Did the government cause the Great Depression?

A while back some commenters asked me to respond to this claim by Brad DeLong:

Back then, the Friedmans made three powerful factual claims about how the world works – claims that seemed true or maybe true or at least arguably true at the time, but that now seem to be pretty clearly false. Their case for small-government libertarianism rested largely on those claims, and has now largely crumbled, because the world, it turned out, disagreed with them about how it works.

The first claim was that macroeconomic distress is caused by the government, not by the unstable private market, or, rather, that the form of macroeconomic regulation required to produce economic stability is straightforward and easily achieved.

The Friedmans almost always made the claim in its first form: they said that the government had “caused” the Great Depression. But when you dug into their argument, it turned out that what they really meant was the second: whenever private-market instability threatened to cause a depression, the government could avert it or produce a rapid recovery simply by purchasing enough bonds for cash to flood the economy with liquidity.

In other words, the strategic government intervention needed to ensure macroeconomic stability was not only straightforward, but also minimal: the authorities need only manage a steady rate of money-supply growth. The aggressive and comprehensive intervention that Keynesians claimed was needed to manage aggregate demand, and that Minskyites claimed was needed to manage financial risk, was entirely unwarranted.

DeLong makes a plausible case for all three of his assertions.  However in the end I still believe it’s reasonable to blame the government for both the Great Depression and our more recent Little Depression.  To keep the post from being overly long, I’ll skip over policies that delayed recovery, such as the NIRA, and focus on the Great Contraction.

There are an almost infinite number of ways of looking at Fed policy, i.e. what the Fed is “really doing.”  This leads to lots of fruitless debates over errors of omission and commission.  In 1913 the Fed was set up with the goal of preventing bank panics and providing an elastic currency.  They clearly failed at this task in the early 1930s.  The real question is whether the sort of failure that occurred provides ammunition for the libertarian worldview.  If the Fed would have needed to be much more active than it actually was, that would seem to undercut Milton Friedman’s laissez-faire ideology.

Let’s see how many ways we can blame the Fed:

1.  The US was part of an international gold standard regime.  Between October 1929 and October 1930 the world’s central banks sharply raised the world gold reserve ratio.  The Fed was responsible for nearly 1/2 of that increase.  A higher gold ratio is an activist policy (which violates the “rules of the game”), and is highly contractionary.   After October 1930 the Fed lowered their gold ratio, but other central banks (in the gold bloc) kept raising them.  By this metric the world’s central banks played a huge role in the Great Contraction, but the Fed’s role was mostly limited to the first year.

2.  The Fed reduced the monetary base by about 7% between October 1929 and October 1930.  That contributed to the initial slump.  But after October 1930 the base rose sharply, as the Fed partly (but not fully) accommodated increased currency and reserve demand associated with the banking panics.  The decision to not fully accommodate the increased demand for base money is often viewed as an error of omission, and seems to be the major reason why people like DeLong and Krugman argue that Friedman was being disingenuous in arguing the Fed “caused” the Great Depression.  Indeed Krugman has doubts as to whether any base increase would have been sufficient.

3.  I seem to recall that Friedman also blamed the Fed for mishandling the failure of the Bank of the United States in December 1930.  He argued that support systems available in the pre-Fed era might have prevented the banking panic from spreading.  Thus the government took the function of banking stabilization away from the private sector and gave it to the Fed.  The Fed botched its job, and that fact supports the libertarian worldview.  On the other hand there were plenty of banking crises before 1913, so libertarians can’t really argue that the banking panics would not have occurred if the Fed hadn’t been created.

4.  I think the strongest argument against the government is based on the instability of policy.  Austrians point out that the Fed propped up the economy in the 1920s, with an activist monetary policy under the leadership of Governor Strong.  In fact, monetary policy wasn’t particularly expansionary during the 1920s, using any reasonable metric.  But they are right that Strong “fine-tuned” the economy.  He argued that the Fed should try to smooth out fluctuations in output in prices—in other words he was a proto-market monetarist.  The private sector made all sorts of decisions based on the expectation that Strong’s approach would continue on into the 1930s.  But fine-tuning was abandoned in 1929, as the Fed shifted its focus to the stock market bubble.  This sudden policy switch triggered the Great Contraction.

In the end, we don’t really know what a laissez-faire monetary regime would look like in a modern economy, so it’s fruitless to debate that counter-factual.  The Fed has been given the duty of managing monetary policy, and the question we should be examining is how much of the instability in RGDP is due to flawed Fed policy.  In my view the answer is “most of it.”  The overwhelming majority of the business cycle is due to demand shocks, fluctuations in NGDP.  (I’d guess that DeLong and Krugman would agree with me there.)  I’d also argue that the Fed can and should eliminate most of that NGDP instability.  It’s failure to do so makes it mostly responsible for the Great Depression and the Little Depression.  But this view doesn’t necessarily provide aid and comfort to libertarians, as it’s quite possible that the business cycle can only be smoothed by putting the best and the brightest into a government-run institution, and then instructing them to steer the nominal economy.  That sounds pretty interventionist.

Because I’m a pragmatic libertarian I don’t worry about these sorts of distinctions.  In my view the ideal government would be small relative to existing real world governments, but large relative to the laissez-faire ideal visualized by the more dogmatic libertarians.  By ‘dogmatic’ I mean those who believe libertarianism provides answers to questions.  People who believe you start any analysis with the presumption that the libertarian position is right, and then look for arguments to buttress your case.

In contrast, I believe economic analysis provides answers, and it just so happens that many of those answers line up with the small government agenda.  For instance I favor having the Fed stabilize the price of NGDP futures because it would make NGDP more stable than under a discretionary regime.  It would also take the Fed out of the business of determining interest rates and/or the money supply, but that’s an implication of the policy, not an argument for the policy.

