Why does Geithner think money was tight during the 1930s?

Matt Yglesias has moved, which creates a dilemma.  Do I keep reading the old link at Slate, and then end up reading all the other fascinating/appalling non-Moneybox articles written by the kids over there, or do I follow him to his new link?  I don’t have time for both.  Here Yglesias quotes from Tim Geithner’s book Stress Test:

Loose monetary policy can have limited power in a crisis, because low interest rates don’t help that much when borrowers don’t want to borrow and lenders don’t want to lend, but as the central bankers of the 1930s demonstrated, tight monetary policy can be disastrous.

That last claim caught my attention.  I wondered why Geithner thought money was tight during the 1930s. I presume he’s mostly referring to the Great Contraction, from roughly August 1929 to March 1933. Here are some things the Fed did during the Great Contraction:

1.  Short term interest rates were cut quickly and sharply, from about 6.5% to just above zero.

2.  When rates got low the Fed did more and more QE, raising the monetary base through open market purchases of securities.

3.  There was also the Reconstruction Finance Corporation, aimed at helping to support the banking system.

I know what you are thinking; “Sumner, haven’t you claimed those indicators are misleading, and that money has been tight since 2008 despite all the QE and rate cuts?”  Yes, that’s what I’ve been saying.  And yes, I believe Geithner is right in claiming that money was tight during the 1930s.

But here’s what I can’t understand, why does Geithner think money was tight during the 1930s? I’m pretty sure he’s not a market monetarist, based on his other expressed opinions.  I suppose he might cite the Friedman and Schwartz data on M2, but does anyone seriously think he uses M2 as an indicator of the stance of monetary policy?  Didn’t the Fed stop publishing M3 (its modern equivalent) because almost no one even cared?

So once again, what are these “lessons” that the Fed learned from the Great Depression?  Why does Geithner think monetary policy was tight in the 1930s but easy since 2008?  How does he determine the stance of monetary policy?

I also noticed some other good Yglesias posts.  This one on taxes is excellent.  There’s also a very good post on capital, but I’m going to quibble a bit with his conclusion:

But there are some things mainstream economics doesn’t seem to explain very well.

For example, on the neoclassical theory poor countries that successfully get rich should do so by liberalizing their financial systems, running trade deficits, and importing foreign money until over time they build up enough capital for the marginal productivity of labor to increase. In practice, successful catchup stories (first in Japan, then in Singapore and Taiwan and Korea, now in China) work the other way around — countries use financial repression and run trade surpluses to develop increasingly sophisticated local businesses.

During Korea’s high growth phase they ran fairly consistent current account deficits.  Between 1960 and 1985 I am pretty sure they ran deficits every single year, averaging close to 8% of GDP. That was because domestic investment was far higher than domestic saving.  Then they moved into surplus in the late 1980s, before moving back into deficits in the 1990-97 period.  I think people have a tendency to assume that because Korea has recently run surpluses, it has always done so.  It did things the correct way, borrowing when it was poor to build up its capital stock.

Why quibble over a single country?  Because some people (not Matt) make sweeping conclusions based on a single characteristic of a successful country.  I suppose I’ve been guilty at times.  One thing Korea did do, for instance, is infant-industry policies.  But Hong Kong was just as successful without those policies, and AFAIK, they have not played a particularly important role in a few of the other cases (these things are actually hard to measure, for instance import tariffs and export subsidies offset each other.  If the two policies are done across the board they net out to nothing.)

I don’t know what explains all of the East Asian growth miracles, but I’m skeptical of factors that show up in only some of the countries.  Those factors might have helped, but I doubt they were decisive, especially if others did just as well without those policies.  Perhaps the closest thing to a generalization one can make is “export-oriented.”  But how did they do that?

PS.  In a recent post I quoted Paul Krugman claiming that he couldn’t think of important intellectuals on the other side changing their mind after the worries of high inflation didn’t pan out. Later a bunch of people sent me one quote after another of Krugman praising policy hawks like Kocherlakota and Arthur Laffer for having the guts to admit they were wrong and change their mind.  One commenter prefaced his comment with, “In Krugman’s defense.”  That made me smile. Please, I beg of you, don’t ever “defend” me that way.

