somebody took a pound of gold out of Fort Knox and moved it somewhere?

Allan Meltzer: Usually they just moved it around in the basement of the Federal Reserve of New York. So there would be a French room and a German room and an English room and an Italian room and so on. That, in effect, was moving it from country to country and it was there to settle differences in what we owed them for things that we bought there and what they owed us for things that they bought here. The rule worked fine if you were willing to accept the amount of unemployment that would be required to make the rule work. And the great change that had occurred between pre-World War I and post-World War I was that we were a major industrial country now, people did not want to suffer the unemployment that would be required to make the rule work. All the money was coming to France and the United States and both of those countries didnít want to inflate and they were putting pressure on all the other countries to deflate, to have deflation and unemployment. Thatís what broke the system down. What they should have done then was print money and end the deflation. What they didnít do...

Ben Wattenberg: The deflation in the U.S.?

Allan Meltzer: In the U.S.

Ben Wattenberg Right.

Allan Meltzer: What they didnít do was exactly that. They watched the deflation accumulate and they kept saying well this is the consequence of what went before.

Ben Wattenberg: The Roaring Twenties?

Allan Meltzer The Roaring Twenties, the Great Boom something like what we saw in the nineteen nineties. The stock market rising very rapidly. People spending money. A lot of people borrowing money. Consumer credit is invented during that period. People are buying automobiles and houses, really for many of them for the very first time. So they thought this Great Boom was.....

Ben Wattenberg: In the nineteen twenties?

Allan Meltzer: In the nineteen twenties. Had culminated in a speculative excess and they thought you had to purge that from the system. All right. Not like what weíre doing now. Weíre not trying to purge it from the system. Weíre trying to get the system to come back. They didnít think that that was their responsibility. So they let the system collapse.

Ben Wattenberg: Many people believe, if you ask and they say well Franklin Roosevelt got us out of the Depression. Is that accurate?

Allan Meltzer: Well yes, in part it is. It wasnít because of the New Deal and the many things that he did for the New Deal. The thing that he did that was most effective was he devalued the dollar. He changed the price of gold. We used to pay twenty dollars and sixty-seven cents an ounce for gold; Franklin Roosevelt decided he was going to pay thirty dollars an ounce for gold. That was way more than anybody else was paying for gold, so gold came here and later, of course, it came here because of Hitler. People wanted to send their money here. So we had a big increase in gold and because of the big increase in gold, we printed money, following the rules of the Gold Standard now and that made things much better. So we had a boom and by nineteen thirty-six, nineteen thirty-seven, early nineteen thirty-seven, we were almost back to where we had been in nineteen twenty-nine and then the Fed made another error. It got concerned that this was going to be inflationary. Remember now weíre in the Great Depression. There is still fifteen percent of the labor force is unemployed but they get concerned that thereís going to be an inflation. So they crack down on the system. Raising interest rates, slowing the growth of money and causing another very deep recession in nineteen thirty-seven, thirty-eight.

Ben Wattenberg: Okay. And then World War II comes along and we win it and we become sort of the....

Allan Meltzer: World power.

Ben Wattenberg: World power along with the Soviet Union, as it developed.

Allan Meltzer: Yes.

Ben Wattenberg: And then by your license, as I understand it, what do you know this great institution, the Federal Reserve Bank, makes another cataclysmic mistake.

Allan Meltzer: The Great Inflation.

Ben Wattenberg: Yes.

Allan Meltzer: The Great Inflation, yes.

Ben Wattenberg: Now, from when to when does the Great Inflation last?

Allan Meltzer: It starts nineteen sixty-five, sixty-six and it ends when they finally decide that they have to do something about it, nineteen eighty, eighty-one, when Reagan is elected on a program that heís going to end the inflation.

Ben Wattenberg: How high was it?

Allan Meltzer: It got as high as about ten or twelve percent a year.

Ben Wattenberg: And there were certain parts of years it was up to sixteen, seventeen percent?

Allan Meltzer: Thatís right.

Ben Wattenberg: What was the mistake that the Fed made in that instance?

Allan Meltzer: It was afraid that it would create unemployment. So every time it started to stop the growth of the money stock and to end the inflation, unemployment rose and then it threw in the towel and it did something about the unemployment. So people began to understand that they werenít really going to do anything about the inflation and that every time the inflation started to be subdued, as the unemployment rose, they would give up and create more money.