Prior to Friedman and Schwartz the conventional view was that you needed big government to prevent a repeat of the Great Depression.  Friedman convinced the profession that small government plus an effective Fed could do the job.  That opened the door to the neoliberal policy revolution, which began in the late 1970s.  A little bit of ground has been lost in the current recession, but Friedman’s basic argument still stands.


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40 Responses to “Did the government cause the Great Depression?”

  1. Gravatar of Saturos Saturos
    15. May 2012 at 07:23

    “it’s quite possible that the business cycle can only be smoothed by putting the best and the brightest into a government-run institution, and then instructing them to steer the nominal economy.”

    But doesn’t this conflict with futures targeting, under which there is not very much left for Fed officials to do? Are you still not quite sure about the merits of your own idea, as sure as you are that “The overwhelming majority of the business cycle is due to demand shocks, fluctuations in NGDP … I’d also argue that the Fed can and should eliminate most of that NGDP instability.”?

  2. Gravatar of Saturos Saturos
    15. May 2012 at 07:30

    And what was the rationale for increasing the reserve ratio after the crash? The rate hike earlier on was enough to pop the bubble, wasn’t it? What were they thinking? I know you’re not a mind-reader, Scott, but any insights? Was it again a failure of understanding, did they have no idea this would create a depression?

  3. Gravatar of Saturos Saturos
    15. May 2012 at 07:30

    And of course, we now know it wasn’t even a bubble.

  4. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. May 2012 at 07:49

    And now the Krugman (DeLong beat him to it) moth is drawn to the JP Morgan-Chase flame;

    http://seattletimes.nwsource.com/html/opinion/2018208848_krugman15.html

    ——————quote——————-
    It’s clear, then, that we need to restore the sorts of safeguards that gave us a couple of generations without major banking panics. It’s clear, that is, to everyone except bankers and the politicians they bankroll “” for now that they have been bailed out, the bankers would of course like to go back to business as usual. Did I mention that Wall Street is giving vast sums to Mitt Romney, who has promised to repeal recent financial reforms?
    Enter Dimon. JPMorgan, to its “” and his “” credit, managed to avoid many of the bad investments that brought other banks to their knees. This apparent demonstration of prudence has made Dimon the point man in Wall Street’s fight to delay, water down and/or repeal financial reform. He has been particularly vocal in his opposition to the Volcker Rule, which would prevent banks with government-guaranteed deposits from engaging in “proprietary trading,” basically speculating with depositors’ money. Just trust us, the JPMorgan chief has in effect been saying; everything’s under control.
    ———————endquote———————–

    Of course, Dimon’s bank didn’t speculate “with depositors’ money”, but with their own shareholders’, and is a hedging strategy (albeit one that failed in the execution) fairly called ‘speculation’?

    So, this failed strategy may reduce the profits of the shareholders by 10% or so this year, but what have you done for me lately, Jamie?

  5. Gravatar of Morgan Warstler Morgan Warstler
    15. May 2012 at 08:08

    Iowahawk says it is structural:

    http://iowahawk.typepad.com/iowahawk/2012/05/one-afternoon-in-a-garage-in-reno-nevada.html

    “It would also take the Fed out of the business of determining interest rates and/or the money supply, but that’s an implication of the policy, not an argument for the policy.”

    1. ROFL
    2. Arguments are whatever convinces the audience.
    3. ROFL
    4. The audience doesn’t like the Fed or big government.
    5. So it is AN ARGUMENT for the policy.

    And if you think you just took down DeKrugman’s attack on Friedman with the above…

    You got a LONG WAY TO GO before you are the heir to Friedman.

    As I said before when DeKrugman said that it meant it as a way of demeaning Friedman…. of reducing him to being a monetarist.

    —-

    If you want the title you win the small government argument ON ITS FACE.

    If you don’t want the title SAY OUT LOUD you can’t deliver the red meat goods that made Friedman enough of a god to the right, that they also listened to him on Monetary.

    Scott, you can do eeet!

    —-

    Just give it a shot, speak in Friedman’s voice, think how he’d go after DeKrugman.

  6. Gravatar of Saturos Saturos
    15. May 2012 at 08:19

    ” It would also take the Fed out of the business of determining interest rates and/or the money supply, but that’s an implication of the policy, not an argument for the policy.”

    Yeah, as Morgan says, you’re the least public-choice libertarian I’ve heard of. You’re unwilling to extrapolate from all the theory and evidence against government action you do know of to make a generalized presumption against government, as Friedman did. Taking something out of government hands and into the hands of those whose private interests do coincide with social interests is a prima facie argument for a policy proposal.

  7. Gravatar of Saturos Saturos
    15. May 2012 at 08:21

    Public-choice, incidentally, is associated with the most pragmatic libertarian there ever was, Gordon Tullock. In fact he didn’t call himself a libertarian, he just called himself a utilitarian.

  8. Gravatar of Philo Philo
    15. May 2012 at 08:39

    “Thus the government took the function of banking stabilization away from the private sector and gave it to the Fed. The Fed botched its job, and that fact supports the libertarian worldview.” At least, it does so if the private sector would have done a better job of banking stabilization””a very plausible supposition.

    The same is true of regulating the money supply: the government took this function away from the private sector and gave it to the Fed, and the Fed botched the job.

    In both these botches, the question whether the Fed was *active* or *passive* is a metaphysical subtlety of little interest even to philosophers, let alone to practical people.

    By the way, even some factors in the Great Depression that were not the Fed’s fault may be blamable on the government: both before and after the Fed was created, the government was interfering many ways with the markets for money and banking.

