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 / Winter 2008 /Issue 53(originally published by Booz & Company)


The Thought Leader Interview: Allan Meltzer

He says the Fed has recently made several mistakes that fall into the latter category, including the way in which it conducted some of the recent bailouts and the way that it is allowing inflation to take root again. Both are evidence of a more endemic problem: The Fed­eral Reserve, in Meltzer’s opinion, is allowing itself to be driven by events and pushed around by Congress, squandering the hard-won reputation for institutional independence that it gained in the 1980s and 1990s. It is thus devaluing the only truly worthwhile currency that a central bank has: its credibility as a bulwark against inflation. The Fed’s emergence as the über-regulator of the U.S. financial system — with regulatory powers extending to Wall Street firms — is ill advised, according to Meltzer, because this will further politicize the Fed and divert its attention from its most critical role.

Meltzer sees some new regulation as inevitable, but he favors simple fixes. Imposing strict capital adequacy requirements on all financial institutions and establishing clear penalties for those that get into trouble would go a long way, he believes, toward limiting the damage from future financial-sector problems. The other reform he fa­vors, however, can come only from the financial industry itself. That reform is an overall rethinking of the incentive and compensation structures that set the stage for the recent disasters.

Meltzer’s own intellectual progression follows the aphorism (at­tributed to the early-20th-century French Prime Minister Aristide Briand) that a man who is not a socialist at 20 has no heart, and a man who is still a socialist at 40 has no head. In the 1948 presidential election, Meltzer was a 20- year-old campaign volunteer for the Progressive Party, whose platform included full voting rights for African-Americans and universal health insurance (the party’s candidate, Henry Wallace, received 2.4 percent of the popular vote). Meltzer had graduated from Duke University that year with a bachelor’s degree in economics. He shed his left-wing leanings during his graduate studies with economists such as Armen Alchian and Karl Brunner, earning his master’s degree in 1955 and his doctorate in 1958 at the University of California at Los Angeles. Brunner, a Swiss émigré with an interest in monetary economics, became his mentor, and later his colleague and coauthor. Together they wrote dozens of ar­ticles and several books.

Meltzer and Brunner were in­fluential figures in the economic school of monetarism, a disruptive innovation in the history of economic thought. Monetarism em­phasized the importance of controlling the growth of the money supply to restrain inflation and promote stable growth, and is associated with the late Nobel laureate Milton Friedman. This idea was considered heretical by many economists in the 1960s and 1970s, and one of its central suggestions — that the discretionary policies of central banks be replaced by a simple rule for monetary growth — never gained traction, although former Federal Reserve Chairman Paul Volcker described his own approach to ending inflation in the early 1980s as “practical monetarism.” Eventually monetarism withered as a distinct school of economic thought, but its central ideas about the importance of controlling the growth of the money supply have been absorbed into both the mainstream of economic thought and the practices of the Fed and other central banks.

In late July 2008, Meltzer spoke with strategy+business in his Pittsburgh office as he was pre­paring to attend the meeting of Federal Reserve officials and monetary economists held every August in Jackson Hole, Wyo. We spoke with him again in late September following the subsequent market collapse of Countrywide, Lehman Brothers, AIG, Merrill Lynch, Washington Mutual, and others. He updated a few of his answers, but his overall opinions were unchanged.

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