Ben Wattenberg: Tell me about the chairman of the Fed at that time, Arthur Burns.

Allan Meltzer: He should have known better.

Ben Wattenberg: He was the Allen Greenspan of his day?

Allan Meltzer: Of his day, and he was the first economist. He was a student of business cycles. He was one of the most admired economists who had studied business cycles. Now heís in a political world and instead of doing the things that he knew he had to do, he really tried to make sure that he didnít get into political difficulties and allowed the inflation to continue and made it worse.

Ben Wattenberg: Well is that because he was a buddy of President Nixonís?

Allan Meltzer: In part and in part it was that, I believ,e he just simply didnít have the courage to do what Volker later did. And the public was not ready for it, in his defense.

Ben Wattenberg: You accounted to me a conversation that you believe took place between Burns and Nixon.

Allan Meltzer: Not believed. I mean these are on the tapes.

Ben Wattenberg: Oh, itís on the tapes. Oh, I see.

Allan Meltzer: Nixon would say to Burns, Arthur, youíre the greatest business-cycle economist in the world. Everyone knows how great you are. You warned me in nineteen sixty, when I was running against John Kennedy there was going to be a recession and they...

Ben Wattenberg And Nixon felt that he lost to Kennedy because of that recession.

Allan Meltzer: Because of that recession.

Ben Wattenberg: Right.

Allan Meltzer: And so he would say, Arthur, youíre not going to let that happen again.

Ben Wattenberg: And this would have been like nineteen seventy-one or something?

Allan Meltzer: This is nineteen seventy-one. A year before the election.

Ben Wattenberg: The run-up to the election.

Allan Meltzer: Right, right and so we have a big explosion in money and we hold the interest rate low and the economy booms through the nineteen seventy-two election year and then we run into serious trouble exacerbated by the oil shocks that come in nineteen seventy-three. But in nineteen seventy-three, because of all the stimulus we put in the economy to help Nixon get elected, the economy is running flat out. Thereís.....

Ben Wattenberg: I mean I am sort of....usually attuned to trying to punch holes in conspiracy theories but this...I donít know, this conspiracy may be a little harsh as a word... but this was Burns acting politically, conspiring to help Nixon get elected.

Allan Meltzer: It certainly looks that way.

Ben Wattenberg: What about this idea....I mean the Fed always comes under harsh attack that theyíre not accountable, that theyíre unelected and, therefore, they can engage in these kinds of conspiracies? They are unelected, arenít they?

Allan Meltzer: They are unelected. You want to have the Fed independent. You donít want the government itself to have its hand on the money printing process because youíll get repeats of the Nixon thing from time to time.

Ben Wattenberg: That the government itself would act politically.

Allan Meltzer: Would act politically.....

Ben Wattenberg: So they put some distance....right.

Allan Meltzer: Just lean a little bit more in this direction but.....

Ben Wattenberg: How many members of the Fed are there?

Allan Meltzer: Seven.

Ben Wattenberg: Seven.

Allan Meltzer: Seven but then there are the presidents of the Federal Reserve Banks and thereís a whole structure...

Ben Wattenberg: Right.

Allan Meltzer: that the people making the decision at any time are twelve people.

Ben Wattenberg: Right.

Allan Meltzer: So you donít want to do that. For that you want to have an independent central bank. You want to have them independent, but then you donít want to have them completely independent in the sense that they could go off and do whatever they want. There has to be some accountability.

Ben Wattenberg: Well how can you stop them? How can you stop them?

Allan Meltzer: I think that the way to stop them is to have the government set the objective. Say we want to have two percent inflation or we want to have one percent inflation and thatís our objective two years from now or three years from now and then have the Federal Reserve responsible for doing that. If they donít do it...

Ben Wattenberg: But thatís not in the law now. That....that

Allan Meltzer: No thatís not in the law. Thatís what I want them to do. And then say if the Federal Reserve doesnít do it, then the chairman has to offer his resignation. And then the President can decide that he either wants to replace the chairman, because he didnít do what he was supposed, or heís going to accept responsibility for whatever it was. The chairman will say, well, oil prices rose and I had no control over that, and the President will say weíll accept that as an answer or weíre going to get a new Federal Reserve. We need to have the President accountable. Now some countries have adopted that system and it seems to work well. New Zealand was the first, where the Minister of Finance, equivalent to the Secretary of the Treasury, says this is the inflation rate we want and we want you to deliver it and if you donít deliver it, then you have to resign. That was my proposal to the Reserve Bank of New Zealand and it actually became part of their law.