  9. Gravatar of Curious Curious
    15. May 2012 at 08:48

    I’ve never understood why a private banking system wouldn’t naturally prevent bank runs. Sure, a run on undercapitalized Bank A can spill over to safely-capitalized Bank B, but I fail to see how it isn’t the consumer’s responsibility to diversify accordingly, or how it isn’t Bank B’s responsibility to convince depositors that their money is safe (for example via more transparency with their books, or a “consumer reports” of banks, etc.). Can’t adults make their own decisions, suffer the consequences of their own decisions, and adjust accordingly without resorting to the use of government force? I’m interested in knowing how a central bank is, with 100% certainty, necessarily better than a collection of private banks able to issue their own notes. It seems to me the question about whether the Fed or “the government” caused the two greatest finical crises in human history is unfairly posed to the free-marketeer because he is forced to argue from a position where the government has already taken control of the money supply.

  10. Gravatar of Major_Freedom Major_Freedom
    15. May 2012 at 09:23

    I love how DeKrugman says:

    “The first claim was that macroeconomic distress is caused by the government, not by the unstable private market, or, rather, that the form of macroeconomic regulation required to produce economic stability is straightforward and easily achieved.”

    He says “unstable market”, not just “market”, which makes it seem obvious where any economic distress could come from. One could just as easily have said

    “The first claim was that macroeconomic distress is caused by the unstable government, not by the private market, or, rather, that the form of market regulation required to produce economic stability is straightforward and easily achieved.”

    And then ask where distress could come from if it happens. DeKrugman is playing a psyops game with himself and his readers.

    ssumner:

    I think the strongest argument against the government is based on the instability of policy. Austrians point out that the Fed propped up the economy in the 1920s, with an activist monetary policy under the leadership of Governor Strong. In fact, monetary policy wasn’t particularly expansionary during the 1920s, using any reasonable metric.

    As Rothbard noted:

    “Thus, we see that the 1920s saw a significant shift in the relative importance of demand and time deposits: demand deposits were 51.3% of total deposits in 1921, but had declined to 44.5% by 1929. The relative expansion of time deposits signified an important lowering of effective reserve requirements for American banks: for demand deposits required roughly 10% reserve backing, while time deposits needed only 3% reserve. The relative shift from demand to time deposits, therefore, was an important factor in permitting the great monetary inflation of the 1920s. While demand deposits increased 30.8% from 1921 to 1929, time deposits increased by no less than 72.3%!”

    “During the 1920s, time deposits increased most in precisely those areas where they were most active and least likely to be misconstrued as idle “savings.”…The least active time accounts are in savings banks, the most active in the large city commercial banks. Bearing this in mind, below are the increases over the period in the various categories:

    Savings Banks 61.8%
    Commercial Banks 79.8%
    Member Banks 107.9%
    Country Banks 78.9%
    Reserve City Banks 128.6%
    Central Reserve City Banks 450.0%

    “Two influences may generate bank inflation””a change in effective reserve requirements and a change in total bank reserves at the Federal Reserve Bank…”

    “Clearly, the first four years of this period was a time of greater monetary expansion than the second four. The member bank contribution to the money supply increased by $6.9 billion, or 37.1%, in the first half of our period, but only by $3.9 billion or 15.3% in the second half. Evidently, the expansion in the first four years was financed exclusively out of total reserves, since the reserve ratio remained roughly stable at about 11.5:1. Total reserves expanded by 35.6% from 1921 to 1925, and member bank deposits rose by 37.1%. In the later four years, reserves expanded by only 8.7%, while deposits rose by 15.3%. This discrepancy was made up by an increase in the reserve ratio from 11.7:1 to 12.5 : 1, so that each dollar of reserve carried more dollars in deposits. We may judge how important shifts in reserve requirements were over the period by multiplying the final reserve figure, $2.36 billion, by 11.6, the original ratio of deposits to reserves. The result is $27.4 billion. Thus, of the $29.4 billion in member bank deposits in June, 1929, $27.4 billion may be accounted for by total reserves, while the remaining $2 billion may be explained by the shift in reserves. In short, a shift in reserves accounts for $2 billion out of the $10.8 billion increase, or 18.5%. The remaining 81.5% of the inflation was due to the increase in total reserves.”

    “Thus, the prime factor in generating the inflation of the 1920s was the increase in total bank reserves: this generated the expansion of the member banks and of the non-member banks, which keep their reserves as deposits with the member banks. It was the 47.5% increase in total reserves (from $1.6 billion to $2.36 billion) that primarily accounted for the 62% increase in the total money supply (from $45.3 to $73.3 billion). A mere $760 million increase in reserves was so powerful because of the nature of our governmentally controlled banking system. It could roughly generate a $28 billion increase in the money supply.” – America’s Great Depression

    These numbers are in fact particularly expansionary. Of course the absolute amounts look tame according to present day amounts, but in relative terms, which is the proper gauge of comparison, it is clear that the 1920s were indeed quite inflationary.

    Look at the sizes of the percentage increases.

    But they are right that Strong “fine-tuned” the economy. He argued that the Fed should try to smooth out fluctuations in output in prices””in other words he was a proto-market monetarist. The private sector made all sorts of decisions based on the expectation that Strong’s approach would continue on into the 1930s. But fine-tuning was abandoned in 1929, as the Fed shifted its focus to the stock market bubble. This sudden policy switch triggered the Great Contraction.

