lecture on economic policy

I attended Professor Meltzer’s lecture entitled “Lessons about economic policy from history.” Professor Meltzer has been a professor at Carnegie Mellon University for 53 years and his lecture was about the three volumes that he had written about the Federal Reserve and its role over the last 100 years.

The first part of the lecture was about why the Federal Reserve started. Previously, there had been no argument among the political parties in power that a central bank should exist but the real question was who would run it? The Federal Reserve (or Fed) was founded in 1917 by an act of Congress to act as an independent entity. However it wasn’t until 1935, when the regulations on the Fed were revised, that the bank was created as we know it today and then it wasn’t till 1951 that it made its presence known on a large scale. Initially, the agreement was that the Fed was free to raise interest rates and help finance government debt; however, it was not its job to advise Congress on any policies. This plan worked until President Johnson ran up the debt with his Great Society. Once the inflation that resulted from all the programs from the Great Society began, it became hard to stop it. Soon the major goal of the Fed became to keep high stability and high employment, which can’t really be done since with high employment comes high inflation. The public assumed that price instability was the only way to keep employment. As the government spent more money to help keep employment high, the Fed financed the debt by increasing its share of government securities. The debt became mainly financed by Japan and currently China. President Reagan had once said that “Deficits don’t matter” and professor Meltzer finished that phrase with “…as long as foreigners finance them.”

The second part of the lecture was about inflation. President Johnson didn’t care about inflation and President Nixon increased interest rates which was unusual for a nation during peacetime. For Nixon, the most important thing was to prevent unemployment. He blamed losing the 1960 election on the fact that there had been a recession during that time that had been orchestrated by the Fed (President Eisenhower was a firm believer in fiscal responsibility). During Nixon’s second election, he told Chairman Burns (who was also a personal friend of his) to “inflate” the economy to ensure that Nixon won. And then when President Cather came into office he also wanted inflation even though he had never before shown an inclination towards it. This change of heart was because the public had come to believe that inflation was the soundest economic policy. When this policy wasn’t enforced by the Chairman of the Fed (the bank is independent so the President has no power over it), some Democratic senators told Carter that he was following a “Republican” policy of unemployment and high interest rates. Thus Carter asked for credit controls, which he was allowed to do under the regulations. There was an immediate 10% interest rate decrease and it was the largest GDP decrease ever. Professor Meltzer claims that deflation hasn’t deterred growth and didn’t do any real harm, except for the deflation that was seen in the Great Depression.

Professor Meltzer then went on to state reasons why he feels why the current economic crisis occurred. In 1937, Fannie Mae was formed. Its main purpose was to buy and sell mortgagees to make them seem more like commodities and more debt. However, President Clinton wanted more low income people to own homes so he passed laws stating that people didn’t need a credit history or didn’t need to make a down payment in order to buy a house. So these people didn’t really have any assets other than their house. And the other point was about the phrase” too big to fail.” This term didn’t come into existence until the 1970’s when a large bank was about the fail and the government bailed it out stating that its collapse would cause too many negative ripples in the economy. After this, the world came to the agreement that banks had to hold more capital to cover losses. To bypass this, banks took the bad debt off the books and placed it into separate companies it hide it. Also, there isn’t an incentive for banks to play safe when Congress had a fund to bail banks out.

The current government is running high deficits. At this rate, by 2019 90% of this nation’s GDP will be deficit-paid.