Ben Wattenberg: One of these structures that you have mentioned as responsible for the great Pax Americana boom from 1945 to 2000 or so has been the World Bank. And yet, you lay some pretty heavy strokes on the World Bank.

Allan Meltzer: Well, the World Bank is an inefficient organization and it lends about twenty billion dollars every year-or more. If you or I were to lend twenty billion dollars every year weíd expect to see people coming out of poverty, improvement. The World Bank has a big sign in its building which says 'Our job is to eliminate poverty.' But theyíre not doing it. Many of these countries are going backwards.

Ben Wattenberg: But yet you have said that as a rule countries in this time have made a great deal of economic progress.

Allan Meltzer: Right. But those are the countries that have gone into the free market system, have open their economies to trade, things of that kind. The areas where weíve seen the failure are the areas where the World Bank has been most active.

Ben Wattenberg: What are they loaning money for?

Allan Meltzer: All kinds of things. The problem is they donít have a very good system for monitoring where did the money go. A lot of the money is stolen. Everybody understands that including the World Bank. Thereís corruption in the world. Theyíve pointed out corruption, but they donít do much to root it out. For example, they wonít say, if your country is corrupt and we have reason to suspect that the money isnít being used for the purposes that it is supposed to be used for, weíre not going to give you any more money. That would be a big incentive to try to see that at least some of the money got spent for education or health care or the environment or economic development, but they donít do that.

Ben Wattenberg: And what about the IMF?

Allan Meltzer: The International Monetary Fund? They have done better and theyíre trying...

Ben Wattenberg: What is their job?

Allan Meltzer: Their job is to maintain global stability. To make sure that if thereís a crisis in one country that it doesnít spread to all the other countries or many other countries.

Ben Wattenberg: Are they sort of like a super Fed?

Allan Meltzer: Like a super Fed in a way, yes. They have a lot of the same responsibilities as the Fed. But what they do is theyíre more anxious to give advice and lend money to countries than they are to see that the advice is carried out. So we need to shift that whole system from one where we tell you what to do, we hope that youíre going to do it, to a system where we build in incentives but we want the country to make the reforms and we say if you do these reforms, weíll help you in a crisis and if you donít, then the people who lend you money are at risk. And by making that distinction, weíre going to get a system where the finance minister of the country will be able to go to the parliament and not say we have to do this because the IMF insists upon it. Heís going to say we have to do that because itís good for the growth of this country. When we get that transition, away from command and control and into an incentive based system, weíre going to have a system that works much better.

Ben Wattenberg: Tell me about Allen Greenspan. Heís become sort of mythic. Do you think heís done a good job? Because youíre pretty brutal about some of your assessments.

Allan Meltzer: Well I try to be honest.

Ben Wattenberg: Yes. No, I understand.

Allan Meltzer: But the word I would use is honest.

Ben Wattenberg: Yes. Well I donít mean brutal. I mean straightforward.

Allan Meltzer: All right. Thatís all right. I think he has been the best chairman of the Federal Reserve so far. That doesnít mean he hasnít made mistakes. He has. But making mistakes is part of making judgements.

Allan Meltzer: On the whole, his judgements have been extremely good and the economy has done very well. Weíve had now, between the Volker and the Greenspan era, weíve had two of the longest expansions in the U.S. history, punctuated by two relatively mild recessions. Thatís a very good record. Weíve seen incomes, per capita income, incomes of ordinary individuals increase by fifty percent in twenty years. Thatís very, very good by any standard that we have for any previous period.

Ben Wattenberg: If you look before World War II at the fluctuations in the growth of the gross national product or the gross domestic product, whatever it was, and going way back into the eighteen eighties, eighteen nineties, the chart looks, if this is this zero access of rise and fall, it looks like this.... (waves hand up and down broadly)

Allan Meltzer: Much bigger.

Ben Wattenberg: And then all of a sudden after World War II, the fluctuations start looking like that (smaller motion up and down) and its been like that almost sixty years. Itís a very stable system and it wasnít before. Is that due to the Fed?

Allan Meltzer: Itís due to the Fed and the learning that we have done. I mean from the mistakes that we made in the earlier periods. The things that we talked about before under the gold standard. We have a much better system than we had before. We also had much better data. So weíre not really sure that change is as great as it appears from those charts because the charts when we go back far, depend upon very rough, crude data. Nothing like what we have now.