    It was either this or destruction of the currency brought about by physical scarcity asserting itself. This is the thing with you market monetarists. You never think beyond the immediate moment. You believe inflation can in principle continue on accelerating and thus capable of preventing any “contraction.” The problem with this view is that it depends on an assumption of infinite resources. Yes, if resources were infinite, then inflation would be able to continue on accelerating without any need for any contraction, since new money can be printed and spent on the next resource in the infinite lineup of available resources.

    Except physical reality is the ultimate constraint. A policy of inflation, if used in a way that never results in a spending “contraction”, would eventually hit the physical scarcity wall, and any attempt to inflate even more, to stop spending from contracting, will result in a destruction of the currency. So in the real world US economy, and unlike Zimbabwe, the choice was always made, intentionally or not, to accept physical reality, accept monetary contraction, and stave off destruction of the currency.

    This is why we see almost 100% correlation between monetary expansions and economic booms, and monetary contractions and economic busts. It’s because the Fed hasn’t yet did what you say they should do, which is accelerate its printing every time the pressure of spending to contract accelerates, as the physical reality limit is approached.

    You say it’s the lack of printing enough money in the early 1930s that brought about the correction. There is only a kernel of truth to this, because if instead the Fed did accelerate its printing, then it would have only taken the economy even closer to the limits imposed by physical reality, where inflation can no longer sustain the inflation addicted economy.

    In the end, we don’t really know what a laissez-faire monetary regime would look like in a modern economy, so it’s fruitless to debate that counter-factual.

    As opposed to you constantly talking about what the counter-factual NGDP targeting monetary world would look like?

    We don’t have to know what a laissez-faire monetary world would look like in order to know whether or not it is superior in helping the most individuals achieve their desired social ends.

    We can use economic logic to know what is true given these new constraints, no matter what people decide to do given these new constraints.

    We know that the private property system subject to profit and loss does a remarkable job in potatoes, cars, clothes, and all other goods besides money. Applying it to money production as well would optimize the monetary system.

    Money is a commodity just like potatoes and cars and clothes are, with the primary distinction being that it is just the most marketable, the most universally accepted commodity. What is the second most accepted commodity in the world? Rice? Wheat? Money is just the top ranking commodity, that’s all. There is nothing inherent in money that immunizes it from economic laws. Economic law applies to money no less than potatoes, cars, and clothes. Just because the government has monopolized it by force, it doesn’t mean money transcends economic laws and is to remain outside the sphere of private property subject to profit and loss.

    In a laissez-faire monetary world, we can in fact make legitimate statements about what would happen, just like we can do so with laissez-faire produced potatoes, cars, and clothes.

    Thus, if money were laissez-faire, we would almost certainly see a relative increase in the production of money when the relative profitability of money production increases, and we would almost certainly see a relative decrease in money production when the relative profitability of money production decreases. Why would the relative profitability between the money commodity and all other commodities change? When the demand for money changes relative to all other goods.

    Now, the most likely response to this by inflationists is to ask “well, what happens when the demand for money rises to X, but the market is only capable of producing X-x money? Won’t there be a “shortage” of money? Won’t there be “distress”? No, there won’t be, for the same reason there is no “distress” brought about by the fact that the desire for goods as such has ALWAYS outstripped the availability of goods as such. Since resources are scarce, humans are compelled to make choices on what to produce more of next.

    It would be silly to believe that there is a finite height, or level, of desired cash. People ALWAYS want more cash, just like they always want more goods as such. Just because fiat allows ANY perceived increase in demand for money to be satisfied, it doesn’t mean inflating to satisfy that perceived demand increase is welfare creating. People have to make choices on what to produce more of given the existence of economic scarcity. Not all new money creation to satisfy more money demand can be considered optimal, if the creation of that new money didn’t first pass the profit and loss test. The demand for more money in a laissez faire world would first pass the profit and loss test, and if it profitable, then more money is warranted. If not, then the relative increase in demand for money doesn’t actually exist, even if “spending” should fall below where it was yesterday, or this morning.

    This is why 5% NGDP targeting would be so destructive. It calls for more money to be printed without subjecting it to the profit and loss test first, whenever the status quo spending changes, as if aggregate spending falling from where it was yesterday somehow means more money printing is ipso facto socially optimal.

    Now, does money production become relatively more profitable when spending on goods as such declines from where it was in the recent past? Certainly. Nobody can deny that. But how much new money should be created exactly? Whatever amount that would put spending back to where it was yesterday? No, of course not, for the same reason that should there be a relative decline in typewriter purchases and relative increase in PC purchases, it doesn’t mean that the state should transcend the profit and loss system and bring about the production of more typewriters.

    If there is a decline in spending on goods, then while the relative profitability and hence production of laissez-faire money would rise, it won’t necessarily rise in such a way that “spending” today will be the same as spending yesterday, or 5% higher or whatever. It would rise to the point where the costs of additional money production were no greater than what would detract from producing other desired goods, which may result in lower, higher, or unchanged “spending”.

    There is nothing beneficial in “stability” in economic life. Stability is a chimera derived from ancient eschatological mystical desires to bring an end to history, and to reabsorb into the “perfect”, and hence “unchanging” creator. The thinking goes that stability on Earth is desirable because the perfect God is stable. That’s why Fisher felt that price stability was optimal in the 1920s, after which he lost his fortune in the stock market, and why the Fed is not stable and never will be stable.

    You’re calling for a stable Fed, which is impossible the same way a stable set of regulations and laws is impossible. You’re preaching a new religion of spending stability, where even if it were practised, would have destructive side effects, the same way stable price policies have destructive side effects, the same way stable interest rates have destructive side effects, the same way stable money supplies have destructive side effects, the same way every other “stability” seeking in money has destructive side effects.

