We all know how it developed.
Matt Yglesias has a post describing how Hjalmar Schacht cleaned up after not one but two monetary policy disasters:
I was reading recently in Hjalmar Schacht’s biography Confessions of the Old Wizard (thanks to Brad DeLong for getting me a copy) and part of what’s so incredible about it are that Schacht’s two great achievements””the Weimar-era whipping of hyperinflation and the Nazi-era whipping of deflation””were both so easy. The both involved, in essence, simply deciding that the central bank actually wanted to solve the problem.
. . .
The institutional and psychological problem here turns out to be really severe. If the Federal Reserve Open Market Committee were to take strong action at its next meeting and put the United States on a path to rapid catch-up growth, all that would do is serve to vindicate the position of the Fed’s critics that it’s been screwing up for years now. Rather than looking like geniuses for solving the problem, they would look like idiots for having let it fester so long. By contrast, if you were to appoint an entirely new team then their reputational incentives would point in the direction of fixing the problem as soon as possible.
This reminded me 1936-37, when the Fed made the mistake of doubling reserve requirements. Late in the year the economy slumped badly, and it was clear that the decision had been a mistake. At the November FOMC meeting they discussed the possibility of reversing the decision:
“We all know how it developed. There was a feeling last spring that things were going pretty fast … we had about six months of incipient boom conditions with rapid rise of prices, price and wage spirals and forward buying and you will recall that last spring there were dangers of a run-away situation which would bring the recovery prematurely to a close. We all felt, as a result of that, that some recession was desirable … We have had continued ease of money all through the depression. We have never had a recovery like that. It follows from that that we can’t count upon a policy of monetary ease as a major corrective. … In response to an inquiry by Mr. Davis as to how the increase in reserve requirements has been in the picture, Mr. Williams stated that it was not the cause but rather the occasion for the change. … It is a coincidence in time. … If action is taken now it will be rationalized that, in the event of recovery, the action was what was needed and the System was the cause of the downturn. It makes a bad record and confused thinking. I am convinced that the thing is primarily non-monetary and I would like to see it through on that ground. There is no good reason now for a major depression and that being the case there is a good chance of a non-monetary program working out and I would rather not muddy the record with action that might be misinterpreted. (FOMC Meeting, November 29, 1937. Transcript of notes taken on the statement by Mr. Williams.)”
This is one of the most chilling statements I have ever read. The opening sentence is the sort of thing juvenile delinquents say to each other when their prank has gone horribly awry, and they are nervously working on a joint alibi. An incredible effort at denial runs all through the piece. First he admits that they raised reserve requirements because “some recession was desirable.” Then he claims it was just a “coincidence in time” that the downturn followed the reserve requirement increase, even though the express purpose of the increase was to cause a “recession.” Then he claims that if they reverse their decision it will look like the previous decision had caused the recession. Then he said that a depression can’t be happening, because there is no good reason for a depression. Well it was happening, unemployment rose to almost 20% in 1938. In the end, they decided to stick with the high reserve requirements throughout the rest of 1937. Reading that quotation one can almost see the perspiration on Mr. Williams’ forehead.
In a recent comment section a Fed employee named Claudia Sahm took me to task for some intemperate remarks I made about the Fed. I think her criticism was valid. I should not throw around terms like “criminally negligent.” I don’t doubt that the vast majority of Fed employees are well-meaning. Maybe all of them are. But Matt’s piece reminds me that human psychology is very complex. We often don’t know why we do things. Why am I blogging? Is it the valiant crusade I’d like to believe I’m engaged in, or am I just fooling myself? (As Robin Hanson would presumably argue.) Suppose Ben Bernanke had been at Princeton for the past 5 years. Now suddenly the Fed chairman is “promoted” to Secretary of the Treasury, and replaced with Bernanke. (As G. William Miller was replaced mid-term with Volcker.) What would happen next? My guess is that Bernanke would immediately set out implementing some of the bold policies that he recommended the Japanese adopt back in 2003.
In 2008 the Fed did what the consensus of economists thought they should be doing. If we could go back in time to the meeting right after Lehman failed, most economists would now say the Fed should slash interest rates sharply (they actually left them unchanged.) If John Taylor is appointed Fed chairman in 2014, and if aggregate demand is still quite depressed, I very much doubt he’d adopt the tightening of monetary policy that many on the right are now calling for.
Update: Speaking of Robin Hanson, his new post relates to his very issue. And I also enjoyed this recent post:
For example, to impose punishments bigger than lifetime exile, beat them a bit first.
Some worry about variation in how much people dislike exile. But there is also variation in how much people dislike fines, prison, torture, and public humiliation. The best way to reduce punishment variation is probably to bundle together many kinds of punishment. Maybe fine them some, beat them a little, humiliate them a bit, and then exile them for a while.
In 2006 the US spent $69 billion on corrections, and 2.3 million adults were incarcerated at year-end 2009. A state prisoner cost an average of $24,000 per year in 2005 (source). Why waste all that money?!
Not so much the ideas, but the way they are expressed. Only an economist can write like that!