On the other hand, Krugman has very good posts bashing the ECB here and here.


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29 Responses to “Why does Geithner think money was tight during the 1930s?”

  1. Gravatar of TravisV TravisV
    13. May 2014 at 12:16

    One possibility: Geithner includes bank bailouts / failures when evaluating the stance of monetary policy.

    In the 1930′s, the government allowed the Bank of the U.S. and other major banks to fail.

    In contrast, we bailed out the biggest banks this time around and kept them functioning. That effectively means monetary policy was “easier” than in the 1930′s.

    Note: I STRONGLY disagree with that view. I think the Fed should have been far more aggressive with “unconventional” monetary policy. That would have been much more helpful than the bank bailouts.

    P.S.: Jeffrey Hummel wrote a brilliant essay on this topic that I leaned a lot from:

    http://macromarketmusings.blogspot.com/2014/04/bernanke-vs-friedman-financial.html

    However, Hummel’s paper has some flaws. See Glasner’s review of it here:

    http://uneasymoney.com/2011/07/28/central-banking-is-not-central-planning

  2. Gravatar of Major_Freedom Major_Freedom
    13. May 2014 at 15:05

    “I suppose he might cite the Friedman and Schwartz data on M2, but does anyone seriously think he uses M2 as an indicator of the stance of monetary policy?”

    It is reasonable to assume that yes, money supply, or perhaps the quantity of credit or rate of credit expansion, is what Geithner had in mind. That is what orthodox monetarists like Friedman (and Bernanke) have in mind.

    “Didn’t the Fed stop publishing M3 (its modern equivalent) because almost no one even cared?”

    No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are.

    The growth rate in aggregate money supply turned steeply negative post-2008 by the way. It also did so during the early 1930s. Contrary to the claim that money supply doesn’t explain very what is going on with profitability and employment, that it is not as reliable as NGDP, it is actually MORE reliable, because it explains why the stock market boomed during the 1920s and 2000s, and it is the boom that causes the bust!

  3. Gravatar of benjamin cole benjamin cole
    13. May 2014 at 15:36

    Excellent blogging. There is an indelible impression the Fed has been expansive since 2008—despite the fact that we have had deflation in unit labor costs since then.
    So, five years of reckless and dangerous Fed expansionism has led to falling labor costs…btw I think Krugman is one step away from joining Market Monetarism…he just likes fiscal stimulus too…I say try honey with Krugman…the other problem is that Krugman correctly describes mosr macroeconomics as class warfare in drag and he does not want to be on the wrong side of that equation…

  4. Gravatar of Major_Freedom Major_Freedom
    13. May 2014 at 16:49

    Benjamin:

    “There is an indelible impression the Fed has been expansive since 2008—despite the fact that we have had deflation in unit labor costs since then.”

    It does not follow from a fall in wage rates that thete is tight money.

  5. Gravatar of John Becker John Becker
    13. May 2014 at 18:04

    It’s not about what poor countries “should do” as though they were a single entity and not a collection of different people with different goals and dreams. For a poor country to get rich, they should create and enforce private property rights and simply let the chips fall where they may. Whether they have a current account deficit or surplus doesn’t really matter.

  6. Gravatar of Philo Philo
    13. May 2014 at 18:56

    Probably Geithner is simply deferring to authority. Milton Friedman said money was tight in the early 30s, and Milton Friedman was an authority. On the other hand, Geithner probably hasn’t heard *anyone* say money has been tight over the last six years. (Scott Sumner? Who is he?)

  7. Gravatar of jimmy james jimmy james
    13. May 2014 at 20:22

    But here’s what I can’t understand, why does Geithner think money was tight during the 1930s?

    He’s probably looking at real interest rates during that time–by failing to stop deflation the actual cost of money was egregiously dear.

    See, e.g., Fisher’s 1933 Debt-Deflation paper.