    The side effect of imposing stable “spending” is gradual destruction of the real economy, as inflation ignores the profit and loss test, and it gradually destroys the storing of purchasing power nature of money, as accelerating inflation of the money supply is needed in order to sustain growth in “spending” in an increasingly resistant and stressed real economy.

    Imposing stable spending increases outside of profit and loss does NOT bring about sustainable economic growth! It brings about an increasingly resistant and stressed capital structure as the limits of scarcity is approached.

    Why is it that the Fed keeps “failing” to print enough money? It’s because they keep believing the same inflation has the same effects. It’s the same constancy assumption made that does not apply to human action. The Fed has to accelerate inflation in order to “succeed” in preventing spending from falling. The end point of accelerating inflation is of course destruction of the monetary system, which is why they have so far, intentionally or not, refrained from doing what is necessary to maintain “spending.”

    If the Fed listened to you market monetarists, we’d be even closer to monetary destruction than we currently are today.

  11. Gravatar of Jim Glass Jim Glass
    15. May 2012 at 10:40

    I just read the Friedman and Schwartz chapters on the Great Contraction, now available as a separate volume, while spending a lot of time in a hospital waiting room.

    They put a lot of specific blame on the Fed for the first wave of bank failures and consequent fall in the money supply that kicked the deflation off, due to the way it caused banks to abandon the system of “suspensions” that had previously effectively stopped contagious bank runs.

    During a suspension a bank would continue to operate normally in all ways, except that deposits couldn’t be withdrawn temporarily. During that period, other banks would arrange cash financing against the bank’s assets to cover the deposit withdrawals and normalcy would resume, or in the minority of cases where a bank was closed losses were minor. Contagion was prevented, thus there was no systemic need to liquidate loan collateral, so it retained its value and the system remained intact.

    This didn’t work during the first great wave of bank runs of the Depression, and F&S specifically blame the Fed saying:

    (1) Suspensions are unpleasant for banks, and the banks that were part of the Fed system believed that an explicit part of the Fed’s mandate was to provide them the financing needed to avoid suspensions, so they saw no need to protect themselves — but then the Fed didn’t deliver;

    (2) The bigger banks that were part of the Fed system and believed themselves protected saw a competitive opportunity to stick it to the smaller banks that weren’t, and which were more vulnerable to runs. “Let ’em go under, we pick up the leavings.” That is, under the Fed arrangements big banks saw bank runs among small banks as an *opportunity* rather than a *danger*.

    So when the runs started, the bigger banks (unlike in the past) refused to help. The contagion started, the growing runs forced liquidation of collateral, which drove its price down, which now endangered the bigger banks, which turned to the Fed for help … see (1).

    F&S compare the record of suspensions in prior recessions and banking crises to that at the start of the Depression, and the difference in bank behavior is stark. They conclude from the numbers that that if past practice had been followed the flood of bank failures would largely have been avoided, and the initial big economic fall correspondingly mitigated … consequences(?). Difference: Fed.

    That is, the Fed did much worse than botch the job of providing liquidity to banks — it gave banks a motive to destructively turn on each other.

    F&S cite the Bank of the United States as an illustration of this. Its competitors in the same urban market turned on it to put it under, seeing its failure as an opportunity for them rather than a risk. The Fed did nothing. The numbers from its final liquidation indicate it was probably solvent all along and with help that was routine in the past could have stayed in business, in the worst case it should have been a problem so small nobody remembers. Instead it proved a calamity for all.

    ‘Nuff of all that. For a book on a technical subject that is 50 years old, I found it really a surprisingly good and engaging read. I’m going on to the whole big volume now.

    There’s a lot on the internal politics of the Fed during all these events, which is at least as interesting as textbook-type analysis of its policy decisions. More so, since the internal politics is what really drove the policy decisions.

    And it is *startling* how many people back then made the exact same statements using the same words to make same arguments for same positions as people have from 2008-today. In a lot of ways it’s like 80 years of advance in economic theory never occurred. People remain the same.

  12. Gravatar of Morgan Warstler Morgan Warstler
    15. May 2012 at 11:54

    Note the difference between Jim Glass:

    “This didn’t work during the first great wave of bank runs of the Depression, and F&S specifically blame the Fed saying:

    (1) Suspensions are unpleasant for banks, and the banks that were part of the Fed system believed that an explicit part of the Fed’s mandate was to provide them the financing needed to avoid suspensions, so they saw no need to protect themselves “” but then the Fed didn’t deliver;

    (2) The bigger banks that were part of the Fed system and believed themselves protected saw a competitive opportunity to stick it to the smaller banks that weren’t, and which were more vulnerable to runs. “Let ’em go under, we pick up the leavings.” That is, under the Fed arrangements big banks saw bank runs among small banks as an *opportunity* rather than a *danger*.

    So when the runs started, the bigger banks (unlike in the past) refused to help. The contagion started, the growing runs forced liquidation of collateral, which drove its price down, which now endangered the bigger banks, which turned to the Fed for help … see (1).

    F&S compare the record of suspensions in prior recessions and banking crises to that at the start of the Depression, and the difference in bank behavior is stark. They conclude from the numbers that that if past practice had been followed the flood of bank failures would largely have been avoided, and the initial big economic fall correspondingly mitigated … consequences(?). Difference: Fed.

    That is, the Fed did much worse than botch the job of providing liquidity to banks “” it gave banks a motive to destructively turn on each other.”

    And DeKrugman explaining Friedman:

    “The Friedmans almost always made the claim in its first form: they said that the government had “caused” the Great Depression. But when you dug into their argument, it turned out that what they really meant was the second: whenever private-market instability threatened to cause a depression, the government could avert it or produce a rapid recovery simply by purchasing enough bonds for cash to flood the economy with liquidity.

