Economics, Monetary Policy, Pethokoukis

Monetary policy paradox: If the Fed could time travel, could it have prevented itself from being created?

Credit: San Francisco Fed

Credit: San Francisco Fed

The San Francisco Fed:

The Federal Reserve was created 100 years ago in response to the harsh recession associated with the Panic of 1907. Comparing that recession with the Great Recession of 2007–09 suggests the Fed can mitigate downturns to some extent. A statistical analysis suggests that if a central bank had lowered interest rates during the 1907 panic the same way the Fed did during the 2008 financial crisis, gross domestic product would have contracted two percentage points less than it actually did.

And if the 1907 Panic would have been less severe, maybe there would have been no Fed created — at least not in 1913. And if no Fed, then would the Great Depression — or Great Contraction, as monetarists often describe it — have been merely a Great Recession, if that? As Ben Bernanke admitted to Milton Friedman: “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”

And if no Great Depression, then no New Deal? That’s the conclusion of Lawrence Stratton and Paul Craig Roberts in a 2001 Hoover Institution essay: “The great depression and its offspring, the New Deal, could both have been avoided if the Federal Reserve had performed the task assigned to it. … The Great Depression occurred because the Federal Reserve missed every opportunity to take active measures to ease the internal drain on bank reserves.”

The Great Depression shattered public faith in free markets, increased faith in big government. Indeed, market monetarists have made a similar point, arguing that big economic downturns frequently get blamed on free-market failure with government fiscal stimulus riding to the supposed rescue. Then again, conservative amnesia about the role of monetary policy in dealing with economic shocks has left the field to the Keynesian spenders. If Ben Bernanke really did have a time machine and could use it only once, maybe bringing Friedman to 2013 would be its best use.

6 thoughts on “Monetary policy paradox: If the Fed could time travel, could it have prevented itself from being created?

  1. Good heavens man. Learn some history. JP Morgan quickly sorted out the survivors and casualties of the Panic of 1907, brokered antitrust immunity for US Steel to rescue a major player and had things in hand in 90 days. Congress went to work on the Federal Reserve in part because they realized that Morgan at age 70 likely wouldn’t be around next time.

    The Panics of 1819, 1837, 1857, 1873 and 1893 were deeper for the most part. The Panic of ’73 became known as the Long Depression — 65 months of contraction. ’93 is considered the second deepest after the Great Recession. Each steered history. ’19, ’37 and ’57 hardened the rift between the agrarian South and the industrializing — and Panic prone — North. ’73 created a populist movement; ’93, the progressive movement.
    Taken together, they suggest that a Fedless economy would a series of disasters. For one, without the Fed supporting mortgage finance in ’08, abandoned McMansions would be as prevalent as abandoned Victorians were in ’93.

    • Yes, we should be happy that losses are socialized and profits privatized. I told my wife that if I had known at 21 what I know now, I would have been a banker. If I make a big mistake in my job, I am at risk for losing it. Bankers get a bonus for criminal conduct.

      • Yep, life isn’t fair.The FDIC under Seidman, determined to repeal too-big-to-fail, took down nine of 10 bank holding companies based in Texas in the late 1980s. El Paso was about as far as you could get from the real estate and oil bubbles in Dallas and Houston. So, naturally, loans there were the first to be called because there was a fair chance El Paso businesses could scrape together enough cash to repay the FDIC. Massachusetts was next, and a sadder but wiser Seidman had added a corrollary– too many to fail.

        Bubbles are the key ingredients in financial crises, and I must admit I can recall only one case of the Fed (under Volcker) squelching speculation. But it is naive, if not downright silly, to imagine that banks could maintain reserves necessary to cover imploding cotton prices/ railroad stocks/oil syndications/silver/real estate …. or that liquidation of an entire class of collateralized assets as in Texas could be done without deepening the misery exponentially.

        • The creature from Jekyll island was created not to create a thriving US economy, but to control the US economy. For god’s sake, man, learn some history. Why are you defending these monstrous organizations, they are like religions, so many people buy into their ideologies.

          • I look at history and say the economy needs controlling, and I am pretty confident that is the majority view. For most of the 19th century, the US had no central bank, a hard currency and abundant and compliant labor. Depressions came along every 20 years.

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