  8. Gravatar of benjamin cole benjamin cole
    14. May 2014 at 00:46

    Major Freedom:
    Maybe not in theory, but in the real world…

  9. Gravatar of Saturos Saturos
    14. May 2014 at 03:23

    Do hard money-demand microfoundations make economists prefer interest-rate explanations?
    http://orderstatistic.wordpress.com/2014/04/14/are-the-micro-foundations-of-money-demand-important/

  10. Gravatar of ssumner ssumner
    14. May 2014 at 05:07

    Travis, OK, but does that mean that money is not tight when banks don’t fail? And what about Lehman? Was that a tight money policy? If so, then didn’t we repeat the mistakes of the 1930s?

    Philo, Perhaps. Unfortunately there is no authority any more, as Friedman is dead and no one seems to know what “tight money” even means today.

    Jimmy, Real interest rates on 5 year TIPS soared from 0.57% in July 2008 to 4.2% at the beginning of December 2008. Does he think the Fed enacted a really tight money policy in late 2008? If so he’d be correct, but I just wonder if that’s what he believes.

  11. Gravatar of ssumner ssumner
    14. May 2014 at 05:16

    Saturos, I doubt that, it’s not hard to understand why people hold money. Economists themselves hold money, and I’m pretty sure they know why they hold money. I do.

    I think they (wrongly) believe that interest rates are the transmission mechanism between money and AD.

  12. Gravatar of Peter K. Peter K.
    14. May 2014 at 06:33

    Republican economists and policymakers were regularly writing Bernanke asking him to stop. Kocherlakota and Laffer are the exceptions.

    http://delong.typepad.com/sdj/2014/05/open-letter-to-ben-bernanke-hoisted-from-the-archives-from-3-12-years-ago.html#more

  13. Gravatar of Major_Freedom Major_Freedom
    14. May 2014 at 08:50

    Benjamin:

    You cannot understand the real world without proper theory.

    By assuming, despite theory, that a fall in wage rates must mean tight money, you set yourself up for making an incorrect assessment of the real world because the theory you are using is distorting your understanding.

  14. Gravatar of Daniel Daniel
    14. May 2014 at 09:13

    You cannot understand the real world without proper theory.

    Oh, the irony – to hear that coming from a man stuck in 17th century thinking.

  15. Gravatar of TravisV TravisV
    14. May 2014 at 10:22

    Greg Mankiw calls Summers on Piketty “One of the best reviews of the book I have seen.”

    http://gregmankiw.blogspot.com/2014/05/summers-on-piketty.html

  16. Gravatar of Major_Freedom Major_Freedom
    14. May 2014 at 18:37

    Daniel:

    The only irony is that yours is no later than 3rd century AD, with Emperor Diocletian and his money debasement fetish claimed as a priori superior to individual competition.

    Mine is no earlier than 20th century praxeology and individualism. So nice try.

  17. Gravatar of Daniel Daniel
    15. May 2014 at 00:20

    Praxeology – rebranded 17th century rationalism. Because f*ck the facts

    Individualism – because all you need to know about how a gas behaves is to look at an individual atom.

    Some were dropped on their heads – you were thrown against a wall.

  18. Gravatar of Saturos Saturos
    15. May 2014 at 04:06

    You should definitely read Yglesias at Vox. Vox is the BEST.

  19. Gravatar of TallDave TallDave
    15. May 2014 at 06:35

    Peter — It’s a huge cognitive dissonance problem for libertarian MMs (which is probably most of them). Libertarians on the whole are some of the strongest “sound money” proponents, heck many even want to return to the gold standard. And Rand Paul is the best libertarian candidate of our times… on everything except arguably the most important issue in economics today. Vexing.

    Saturos — I’m sorry, could you explain why Vox is the best using flashcards and short sentences?

  20. Gravatar of ssumner ssumner
    15. May 2014 at 07:27

    Peter, Yup, lots of Republicans said that, and yes lots of people have changed their minds (as I said). So what’s the point?

    Travis, Like Brutus’s speech in Julius Caesar—he pretends to praise Piketty while tearing him to pieces.

    Saturos. You mean second best, don’t you? :)

  21. Gravatar of flow5 flow5
    15. May 2014 at 10:14

    Estimates by the Department of Commerce put the net debt figure at the end of 1939 @ $183.2 billion compared with a figure of $190.9 billion at the end of 1929. I.e., for the period encompassing the Great Depression there was no over all debt expansion. I.e., the Fed didn’t have enough eligible collateral to “prime the pump” during the Great Depression (gov’t securities weren’t acceptable until 1933). And both Roosevelt and Hoover in 1932 ran on platforms calling for balanced budgets.

