Allan H. Meltzer, RIP

By: Joseph T. Salerno

Allan H. Meltzer, a distinguished monetary economist and historian and a longtime professor of economics at Carnegie-Mellon Institute, died on Monday at the age of 89.  Details of his life and career can be found in his obituaries (here, here, and here).  At the time of his death Meltzer was particularly renowned for his widely acclaimed work, A History of the Federal Reserve, published in two volumes in 2003 and 2009, which took him fourteen years to write.  The volumes were highly praised by leading monetary economists with broadly monetarist inclinations like John Taylor and Michael Bordo.  Meltzer discussed the writing and lessons of the book as well as some of his other important contributions to monetary economics in an in-depth interview he gave to the Federal Reserve Bank of Minneapolis in 2003. 

While his book on the Fed is an important contribution and resource for those pursuing research in monetary history, I want to highlight two other scholarly contributions by Meltzer that tend to be neglected or even dismissed by the mainstream of monetary thought but which should be of interest to Austrian economists.  Although Meltzer was an adherent to “monetarism”—a term coined by his long-time collaborator and co-author Karl Brunner—he and Brunner were incisive critics of the monetary theory, or lack thereof, underlying Milton Friedman’s brand of monetarism.  

In a paper published in 1972, Brunner and Meltzer presented a penetrating analysis of Friedman’s “monetary framework.”  Their criticism was all the more devastating because they were doctrinal insiders who self identified as “weak monetarists.”  Their thesis was “the absence of an explicitly stated theory capable of generating the propositions that have been supported by empirical investigation has impeded the further development of monetary theory. . . . Friedman’s statement of monetary theory does not seem to us an adequate underpinning for monetary theory or a particularly useful basis for empirical work.”  They went on to note the complete absence of relative prices, interest rates, and credit markets in Friedman’s explanation of the monetary transmission mechanism.  Perhaps most important from the standpoint of Austrian business-cycle theory, they pointed out Friedman’s fundamental error in failing to distinguish between “money and bank credit” and include “the market for bank credit in his analysis of the markets for money and output.”  Also amenable to Austrians was Brunner and Meltzer’s rejection of Friedman’s arbitrary assumption that real interest rates are constant over the business cycle because market rates adapt rapidly to changes in expectations in the short run.  Not only does Friedman neglect the elementary distinction between real and market rates, he does not even acknowledge that interest rates are “a proxy for relative prices of assets and output.”   Brunner and Meltzer concluded:

By keeping real rates constant, ignoring fiscal variables, and relative prices, Friedman’s ‘common model’ neglects the variables that . . . explain many of the short-run changes in expenditures and market interest rates [i.e., business cycles].

Elaborating on these insights, Brunner and Meltzer went on to publish a book featuring their own theoretical monetary framework in 1993.  Unfortunately, the book did not have much of an impact as it was published right at the cusp of the New Keynesian revolution that ushered dynamic stochastic general equilibrium models to the forefront of monetary and macroeconomic analysis.  Despite its relative obscurity, it is a book well worth reading. 

Meltzer’s second important contribution, which was not well received, was his radical re-interpretation of the central message of Keynes’s General Theory.  Published in 1988, Keynes’s Monetary Theory: A Different Interpretation rejected the standard textbook characterization of Keynes’s economics.  The General Theory, contended Meltzer, was not primarily concerned with spending multipliers, changes in aggregate demand, and the adjustment of quantities rather than prices.  Nor were downward rigidity of wages, animal spirits, instability of investment, and the liquidity trap concepts crucial to Keynes’s main argument.  Rather, Meltzer’s contended, Keynes was mainly concerned to rid the economy of excessive uncertainty, which caused wealth-holders to increase their demand for money relative to claims to capital goods and to expect higher risks of default in lending money.  The heightened liquidity premium to which was added a higher risk premium for lending translated into higher costs of borrowing for entrepreneurs, a reduction of investment, and thus a chronic suppression of output, employment, and the capital stock below maximum levels.

According to Meltzer, Keynes’s solution to this problem was the “socialization of investment.”   By assuming control of long-run investment decisions, the State would not be inhibited by high liquidity and risk premia, because the rentiers would be effectively “euthanized” and there would be no (long-term) market for investible funds.  State-directed investment at a zero interest rate would thus bring about the happy state of “capital saturation” at which the marginal productivity or “marginal efficiency” of capital was zero and employment and output achieved optimal levels. 

While, as I have written elsewhere, one of Keynes’s main policy prescriptions indeed was government direction of investment as a means of bringing about capital saturation, Meltzer was perhaps a bit too dismissive of Keynes’s concern with short-run fluctuations.  Nonetheless Meltzer’s book is of crucial importance as an antidote to the entrenched but misleading view among most economists that the General Theory was all about how to save capitalism by using the spending multiplier to tame unruly short-run fluctuations in aggregate demand.  

In addition to these contributions, it is to Meltzer’s credit that he was one of the most vocal and unyielding among the few prominent macroeconomists who opposed the Fed’s adoption of unconventional monetary policies, especially quantitative easing (here, here, and here).   

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