Archive for the Category Crisis of 2008


David Beckworth on EconTalk

David Beckworth was interviewed by Russ Roberts this morning in a special video version of EconTalk, which was held at the Cato Institute and hosted by George Selgin. Unfortunately I am not able to find a link for the talk, but I’ll put one up if someone else can direct me to it.

Update:  Here’s the link:

Update#2:  I’m told the link no longer works, but a new link should be up in about 10 days.

There was some discussion of whether the market monetarist critique of Fed policy in 2008 is just Monday morning quarterbacking.  David seemed to concede that this complaint had some merit, and perhaps to some extent it does.  But I also think David is being too modest.  Here’s David criticizing interest on reserves, way back in October 2008, right after it was first adopted:

Is the Federal Reserve (Fed) making a similar mistake to the one it made in 1936-1937? If you recall, the Fed during this time doubled the required reserve ratio under the mistaken belief that it would reign in what appeared to be an inordinate buildup of excess reserves. The Fed was concerned these funds could lead to excessive credit growth in the future and decided to act preemptively. What the Fed failed to consider was that the unusually large buildup of excess reserves was the result of banks insuring themselves against a replay of the 1930-1933 banking panics. So when the Fed increased the reserve requirements, the banks responded by cutting down on loans to maintain their precautionary level of excess reserves. As a result, the money multiplier dropped and the money supply growth stalled as seen in the figure below.

.  .  .

Now in 2008 the Fed did not suddenly increased reserve requirements, but it did just start paying interest on excess reserves. The Fed, then, just as it did in 1936-1937 has increased the incentive for banks to hold more excess reserves. As a result, there has been a similar decline in the money multiplier and the broader money supply (as measured by MZM) which I documented yesterday. If the Fed’s goal is to stabilize the economy, then this policy move appears as counterproductive as was the reserve requirement increase in 1936-1937.

David says that in retrospect he thinks that Fed policy went off course even earlier, in the middle of 2008. Speaking for myself, I didn’t really become aware of the problems with monetary policy until September 2008, after the Fed refused to cut rates despite plunging TIPS spreads.  In retrospect, money became much too tight a couple of months earlier.

Because of data lags, it’s not always possible to predict a recession until the recession is already well underway.  During the past three recessions, a consensus of economists didn’t predict a recession until about 6 months in.  That’s right, not only are macroeconomists unable to forecast, we are also unable to nowcast.

This is why NGDPLT is so important. Under a level targeting regime, the market tends to prevent sharp drops in NGDP from occurring in the first place.  Under NGDPLT, the economy would not have fallen as sharply in late 2008, partly because level targeting would have prevented a steep plunge in asset prices, and partly because current AD is heavily dependent on future expected AD.  If you keep future expected AD rising along a 5% growth path, current AD will not fall very far during a banking crisis.

There was also some discussion of the shortage of safe assets.  Two questions came to mind:

1.  Does this theory imply that risk spreads should have widened in recent years, as the demand for T-bonds has increased faster than the demand for riskier bonds?

2.  Has this in fact occurred, and if so to what extent?


Kocherlakota edges ever closer to market monetarism

TravisV directed me to Narayana Kocherlakota’s newest Bloomberg essay:

What drove this increase in inequality? It wasn’t the result of the Fed propping up housing or stock markets, which declined sharply from 2007 to 2010. Rather, it seems that the poor would have been better off if the Fed had done more to support asset prices — and particularly home prices. In other words, inequality rose because monetary policy was too tight, not because it was too easy.

There are two ways to read this.  If Kocherlakota means the Fed should target house prices, then I obviously disagree.  I think a more plausible reading is that Kocherlakota thinks money was too tight during 2007-10, and that excessive tightness had many side effects including declining asset prices.

Of course that’s “the real problem is nominal” story I’ve been peddling since 2009.  In early 2009, most people thought I was crazy.  Money was clearly “extraordinary accommodative” or so I was told.  And even if if was tight, the fall in home prices was “obviously due to factors unrelated to tight money”.  And now we have a former member of the FOMC espousing a very market monetarist view of the Great Recession.

We’re winning.


Market monetarism is on the march

Cardiff Garcia quotes from a recent report by James Sweeney at Credit Suisse:

Many commentators point to high debt levels as a major driver of the [2008] crisis. However, high debt levels signal vulnerability, not imminent crisis. Crisis occurs when highly leveraged entities suddenly cannot service their debts. This is most likely when nominal growth suddenly slumps, or when asset prices fall sharply.

Of course, those two things often happen together. And what’s most likely before a sharp decline in nominal growth and asset prices is a boom in both.  .  .  .

We believe policymakers are so scarred by the events of 2008 that they live in constant fear of anything resembling a recurrence. The simplest way to prevent recurrence has little to do with achieving 2% inflation and much to do with minimizing the variance of nominal growth, preferably while maintaining full employment.

Macroprudential policy and financial stability monitoring may help with these goals, but ultimately monetary policy is the tool most likely to prevent large cyclical swings in nominal growth.

We’re winning.

My new article in Foreign Affairs

When I was young, I noticed that Foreign Affairs was the classiest looking publication on most newstands.  The kind of outlet where you’d read something by Henry Kissinger, or Zbigniew Brzezinski.  Thus I’m pleased that their new issue has an article by me, discussing the role of monetary policy in the Great Recession:

Here’s the intro, the only part not gated:

Today, there is essentially one accepted narrative of the economic crisis that began in late 2007. Overly optimistic homebuyers and reckless lenders in the United States created a housing price bubble. Regulators were asleep at the switch. When the bubble inevitably popped, the government had to bail out the banks, and the United States suffered its deepest and longest slump since the 1930s. For anyone who has seen or read The Big Short, this story will be familiar.

Yet it is also wrong. The real cause of the Great Recession lay not in the housing market but in the misguided monetary policy of the Federal Reserve. As the economy began to collapse in 2008, the Fed focused on solving the housing crisis. Yet the housing crisis was a distraction. On its own, it might have caused a weak recession, but little more. As the Fed bailed out the banks at risk from innumerable bad mortgages, it ignored the root cause of serious recessions: a fall in nominal GDP, or NGDP, which counts the total value of all goods and services produced in the United States, not adjusted for inflation. Such a fall began unimpeded in mid-2008, and once that happened, much of the damage had been done.

PS.  Sad to hear about Prince.  For me, he was the high point of 1980s pop, which I think of as the age of MTV.  Younger people might be surprised to know that during the golden age of rock music (mid-60s through early 1970s) the major rock bands rarely appeared on TV.  And of course there was no internet.  Unless you saw them live, you didn’t know what they looked like performing.  MTV changed music, made it more TV-oriented.  I can’t even imagine Led Zeppelin on TV.

MM goes mainstream

I was listening to some speakers on Bloomberg discussing the Malaysian and Chinese credit markets, and this comment (by David Stubbs) caught my attention:

Default cycles tend to come when you get that weaker nominal GDP and certainly when expectations of nominal GDP are not met—indeed the expectations that were embedded in the lending contracts themselves, which drove the credit expansion.

Bank in 2009, this argument was viewed as borderline “crackpot”.  I was told that it was “obvious” that the debt problems were due to reckless subprime mortgages, highly leveraged banks like Lehman and irresponsible Greek deficit spending, and that falling nominal GDP was the result.  Now the heterodox (market monetarist) view seems to be going mainstream.