    In other words, the strategic government intervention needed to ensure macroeconomic stability was not only straightforward, but also minimal: the authorities need only manage a steady rate of money-supply growth. The aggressive and comprehensive intervention that Keynesians claimed was needed to manage aggregate demand, and that Minskyites claimed was needed to manage financial risk, was entirely unwarranted.”

    ——-

    Not at all the same.

    Friedman is arguing for MINIMAL but CONSTANT application from an unbiased referee.

    From a govt. so SMALL it cannot PICK WINNERS AND LOSERS.

    And DeKrugman bastardizes this and acts as though Friedman is complaining the govt. didn’t do enough.

    Life is simple, assume EVERYONE including all public employees is a greedy bastard and establish a rule set that make it almost impossible to use govt. to your own greedy ends.

    Since everyone is greedy, including the govt. itself, govt. must be small.

  13. Gravatar of marcus nunes marcus nunes
    15. May 2012 at 12:31

    These guys at the New York Fed think it was “complacency” that brought the house down!
    http://thefaintofheart.wordpress.com/2012/05/14/please-less-technique-and-more-substance/

  14. Gravatar of n.a.e. n.a.e.
    15. May 2012 at 12:36

    Scott,

    What was the reason for raising the gold reserve ratio in 1929? Do you think the Fed simply did not understand that doing so was a mistake? Also, how is this in violation of the “rules of the game”? Who set the rules of the game to begin with? (just asking out of a curiosity to understand this better, not challenging the factual validity of what you are saying). Thanks.

  15. Gravatar of Bonnie Bonnie
    15. May 2012 at 13:42

    Morgan:

    It isn’t because of Dr. Sumner’s lack of activism that the right doesn’t understand that there has been quite a departure from the successes of Friedman in the area of monetary policy. They have thrown Friedman under the bus themselves. I hear it every time I listen to callers to conservative talk shows state that high gas prices are because of the Fed and are encouraged, or listen to Glenn Beck talk about the coming monetary apocalypse; and those are just examples of the near constant stream of contradictory rhetoric coming from their own. How is it an entire movement can fail to understand the monetary basis of their own ideology to such an extent that they are willing to contradict it and advocate for policies that create an unnecessary and appalling economic existence when the truth about everything they’ve understood is right in front of them? Friedman is gone and forgotten with great violence done to his legacy. There is no bringing him back without challenging the rhetoric that has become a part of the zeitgeist of the right and the propagandists from whom falsehoods spew. That can’t come from Dr. Sumner. It has to come from adherents such as ourselves putting out that challenge, and if they are not effective from the front, we have to do something effective from the rear. Certainly if they are committing frauds of omission over money there must be other things they take equal liberty with. And there is no telling if that genie of the zeitgeist can even be put back in the bottle.

    So what about you? Are you ready to put a check on people like Glenn Beck, or will you shrink from it and just stand by as people accept this miserable state of affairs as the new reality?

  16. Gravatar of CA CA
    15. May 2012 at 13:58

    Well said Bonnie. Unfortunately, it’s not just the Glenn Becks who are spewing this stuff. Just about all the interviewees I see on CNBC and Bloomberg believe the Fed’s policy is too loose and inflation is right around the corner. Or they think the Fed is out of ammunition. And in the modern Republican party, “monetary policy” has become a bad word. It’s a rather said state of affairs.

  17. Gravatar of Morgan Warstler Morgan Warstler
    15. May 2012 at 15:13

    Bonnie, as far as I’m concerned until the Fed adopts 4.5% NDGPLT…

    There should be no QE of ANY KIND as long as Democrats are in charge.

    It may confuse people that growth can occur when moving more control to the state.

    Once the right has the reigns of power, looser money is a far more natural thing… after all, the businessmen are running the show, we should feel more comfortable.

    —–

    This very simple analysis…

    Has gotten slightly more confusing because for decades the Dems had also seen Budget Deficits as a way of promoting the state.

    So the Right got tired of it, and raised the stakes by spending all the money themselves without rewarding Dem voters.

    Once we hit the wall of Deficit Spending, we can go back to the basic game strategy of tight money when liberals are ascendant and looser money when they are in retreat.

    —–

    Couple notes:

    1. I say it like this so bluntly because I want to simplify it down to reality.
    2. But the individual agents in charge, they aren’t being diabolical, they are just seeing the world at a given snapshot.

    ANY AMERICAN BANKER, ANY REAL ECONOMIST is actually a free market thinker. They LOVE savings found in productivity gains, brought on by technology invention.

    They would naturally see the state shrinking back as positive for private sector returns.

    It’s a basic as people tensing up when they are around our pit bull, Lady.

    She can have one a tutu and a boa, and two little girls hanging off of her, and people will still go tense, snatch up their kids etc.

    It simply is natural.

    My pointing out that this means liberals are screwed is no more mean spirited than saying the Constitution thwarts them.

    It does. And so does the Fed being “independent.”

    Optimal strategy is in knowing when to fold them, and true progressives haven’t known when to do that since 1980.

  18. Gravatar of Mike Sax Mike Sax
    15. May 2012 at 15:29

    “as far as I’m concerned until the Fed adopts 4.5% NDGPLT”

    Morgan if all you want is 4.5% aren’t we close to that now?I mean what’s the GDP rate now-inflation is like 2.5% or so-at least.

  19. Gravatar of dwb dwb
    15. May 2012 at 15:57

    @Morgan,
    you are playing to lose the game. voters will eventually reject obstructionist politics. if its a choice between the guy who wants to do nothing, and the guy who wants to do something, they will choose the latter, even if it means fiscal stimulus. Voters eventually tire of the Austrian beatings. Sometimes in a chess match you have to sacrifice a valuable piece to get ahead. I agree that more QE should be simultaneous with NGDPLT, but if the Fed waits until after the election the damage will have been done.