  22. Gravatar of flow5 flow5
    15. May 2014 at 10:19

    The Fed reacted to the economic downswing in the 4th qtr of 2008 very timidly. The FRB-NY’s “trading desk” didn’t purchase any significant volume of SOMA securities until April of 2009 (when stocks & gDp bottomed):

    Securities held outright – H.4.1 (Factors affecting Reserve Balances)

    07/2/2008 — $478,838.00
    08/6/2008 — $479,291.00
    09/3/2008 — $479,701.00
    10/1/2008 — $488,541.00
    11/5/2008 — $490,027.00
    12/3/2008 — $488,445.00
    01/7/2009 — $495,383.00
    02/4/2009 — $511,440.00
    03/4/2009 — $581,721.00
    04/1/2009 — $773,497.00

    I.e., Bankrupt U Bernanke executed a qualitative or “credit easing” program (sterilized balance sheet expansion via emergency credit facilities involving the substitution of risk quality & change in the gov’t vs. private-sector composition of the Central Bank’s assets), instead of quantitative easing (an outright expansion of the money stock).

  23. Gravatar of flow5 flow5
    15. May 2014 at 10:29

    “No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are”

    They were right to stop its collection & publication. But they were wrong about discontinuing the G.6 debit and demand deposit turnover release. Ed Fry (who managed the series), didn’t understand the data. Neither did William Barnett (Divisia – aggregates), Paul Spindt(debit-weighted-money-index), nor Richard Anderson (Monetary Services Divisia Indexes).

  24. Gravatar of flow5 flow5
    15. May 2014 at 10:30

    “No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are”

    They were right to stop its collection & publication. But they were wrong about discontinuing the G.6 debit and demand deposit turnover release. Ed Fry (who managed the series), didn’t understand the data. Neither did William Barnett (Divisia – aggregates), Paul Spindt(debit-weighted-money-index), nor Richard Anderson (Monetary Services Divisia Indexes).

  25. Gravatar of flow5 flow5
    15. May 2014 at 10:30

    “No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are”

    They were right to stop its collection & publication. But they were wrong about discontinuing the G.6 debit and demand deposit turnover release. Ed Fry (who managed the series), didn’t understand the data. Neither did William Barnett (Divisia – aggregates), Paul Spindt(debit-weighted-money-index), nor Richard Anderson (Monetary Services Divisia Indexes).

  26. Gravatar of flow5 flow5
    15. May 2014 at 10:30

    “No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are”

    They were right to stop its collection & publication. But they were wrong about discontinuing the G.6 debit and demand deposit turnover release. Ed Fry (who managed the series), didn’t understand the data. Neither did William Barnett (Divisia – aggregates), Paul Spindt(debit-weighted-money-index), nor Richard Anderson (Monetary Services Divisia Indexes).

  27. Gravatar of flow5 flow5
    15. May 2014 at 10:30

    “No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are”

    They were right to stop its collection & publication. But they were wrong about discontinuing the G.6 debit and demand deposit turnover release. Ed Fry (who managed the series), didn’t understand the data. Neither did William Barnett (Divisia – aggregates), Paul Spindt(debit-weighted-money-index), nor Richard Anderson (Monetary Services Divisia Indexes).

  28. Gravatar of flow5 flow5
    15. May 2014 at 10:30

    “No, they stopped publishing it because they were embarrassed about it. They don’t want to advertise to the markets just how wildly inflationary/deflationary they are”

    They were right to stop its collection & publication. But they were wrong about discontinuing the G.6 debit and demand deposit turnover release. Ed Fry (who managed the series), didn’t understand the data. Neither did William Barnett (Divisia – aggregates), Paul Spindt(debit-weighted-money-index), nor Richard Anderson (Monetary Services Divisia Indexes).

  29. Gravatar of multinonde multinonde
    19. May 2014 at 08:52

    Scott,why do import tariffs and export subsidies offset each other?

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