Given the breadth and substance of Meltzer's contribution to economics, his claim to have invented a new variety thereof is not too far from the truth.
The AEI seminar was divided into three parts: monetary policy, international economic development and political economy.
A professor at Carnegie Mellon University, Meltzer recently published the first volume of a history of the Federal Reserve Bank (covering the years 1913-51) and is working on a follow-up.
A follower of Nobel laureate Milton Friedman in his devotion to monetarism, he has influenced monetary policy-makers not only in the Federal Reserve Board, but in Britain, Japan, Switzerland and Brazil. His core belief is that both inflation and deflation are monetary phenomena and can hence be dealt with by monetary means.
As an example, he referred to the Fed's mistake in 1937 when it looked only at short-term interest rates, drew the conclusion that monetary policy was accommodative, and doubled bank reserve requirements, thus setting off a sharp recession that plunged the U.S. back into the Great Depression.
Alarmingly, Japan repeated this error in 1999, plunging the economy back into a deflationary recession out of which it had seemed to be climbing.
Meltzer, born in 1928, came to prominence in the 1960s when he published a series of path-breaking studies, many in collaboration with the late Karl Brunner (1916-89), which presented a fresh account of the role of financial institutions in the economy, and the relationship of money supply and demand to prices, output, employment, exchange rates and other aspects of economic performance.
He opposed President Richard Nixon's wage and price controls, and in 1973 formed with Brunner the Shadow Open Market Committee, which he chaired until 1999, which produced detailed critiques of Fed policies and policy recommendations focused on price stability, particularly an issue during the "stagflation" of the late 1970s and early 1980s.
Internationally, Meltzer has been a leader in pointing out the economic realities behind successive international crises and exploding the myths that surrounded them.
The Latin American crisis in the mid-1980s, Mexico in 1994 and Argentina in 2001 all had a common origin: excessive government spending, which led to excessive debt and an untenable exchange rate policy.
Most important, in 1999-2000, Meltzer chaired the International Financial Institutions Advisory Commission, which immediately became known as the Meltzer Commission. The panel recommended that bail-outs of private-sector lenders to emerging markets be prevented, since they led to moral hazard in the banking system and excessive lending to risky country borrowers.
It recommended a shift from loans to grants for the poorest countries, since loans would in any case be impossible for these countries to repay. It recommended a shift to performance-based aid, under which aid would be granted only once agreed targets had been met.
Finally, it recommended that the IMF's lending operations be restricted strictly to its "lender of last resort" function, without the regular succession of large loans, not immediately repaid, that have accompanied past lending crises.
These recommendations have become conventional wisdom, at least in the U.S. Treasury, and might yet do much good. It is, however, a pity that the commission didn't tackle the underlying problem with the IMF and World Bank's activities, which is their status as public-sector monopolies, directly unaccountable and peddling nostrums that appeal more to the bureaucrats within their walls than to any proper banking concept of sound lending.
Finally, Meltzer was among the founders of public choice theory, the economics of decision-making in the public sector. At the AEI seminar, economist Scott Richard laid out the central thesis of the paper he had co-authored with Meltzer in 1981, "A Rational Theory of the Size of Government."
The paper demonstrated that, if voters choose economically, so that elections are determined by the economic interests of the median income voter, then on normal economic assumptions about incentives, the amount of government that voters will choose will increase with the mean income of the society (which gives more money to redistribute) and with the ratio of mean to median income, so that a more in-egalitarian society will generally choose a higher level of re-distributive taxation.
This is a very interesting finding, because it explains the poverty trap in the highly unequal societies of Latin America.
By the Meltzer-Richard theorem, these societies will democratically choose a very high level of taxation, hoping to produce a welfare state that will redistribute income towards the poorer sectors of the population.
However, this very heavy taxation will not only reduce the incentives of the wealthy, it will also raise their returns from tax evasion and keeping money abroad. This, apart from reducing the country's economic growth, will lower the actual level of taxation on the wealthy and raise their after-tax income thus, in spite of the heavily re-distributive tax system, increasing income inequality.
Thus, democratic countries with high levels of inequality will tend to be caught in a poverty trap.
Interestingly, this trap would -- in principle -- disappear in countries such as China and President Augusto Pinochet's Chile, in which there is no democracy. In an in-egalitarian society without democracy, the tax system is not forced to become more and more re-distributive, and so incentives for the elite to participate fully in the economy are retained.
Hence, in an unequal society, a dictatorship that decides to keep government small and taxes low is likely to produce faster economic growth (and, probably, less unequal income distribution) than a democracy. Thus China, if it remains undemocratic, might not (as I suggested last week) be condemned to fall into the Latin American trap, even though its inequality is high, provided that its government avoids the temptations of re-distributive taxation.
A further example where such a benefit might have occurred is Russia, where President Vladimir Putin, democratically elected but highly authoritarian, was able in 2000 to force through a 13 percent "flat tax" income tax that removed the redistribution from the Russian tax system and might have put Russia finally on the way to rapid economic growth. Time will tell.
The Nobel prize has been given to a number of U.S. economists, including several responsible for mathematical models that were based on false assumptions and therefore don't work. Meltzer, from the breadth of his interests and the substance of his contributions, would be a worthy candidate indeed for a future such honor.
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