  20. Gravatar of ssumner ssumner
    15. May 2012 at 16:33

    Saturos, I definitely still favor the futures targeting approach, but of course I can’t know that I am correct. So obviously it’s possible that technocrats would be needed. Indeed anything’s possible.

    The Fed had no idea what they were doing back then. It was even worse than today. If you had asked them, I bet they wouldn’t have even known that the gold ratio was rising. Most expert opinion thought money was easy in 1930. Sound familiar? In late 2008 most economists didn’t know real interest rates were soaring upwards. But in a way the mistake in 1930 was even more outrageous, as even the monetary base was declining.

    Patrick, Good find. What gave us several good decades in banking was steadily rising inflation. As soon as inflation fell (in 1982, and again in 2009), banking losses soared. Unless we plan to go back to ever higher inflation, the 1950s regulatory approach won’t work. But I agree that the current system is highly flawed, and I certainly don’t agree with the banker lobby that everything is fine.

    Morgan, Good point. It’s not an argument I find persuasive, but it’s certainly an argument that others find persuasive.

    Saturos, You said;

    “Yeah, as Morgan says, you’re the least public-choice libertarian I’ve heard of. You’re unwilling to extrapolate from all the theory and evidence against government action you do know of to make a generalized presumption against government,”

    That’s not quite right. I do understand that standard economic theory suggests that government regulation is usually counterproductive. The burden of proof is definitely on those who want to fix prices, restrict market access, or nationalize companies. It’s just that in lots of areas I find the anti-laissez-faire position to be quite plausible–let’s say wage subsidies for the poor, or government provided school vouchers, or universal catastrophic health insurance, or roads, or global warming initiatives, or a government-defined medium of account. I see no reason to simply assume government has no role in those areas, and then look around for shoddy research that seems to support my prejudices, until someone like Krugman shreds it to pieces. I’d rather be consistently right than consistently libertarian.

    Like Tullock, I consider myself a utilitarian. But I think the public choice approach can be overdone. In the realm of monetary policy, mistakes are made that can’t plausibly be attributed to special interest politics. Too many losers.

    Philo, Yes, I agree with that comment.

    Curious, It’s quite possible that an unregulated banking system would have done much better in the 1930s–indeed the Canadian system (which was less regulated at that time) seems to support that hypothesis. My point was simply that one couldn’t find the answer by looking at American history. We simply don’t know. But Friedman can be faulted for not paying enough attention to the problem of removing some government interference, when other distortions remain in place. I recall he supported “deregulation” of banking in Iceland, even though deposit insurance remained in place. We all know how that worked out.

    MR, Bank deposits are not government policy, they are credit created by the private sector. I was talking about Fed policy, which was not very expansionary.

    There was no inflation in the 1920s or 1930s, and almost no increase in NGDP.

    Jim Glass, Thanks, it’s been a long time since I read that book, and I’ve forgotten some of the details.

    Marcus, Yes, but did you expect the Fed to blame itself? 🙂

    It’s only years later when one Fed chairmen blames an earlier one (for the Great Inflation, or Great Depression.)

    n.a.e. The rules were just informal, and often violated. But they were nonetheless the only real rules by which policy could be judged. So it was the benchmark people used under the gold standard–the way the system was “supposed” to work.

    I don’t think the Fed understood what they were doing.

    Bonnie and CA, Yes, Friedman would be horrified by the modern GOP.

  21. Gravatar of dwb dwb
    15. May 2012 at 16:47

    I do understand that standard economic theory suggests that government regulation is usually counterproductive. The burden of proof is definitely on those who want to fix prices, restrict market access, or nationalize companies. It’s just that in lots of areas I find the anti-laissez-faire position to be quite plausible-let’s say wage subsidies for the poor, or government provided school vouchers, or universal catastrophic health insurance, or roads, or global warming initiatives, or a government-defined medium of account. I see no reason to simply assume government has no role in those areas, and then look around for shoddy research that seems to support my prejudices, until someone like Krugman shreds it to pieces. I’d rather be consistently right than consistently libertarian.

    well said!!

  22. Gravatar of Jason Jason
    15. May 2012 at 18:24

    Begin Sumner: “However in the end I still believe it’s reasonable to blame the government for both the Great Depression and our more recent Little Depression.”

    End Sumner: “Friedman convinced the profession that small government plus an effective Fed could do the job.”

    You appear to be combining the Fed and the rest of the government as “the government” in the first paragraph (quote 1) and separate “the government” and the Fed in the last point (quote 2). I believe this is exactly what Delong and Krugman are calling out as disingenuous … if you recombine them in government, you get this sentence:

    Friedman convinced the profession that government could do the job.

    (Now all of the weight is being carried by the Fed in both the beginning and the end quotes and generally the argument seems to go through regardless of the size of the government.)

  23. Gravatar of Mike Sax Mike Sax
    15. May 2012 at 18:26

    Serioulsy though as Morgan is begging off, Scott what is NGDP by now-it must be close to 4 if not higher. So when people like Morgan say they want 4.5% NGDP that’s pretty close to the status quo at this point.

    I know some people like Lars want an even lower target like 3% By that defintiion shouldn’t they be demanding the Fed tighten now?

    If I remember right I believe you have a target like 5.5%-if so still have consdierable ground to pick up.