Ben Wattenberg: How is unemployment doing these days?

Allan Meltzer: Unemploymentís around five point eight percent right now. By the standards of past recessions, that would be pretty good--or past periods of slow growth because weíre really not in a recession. That would be pretty good.

Ben Wattenberg: You mean....

Allan Meltzer: But by the standards of nineteen ninety-nine, nineteen ninety-eight, which people have in mind, itís not so good.

Ben Wattenberg: But prior to the nineteen nineties when this whole economy sort of exploded, six percent unemployment was regarded almost as a target....

Allan Meltzer: A norm.

Ben Wattenberg: A norm, yes.

Allan Meltzer: A good norm.

Ben Wattenberg: And thatís where we are now and yet....

Allan Meltzer: Weíre below that.

Ben Wattenberg: Yes. Weíre....

Allan Meltzer: Weíre below that.

Ben Wattenberg: Weíre below that, but people are not satisfied....I mean very definitely arenít satisfied.

Allan Meltzer: Right, and one of the reasons for that is that they got used, in the nineteen nineties, to the idea that it could be much better than that and that their wages would be rising faster, and part of their complaint is their wages arenít rising as fast now.

Ben Wattenberg: But why didnít Allen Greenspan, who you give good marks to, see that so-called bubble and do something about it? I mean thatís really shocked people, you know what I mean, it has taken 401(k) money and pension money and it just decimated it.

Allan Meltzer: Hard call. That was a hard call. I mean there was a productivity boom and it was hard to separate out how much of that was fluff and how much of it was real productivity boom, and I think he made a bad judgement. The mistake he made was there had been an Asian crisis and....

Ben Wattenberg: Asian contagion.

Allan Meltzer: The Asian contagion, right and....

Ben Wattenberg: It started with the Baht in Thailand. The Thai Baht, right?

Allan Meltzer: Correct, correct...very good!

Ben Wattenberg: Right. I...I....

Allan Maltzer: See, your better at this economics than you thought!

Ben Wattenberg: No, no. I mean, I remember a lot of these buzz phrases. I donít know what they mean, but thatís all right. Go ahead.

Allan Meltzer: Then he, you may remember there was a Time magazine cover about the Committee to Save the World-- he and Lawrence Summers and Robert Rueben....

Ben Wattenberg: Right, right.

Allan Meltzer: That they were going to....what were they doing. Well, they were getting the American economy to grow faster by having a very stimulative policy.

Ben Wattenberg: Which would make us the locomotive economy.

Allan Meltzer: The locomotive economy, and they kept the locomotive running too fast.

Ben Wattenberg: How was that? Thatís pretty good.

Allan Meltzer: Too fast, too long...

Ben Wattenberg Right.

Allan Meltzer: And then they ran into the beginnings of what he feared was going to be an inflation and then he cracked down.

Ben Wattenberg: So what he should have done as the bubble expanded, was raise interest rates?

Allan Meltzer: If he had paid attention to the economy and not to the stock market, he would have slowed the economy down at that point.

Ben Wattenberg: By....

Allan Meltzer: By raising interest rates.

Ben Wattenberg: But that would have caused uncharted hell. I mean if youíre growing at four percent a year and then here comes along Allen Greenspan and says, well Iím going to raise interest rates....

Allan Meltzer: Because I think itís growing too fast.

Ben Wattenberg: Because I think itís growing too fast, you guys are making too much money...

Allan Meltzer: Right.

Ben Wattenberg: Is that really doable? Can you do it?

Allan Meltzer: It takes a lot of hard guts to do something like that. I mean, because a lot of the people are going to say he didnít need to do that, things were running, you know, you canít stand prosperity. So thatís a tough call and he was slow. He eventually made that call but he made it too slow.

Ben Wattenberg: Okay. Allan Meltzer, thank you very much for being with us on Think Tank and thank you. Please remember to send us your comments via e-mail. For Think Tank, Iím Ben Wattenberg.


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At Pfizer weíre spending nearly five billion dollars looking for the cures of the future. We have twelve thousand scientists and health experts who firmly believe the only thing incurable is our passion. Pfizer. Life is our lifeís work.

Additional funding is provided by the Lynde and Harry Bradley Foundation, the John M. Olin Foundation, the Bernard and Irene Schwartz Foundation, and the Smith Richardson Foundation.

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