Now I’m really angry. Maybe it comes from studying the Great Depression, and reading all those smug Wall Street types from the 1930s who heaped scorn on the “academic scribblers” who thought deflation was caused by tight money. The people who thought monetary policy was all about interest rates and credit channels and lending. As if Zimbabwe wouldn’t have been able to create hyperinflation without a smoothly functioning credit system. Of course when FDR won he ignored Wall Street and turned to an economist named George Warren, who convinced him that monetary policy wasn’t about banks, it was about determining a path for the price level, for the value of money. Something our modern Fed has resolutely refused to do, despite a widespread consensus among the world’s best economists (including Bernanke) that we need to set an explicit target, and try to hit that target.
A lot of people, including me, have been critical of Ben Bernanke. But when you listen to some of the other members of the FOMC, he sounds positively brilliant by comparison. I already talked about Janet Yellen claiming that monetary policy is ineffective once rates hit zero, despite all sorts of “foolproof” strategies for escaping liquidity traps that have been devised by some of the world’s greatest monetary economists. And now we have the head of the Dallas Fed claiming that monetary policy is ineffective if the “too big to fail” banks get into trouble. Thank God FDR didn’t listen to that sort of advice, or a socialist might have been elected in 1936.
The more I see of the other members of the FOMC, the more I wonder if Bernanke could have done a better job even if he had wanted to. I don’t think he is the most forceful leader; rather he seems more like a typical academic. In that case we really needed to surround him with 11 other people who were equally brilliant. People like Mishkin, Mankiw, Hamilton, McCallum, Hall, Svensson, Woodford, and yes, even PAUL KRUGMAN. Who did, after all, suggest that the Fed needed an explicit inflation target, in the few times he bothered to address the most important issue of the decade—monetary policy.
You might wonder why I mentioned Hamilton. Didn’t this distinguished economist tell the world that my Cato essay was nonsense? Actually, compared to the rest of the profession we are almost Siamese twins. Unlike 90% of the profession we both agree that the Fed should have and could have adopted a more expansionary policy last September. The main difference is that I think if they had targeted one or two year forward NGDP at 5% growth, near term NGDP would have held up relatively well in the 4th quarter of 2008. Hamilton is more pessimistic. But in his blog he was also frustrated with the Fed last year.
Because Dallas Fed President Fisher lectured us all about how it wasn’t the Fed’s fault, those too big to fail banks were to blame, I thought it might be interesting to take a look at whether he was one of the good guys or the bad guys last year. Was he helping or hurting Bernanke’s efforts to unite the board around a slightly more expansionary policy? I say this because there were a lot of press reports that there was grumbling within the Fed about Bernanke’s unconventional (and of course ultimately ineffective) policies of injecting interest bearing reserves into the banking system. So let’s go back to the FOMC vote on August 5, 2008. You may recall that August was the month when industrial production started plummeting. In other words the month when an exceedingly mild recession associated with what Arnold Kling correctly calls the “Great Recalculation” turned into a garden variety severe recession, such as occurs any time NGDP falls sharply. Here is the Fed’s decision to keep rates at 2%:
Votes for this action: Messrs. Bernanke and Geithner, Ms. Duke, Messrs. Kohn, Kroszner, and Mishkin, Ms. Pianalto, Messrs. Plosser, Stern, and Warsh.
Votes against this action: Mr. Fisher.
Mr. Fisher dissented because he favored an increase in the target federal funds rate to help restrain inflation and inflation expectations, which were at risk of drifting higher. While the financial system remained fragile and economic growth was sluggish and could weaken further, he saw a greater risk to the economy from upward pressures on inflation. In his view, businesses had become more inclined to raise prices to pass on the higher costs of imported goods and higher energy costs, the latter of which were well above their levels of late 2007. Accordingly, he supported a policy tightening at this meeting. (Italics added.)
It was agreed that the next meeting of the Committee would be held on Tuesday, September 16, 2008.
By my reckoning that makes Mr. Fisher the person most responsible for the Fed’s disastrously contractionary policy of last year, which reduced NGDP at the fastest rate since 1938, and, along with the ECB and BOJ, drove the world into a deep recession. Not only did this policy cost millions of jobs in this country, but tens of millions in developing countries where people have absolutely no safety net.
I’m as much of an inflation hawk as the next guy, but the markets were far more worried about recession than inflation last August. And in September, when Mr. Fisher refused to recommend any easing, the markets were actually concerned that both inflation and output would come in far below Fed targets. I remember the 1970s too. But weren’t T-bill yields in the late 1970s around 15%, not around 1%? Where is this inflation that right-wingers keep saying is just around the corner? And worst of all, he doesn’t seem to realize that if the banking system really was that crucial, perhaps the Fed shouldn’t have been be flirting with a liquidity trap, as we all saw what happened to Japanese banks when prices started falling.
Some people might ask whether I am being too hard on Mr. Fisher. I don’t doubt he is a great guy who made the best decision he could. [You're probably saying "Too late to equivocate Sumner, you've already blown any chance at a job at the Dallas Fed."] I suppose we have to look at the system. For instance, let’s suppose these errors were in good faith. There wasn’t enough evidence in August to ease. There wasn’t enough evidence in September to ease. And in October, suddenly it was too late to ease? Suddenly the economy was so far gone that only fiscal policy could save us? How does something like that happen? I thought the economy was like a big ocean liner that changed course slowly. I really don’t believe this excuse. But let’s say it’s true for the sake of argument. One meeting no easing is necessay, the next meeting it’s too late to ease. If true, shouldn’t the FOMC be meeting, like, every %$&#@&% day?