Pethokoukis

In a new paper, Fed again declines to admit its role in the Great Recession

Image Credit: Medill DC (Flickr) (CC BY 2.0)

Image Credit: Medill DC (Flickr) (CC BY 2.0)

The St. Louis Fed has released a historical analysis of the Federal Reserve’s responses to financial crises. I find the whole thing interesting, but also a little irksome. The paper points out that “no banking panics occurred during the Fed’s first fifteen years, 1914-29, which suggested that the Fed had accomplished the founder’s objectives.”

Well, that’s good. But then came the unpleasantness known as the Great Depression. Don’t blame Wall Street or speculation or markets, blame the Fed:

The Federal Reserve Act did not provide an automatic, fool-proof mechanism for dealing with crises, as the founders had hoped. Instead, the Fed responded timidly to the banking panics and failures during 1930-33, as well as to large declines in the price level and output, and clearly failed to serve effectively as lender of last resort.

Well, I prefer Ben Bernanke’s more straightforward admission of guilt. As Bernanke said at a University of Chicago conference honoring Milton Friedman on his 90th birthday, “I would like to say to Milton and [collaborator Anna Schwartz]: Regarding the Great Depression, you’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

But then the paper gets to the Great Recession and Financial Crisis:

At the onset of the crisis, the Federal Reserve responded to the rising strains in interbank funding markets with only minor modifications of its traditional tools for providing liquidity to financial markets. Monetary policy was eased swiftly, beginning in September 2007 with a reduction in the target federal funds rate of 50 basis points from 5.25 percent to 4.75 percent.
As the crisis deepened and the condition of interbank markets deteriorated further, the Federal Reserve established other programs to facilitate access by banks to central bank credit. The terms on the main discount window related program, the primary credit facility, were also progressively eased as the crisis deepened. The penalty on discount window loans, normally 100 basis points over the federal funds target rate, was cut to 25 basis points. Further, the maximum maturity of discount window loans was extended from overnight to 90 days and could be renewed at the discretion of the borrower.

Stop the tape. The St. Louis Fed paper misses something. Like the Fed’s 2008 blunders. As Atlanta Fed economist Robert Hetzel has noted, not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%.”

Just as with the Great Depression, the Fed blew it with the Great Recession and that needs to be acknowledged.

8 thoughts on “In a new paper, Fed again declines to admit its role in the Great Recession

  1. Well, I prefer Ben Bernanke’s more straightforward admission of guilt. As Bernanke said at a University of Chicago conference honoring Milton Friedman on his 90th birthday, “I would like to say to Milton and [collaborator Anna Schwartz]: Regarding the Great Depression, you’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

    Nonsense. The problem was created by loose money policies in the second half of the 1920s, not the failure to continue those policies. When it comes to the Great Depression it is not Friedman or Bernanke who got it right but Rothbard.

  2. Stop the tape. The St. Louis Fed paper misses something. Like the Fed’s 2008 blunders. As Atlanta Fed economist Robert Hetzel has noted, not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members. In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%.”

    The bubble was not caused in 2007 or 2008 but in the previous two decades of monetary expansion. When posting about economic issues we should stick with the known facts, not Keynesian or neo-Keynesian mythology.

  3. The problem wasn’t that the Fed kept rates higher than you think they should have been. The problem was the panic in the financial markets, with lenders not wanting to lend (at any rate). And the trouble wasn’t going to go away until lenders became more comfortable that their borrowers/trading partners weren’t going to go out of business.

    • The problem wasn’t that the Fed kept rates higher than you think they should have been. The problem was the panic in the financial markets, with lenders not wanting to lend (at any rate). And the trouble wasn’t going to go away until lenders became more comfortable that their borrowers/trading partners weren’t going to go out of business.

      The problem is the Fed’s manipulation of interest rates in the first place. It created a massive bubble by creating money and credit and stuffing it into the financial system in the first place. Its actions after the bubble burst were not material because the distortions in the markets were already in place. This is where Milton and Ben failed when they looked at the Great Depression. They ignored the fact that the Fed created a massive bubble in equities and only were concerned about what happened when the bubble popped.

      • More than the Fed’s setting of interest rates, I believe the bigger issue was granting credit to people (and companies) who never should have been allowed to borrow money – at any interest rate. Take away this lending and we have no huge bubble.

        The second big culprit was the almost total lack of transparency in the credit markets, resulting in lenders being unable to determine who was exposed to what. This is what led to the rush for the exits at the first rumor of trouble in a firm. But for this, there would have been a contraction in lending but not the almost total shut down.

        • More than the Fed’s setting of interest rates, I believe the bigger issue was granting credit to people (and companies) who never should have been allowed to borrow money – at any interest rate. Take away this lending and we have no huge bubble.

          When the Fed floods the system with liquidity and rates go down you can be sure that credit will go to people and projects that should have been rejected. That does not happen as much or goes on for long in a free market, which is the best argument for taking away the Fed’s monopoly on money creation.

        • The second big culprit was the almost total lack of transparency in the credit markets, resulting in lenders being unable to determine who was exposed to what. This is what led to the rush for the exits at the first rumor of trouble in a firm. But for this, there would have been a contraction in lending but not the almost total shut down.

          I disagree somewhat. With a fractional reserve, fiat money based system the end is inevitable. The financial system is too leveraged to survive a downturn and will always need a bailout. And those bailouts can continue for as long as the currency holds up. Since the purchasing power of all fiat currencies declines to its intrinsic value that cannot keep continuing forever. Which is why you should load up on gold, silver and shares of producers of gold and silver.

  4. I’m just shocked…..

    You mean Ben and his corrupt pals at Goldman Sachs and numerous Wall Street investment firms, European Banks, UN, China and last but not least, the World Monetary Fund, would be honest about the re distributionist policys that rape middle class America?

    Once again, I’m dumbfounded by their

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