1. The market monetarist view that tight money caused the recession is getting some play in the press. Here’s an excellent piece by Ramesh Ponnuru:
There’s another view of the Fed’s role in the crisis, though, that has been voiced by economists such as Scott Sumner of Bentley University, David Beckworth of Western Kentucky University and Robert Hetzel of the Richmond Fed. They dissent from the prevailing view that the Fed has been extremely loose since the crisis hit. Instead, they argue that the Fed has actually been extremely tight, and that when its performance during the crisis is measured against the proper yardstick, the central bank emerges as the chief villain of the story.
In the second half of 2008, housing prices, many commodity prices, inflation expectations and stocks all suggested deflation was coming. Fed officials, though, kept talking about backward-looking measures of inflation that made it look high. Their hawkish pronouncements effectively tightened monetary policy by shaping market expectations about its future direction. In August 2008, the Fed minutes explicitly said to expect tighter money. Even after Lehman Brothers Holdings Inc. collapsed the following month, the Fed refused to cut rates and fretted about inflation (which didn’t arrive). A few weeks later, the Fed decided to pay banks interest on excess reserves, a contractionary move. Only then did it cut interest rates.
2. A few comments on the unit root debate in the earlier comment section. I probably erred by leaving the impression I was a big “unit root” fan. I just thought it was interesting to update the proposed bet now that 5 years has passed. I do think there are interesting studies that suggest something close to a unit root, but also think there are stories that are consistent with demand shocks still having a transitory effect on output. But give the unit root people kudos on one point. It seems to me that the theory has done better “out of sample” than in sample, which is pretty rare in macro. (The fact that it’s rare suggests a whole lotta data mining is going on.)
This claim is non-scientific, but look at this times series of RGDP growth. The 1950s sure look like trend reversion to me. What would a unit root look like? Perhaps a recession would be followed by slower growth than in the preceding cycle, and hence no recovery to trend. This seems to be roughly true of the last several recessions, doesn’t it? That’s out of sample success.
3. In the discussion of Ben Bernanke’s performance a lot of people thought I was too kind, as I expected. Perhaps the following analogy I left in the comment section helps. BTW, this is why I believe that history as a field is fundamentally “wrong,” even though I have enormous respect for the field of history:
Suppose someone else had been elected in 1928 (not Hoover). Say Coolidge. And suppose that because of the policy differences from this counterfactual president the Great Contraction of 1929-33 was only 2/3rds as bad. That person would have been a GREAT president. And yet ALL historians would have said he was horrible. That’s what people miss.
Why do I have great respect for history? Because historians still come up with great insights under very difficult circumstances. Learning lessons from history is incredibly hard. Quite a few alternative monetary policies in the interwar period, either much more liberal (Keynesian/monetarist) or much more conservative (Austrian), would have been better than what actually happened, and yet would probably be viewed by historians as a failure. They never would have known that the monetary policy in the universe we happen to live in was an unusually bad draw. But the circumstances of the interwar period were so bad that most draws were on the bad side. Just as most possible post-1933 governments in Germany would have been bad, but again this universe happened to end up with an unusually bad draw. I think historians understand this problem, but in the end it is still too much to overcome in many situations.
[On the other hand the post-WWII draw was very good—no nuclear war (knock on wood.)]
4. Here’s an interesting video by Dan Klein showing where the word liberal came from. Adam Smith plays a role.
Update: This Marcus Nunes post relates to the unit root issue.