Merle is Merlon's son and Merluvlee's, Merlow's, and Merlee's father. He lives in Starborn Valley and, along with the Ninjis and certain Toads, watches over the Star Kids until they are old enough to enter Star Haven. However, during the events of Paper Mario, Star Kids could not ascend because of the trouble Bowser caused in Star Haven. Merle provides Mario and his comrades the Scarf, one of the keys to unlock the door to Shiver Mountain, helping Mario and company in their quest to vanquish Bowser and his minions. The aforementioned quote is a riddle Merle recalled which was imperative to Mario finding Madam Merlar.
He's Merle, the person who controls this valley. He's the one who called you. He's the son of Merlon. That means...Merle must be the father of the fortune-tellers Merluvlee and Merlow.
"Merle" is an actual word with several varying meanings, though Merle's name would appear to have been derived from a simple corruption of either "Merlon" or "Merlin".