Economics Update (April-June 1997)

Meltzer Critiques Central Bank Performance

W e are approaching the end of the era of disinflation," said Allan H. Meltzer, professor of political economy and policy at Carnegie Mellon University, speaking to Atlanta business and community leaders at the Atlanta Fed in May. He noted that in the past 15 years inflation has been brought from 12 or 14 percent to 2 or 3 percent. Recent policy actions have been successful in avoiding recessions while reducing inflation, particularly in the years that Alan Greenspan has been chairman of the Federal Reserve.

Meltzer is founder and chairman of the Shadow Open Market Committee, a group of academics and practitioners that discusses and issues public statements about current economic policy. Meltzer, now writing a book about the history of the U.S. Federal Reserve System, drew his comments from that history.

"In the last four or five years, (the Fed) has been extremely successful. We all hope it will continue to succeed for, as it succeeds, we benefit."
During the last two decades, Meltzer said, the United States may have learned two economic lessons: "The old lesson is that inflation doesn't solve any real problems for very long and makes others worse. The new lesson is that Keynesian economic ideas failed badly in practice. They became a recipe for instability, inflation and a bloated public sector."

A past member of the President's Council of Economic Advisors, Meltzer believes that there is "no body of principles" in the U.S. central bank that are passed from one Federal Reserve chairman to his successor. This practice is unlike that of other low-inflation countries such as Switzerland, Germany or New Zealand. "In these countries," Meltzer said, "the central bank relies on an operating system that is predictable to outsiders and that gives general guidance to the responsible officials about what they must do and, within broad limits, when they must do it."

However, looking abroad raises some doubts about central banks, according to Meltzer. "For half a decade the Bank of Japan has followed a deflationary strategy, broadly similar to the Fed's policy in 1929 to 1933, at great cost to its citizens," he said. "And the European central banks, driven by their governments, have clung to a fixed exchange rate and marched toward monetary union despite slow growth and rising unemployment rates." He believes that, fortunately, a fluctuating exchange rate "partly insulates the U.S. economy from the worst effects of these mistaken policies. Also, unlike the 1920s, we have followed a more open trading policy."

Meltzer ended his remarks with two reflections. "First," he said, "the Federal Reserve is one of the most prestigious institutions of government. It has great esteem and, currently, high credibility." But, he continued, "the Fed continues to rely on market interest rates" as its policy indicator—a source of mistakes in the past, he believes.

Second, Meltzer added, "The Federal Reserve operates by consensus. After 82 years, it still lacks a developed framework to get from its assessment or evaluation of the economy to its ultimate goals. It moves without much clear rationale, using what I have called 'rampant eclecticism.'"

He also said, "Perhaps the new openness at the Fed, and their greater willingness to talk about what they are doing, will help to keep the economy stable by giving markets better and more timely information." According to Meltzer, "In the last four or five years, (the Fed) has been extremely successful. We all hope it will continue to succeed for, as it succeeds, we benefit."

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