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Ben
Bernanke is a self-described Great Depression buff,
which is a good prerequisite for his current line of
work as chairman of the Federal Reserve.
Whether
the Fed was primarily responsible for the severe and
sustained economic contraction of the 1930s, as asserted
by economists Milton Friedman and Anna Schwartz, or just
bears partial responsibility, is still a subject of
lively debate among economic historians almost 80 years
after the fact.
Bernanke,
for one, wasn’t satisfied that the Friedman-Schwartz
analysis—with causation running from a contraction in
the money supply to falling prices and output—completely
explained “the financial sector-aggregate output
connection,” as he wrote in a 1983 paper for the
National Bureau of Economic Research (“Nonmonetary
Effects of the Financial Crisis in the Propagation of
the Great Depression”).
Instead,
he theorized that “the financial crisis of 1930-33
affected the macroeconomy by reducing the quality of
certain financial services, primarily credit
intermediation.”
Translation: Many commercial banks, considered efficient
at allocating credit (they have a knack for
differentiating “good” from “bad” credits), failed. The
ones that remained solvent wanted to hold liquid assets
or, if they were willing to make loans, charged a higher
rate of interest.
Then and
now
“It was
reported that the extraordinary rate of default on
residential mortgages forced banks and life insurance
companies to ‘practically stop making mortgage loans,
except for renewals,’” Bernanke said, citing the work of
the late economist A.G. Hart.
Sound
familiar? The rate of default isn’t extraordinary just
yet, but the mortgage market is contracting in leaps and
bounds, starting with originations and ending with
securitizations. The tentacles of the home-loan market
are starting to strangle portions of the debt, equity
and even the normally staid money market.
Bernanke
is fully sensitized to the collateral damage damaged
collateral can cause. Over and over in speeches during
his stint as Fed governor from 2002 to 2005, he returned
to the subject of the Great Depression, detailing where
the Fed went wrong and what the Fed could have done to
ameliorate the problems of the banks (provide liquidity
or lower interest rates).
Back to
the future?
“He is
certainly attuned to how financial problems can spill
over and affect the real economy,” said Mark Gertler, a
professor of economics at New York University, a
frequent collaborator and personal friend of Bernanke’s.
So far,
Bernanke is “making sure funds flow smoothly,” he said.
“He’s standing ready to adjust the funds rate if the
stress is spilling over to the economy.”
The New
York Fed’s Open Market Desk injected a total of $62
billion on August 9 and 10 to address the spike in the
overnight federal funds rate as interbank lending dried
up. The effective funds rate has been below the 5.25
percent target since Friday.
That’s
created a considerable amount of chatter in the
markets—and some serious “analysis” from those who
should know better—that the Fed was effecting a stealth
ease.
Nonsense. Where have these folks been since Bernanke
assumed the Fed chairmanship in February 2006? If
Bernanke stands for anything, it’s for greater openness
and transparency. He wants to lift the veil even more,
not lower the shroud and return to the pre-1994 method
of communicating via smoke signals.
Historical precedent
Besides,
if the Fed thinks lower short-term rates are in order
for whatever reason—to calm financial markets, to send a
message, to ease the liquidity squeeze—it will not keep
its intentions secret.
The Fed
demonstrated as much today, unexpectedly lowering its
discount rate by 50 basis points to 5.75 percent and
issuing a statement highlighting the risks to economic
growth from tighter credit conditions. The central bank
also extended the term for which depository institutions
can borrow from the Fed to 30 days.
Some
economists who have studied the Great Depression
challenge Bernanke’s premise that the credit squeeze
played a role separate and distinct from that of money.
Mea
culpa
“It’s a
plausible story but it’s empirically hard to find a
separate effect outside the monetary angle,” said Allan
Meltzer, professor of political economy at Carnegie
Mellon University in Pittsburgh, who is completing the
second of a two-volume history of the Fed.
“The
monetary side brought the credit side down,” as money
and credit are offsetting entries on the bank balance
sheet.
You
don’t need to buy Bernanke’s analysis of the 1930s,
published 25 years ago, to find clues to his conduct of
monetary policy today.
“The
relevance of Bernanke’s work to today is that it helps
him tread the fine line of allowing individual
investors—and firms, if necessary—to fail while avoiding
credit-market gridlock,” said Joe Mason, professor of
finance at Drexel University in Philadelphia. “The
message from the recent interventions is that there is
no gridlock.”
The
message of the markets is increasingly a challenge to
that optimism.
It is
perhaps fitting that Bernanke used the occasion of
Milton Friedman’s 90th birthday to assume institutional
responsibility for the Great Depression. He said: “I
would like to say to Milton and Anna: Regarding the
Great Depression. You’re right, we did it. We’re very
sorry. But thanks to you, we won’t do it again.”
He meant
it. He won’t. |
