by Calculated Risk on 4/08/2010 08:46:00 PM
Thursday, April 08, 2010
From Fed Chairman Ben Bernanke: Economic Policy: Lessons from History
I thought that I would speak to you about the parallels--and differences--between [the Great Depression] and the [great recession], particularly regarding the responses of policymakers. I draw four relevant lessons from the financial collapse of the 1930s ...CR Note: Bernanke goes on to argue the first "lesson has been learned". Maybe. I think financial stability means being proactive, not reactive. And I think NY Fed President William Dudley was on the right track when he discussed identifying bubbles, and the possible tools available to policymakers to pop bubbles early.
The first lesson--economic prosperity depends on financial stability--seems obvious, but this connection was not always well understood. After the stock market crash of 1929, many thought a financial and economic crisis was necessary--even desirable--to wring out speculative excesses that had built up in the 1920s. Remarkably, despite the fact that the Federal Reserve had been founded to mitigate financial panics, the central bank made essentially no effort to prevent the wave of bank failures that paralyzed the financial system at the start of 1930s. ...
Economists themselves have not always fully appreciated the importance of a healthy financial system for economic growth or the role of financial conditions in short-term economic dynamics. ... In contrast, more recent work on the subject, to which I contributed, showed that the health of the financial system and the performance of the broader economy are closely interrelated, both in the short run and in the long run.
[T]he second [lesson]--policymakers must respond forcefully, creatively, and decisively to severe financial crises. Early in the Depression, policymakers' responses ran the gamut from passivity to timidity. They were insufficiently willing to challenge the orthodoxies of their day--such as the liquidationist doctrine of Mellon and others, or the rigid adherence to the variant of the gold standard adopted after World War I. ...CR: Bernanke deserves praise for his creative and aggressive response - once he finally understood what was happening.
In the Depression, effective policy responses came only after three to four years of financial crisis and economic contraction. In our own time, policymakers acted sooner and with greater force than in the 1930s. For example, in October 2008, just weeks after the sharp intensification of the crisis, the Congress authorized the Troubled Asset Relief Program (TARP) to support stabilization of the financial system. It was far from perfect legislation, but it was essential for preventing an imminent financial collapse. For its part, the Federal Open Market Committee, the monetary policymaking arm of the Federal Reserve, sharply and proactively cut its target for short-term interest rates from the fall of 2007 through 2008. After the target could go no lower, the Committee embarked on an unprecedented (for the United States) program of long-term securities purchases, recently completed, to support private credit markets, including the mortgage market.
[T]he third lesson: International crises require an international response. ... In the recent episode, policymakers, bankers, and business people recognized that the world's economies and financial systems would sink or swim together.Excuse my snark, but it is refreshing to hear Bernanke speaks about monetary policy issues.
I'll conclude with the cautionary fourth lesson--history is never a perfect guide. ... [O]ur traditional tools, developed in an earlier era, were of little use in addressing panic in the shadow banking system or in the money market mutual fund industry. So, we engaged in what I call "blue sky thinking"--generating many ideas. Most were discarded, but, crucially, some led to the development of new ways for the Federal Reserve to fulfill the traditional stabilization function of central banks. Using emergency authority last employed during the Depression, we created an array of new facilities to provide backstop liquidity to the financial system (and, as a byproduct, coined many new acronyms). Thus, we were able to help restore the flow of credit to American families and businesses by shoring up important financial markets, such as those for commercial paper and securities backed by consumer loans.
Posted by Calculated Risk on 4/08/2010 08:46:00 PM