  24. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    15. May 2012 at 19:11

    Here’s a pretty good piece from Reuters on JP Morgan, much less hysterical than Krugman);

    http://www.reuters.com/article/2012/05/14/us-jpmorgan-trades-idUSBRE84D04X20120514

    I like the way it ends;

    “We want to maximize the economic value of these positions and not panic or do anything stupid,” [Dimon] told analysts. “We’re willing to bear the volatility, and that’s life.”

  25. Gravatar of Morgan Warstler Morgan Warstler
    15. May 2012 at 19:42

    Sax,

    Scott will take 4.5%.

    MOREOEVER, he has admitted that if he gets no makeup, and it just starts TODAY, in the long run, no big deal.

    Remember Sax, according to Scott:

    NGDPLT works because of the expectations, so even if the Fed comes down with a hammer at 4.5% TODAY…

    It only take a very short period of time before:

    1. HOLY SHIT WE ARE AT 4.5%!!!!!!!

    2. SHIT!!!!

    3. Damn, we gotta get under 4.5% or rates are going up!!!!

    4. Shit, we gotta relax regulations, and fire lots of public employees, I KNOW we’ll close the Post Office!!!

    Get this through your head Sax, very quickly NGDPLT gives us MONTHLY GUT CHECKS about who and what gets to suck up the growth.

    Ask yourself:

    1. Will we be easing drilling policies, yes or no?
    2. Will we be championing Right to Work, yes or no?
    3. Will we be tossing out Minimum Wage, yes of no?
    4. Cutting public employees? Get the ax.
    5. Sure we won’t be having wars, and that’s a good thing too

  26. Gravatar of Jim Glass Jim Glass
    15. May 2012 at 21:20

    how is this in violation of the “rules of the game”? Who set the rules of the game to begin with?

    To begin with, according to Friedman (in Money Mischief), the 19th Century gold standard was set up by mistake. When Britain was going to return to metallic money after the Napoleonic wars, Parliament asked Ricardo for advice as to whether to use gold or silver. Ricardo recommended gold, when in hindsight it is clear that by the standards he was supposed to judge by (mining technology, prospective supply growth, etc.) he should have recommended silver.

    So contrary to popular mythology, there never was any rulebook saying there even ever had to be a gold standard.

    Beyond that, the rule of the game was that money was supposed to be freely exchanged for gold at a fixed price. That was the official rule. As long as you did that you were on the gold standard. There was no official rulebook of the gold standard anywhere beyond that. Penalty points were not assessed by any judges anywhere for violating ‘the official rules’.

    So I find it very annoying when otherwise sensible people say, “yes, the Great Depression was driven by the gold standard, its mechanisms indeed transmitted the Depression around the entire world, nations didn’t escape the Depression until they left it — but that wasn’t the fault of the gold standard, people didn’t follow ‘the rules’!”.

    Yes, France to contain domestic inflation massively hoarded gold and caused deflationary pressure around the world … Britain returned to gold at a wrong, very deflationary parity … the Fed screwed up repeatedly, etc., etc. Mistake, mistake, mistake, in retrospect.

    But none of them at the time thought they were cheating against the rules. They all thought they were following the rules, and had good reason for doing what they were doing. And if there hadn’t been a gold standard, then no matter how badly people screwed up in one country it wouldn’t have been transmitted abroad to drive others into deflation and depression, with consequences then rebounding back to make things even worse in the first country.

    IMHO saying “there was nothing wrong with the gold standard, the people running it just didn’t follow the rules” is no different than saying “there was nothing wrong with the design of the Chernobyl nuclear plants, the people running them just didn’t follow the rules. If they hadn’t screwed up, those fine reactors would still be humming along nicely today.” But those plant operators didn’t think they were blowing themselves up, they thought they were operating the reactors correctly, and had reasons for doing what they were doing.

    When a system is such that mistakes made by professionals who believe they are operating it correctly result in mass destruction, there is something very wrong with it indeed. Mistakes realized only in retrospect are made all the time. Failure happens. Well-designed systems “fail safe”, they don’t “fail Doomsday”.

    The gold standard had its day. Even if it was only Ricardo’s mistake to begin with. But that day is long gone. I don’t understand the nostalgia for it in so many quarters. Well, maybe I do … but not among people who should know better.

  27. Gravatar of Major_Freedom Major_Freedom
    15. May 2012 at 22:44

    MR, Bank deposits are not government policy, they are credit created by the private sector. I was talking about Fed policy, which was not very expansionary.

    But you criticized the Austrians. That means you have to at least get the Austrian theory correct, let alone agree with it.

    Austrian theory does not distinguish among who is actually responsible for the inflation. It just talks about the effects of inflation. If it’s the central bank, if it’s commercial banks, or if it’s illegal counterfeiters, it doesn’t matter. The economic effects are the same no matter whose names are behind it. A dollar is a dollar is a dollar. Remember, Austrian theory is based on human ACTION, not human names.

    Furthermore, bank credit is facilitated, encouraged and made permanent BY WAY OF Fed policy. You can’t say the Fed’s hands are clean. The whole reason the Fed was created in the first place was to allow commercial banks to expand credit permanently, by way of being a “lender of last resort” for fractional reserve banks.

    Of course the last resort became a first resort, and instead of giving banks cash only in times of extreme duress, it ended up giving banks new money on almost a daily basis as the Fed keeps buying treasuries from the banks with newly created money, which allows the separate banks to continually expand credit together in unison.

    The key thing is that without the Fed, commercial banks would never have been able to create all that new money during the 1920s, as well as ever since then. So when Austrians say “the Fed” was inflationary, they really mean “the Federal Reserve System” was inflationary. Kind of like saying Columbus sailed across the Atlantic, even though there were others who were necessary for the trip.

    It’s not the central bank per se that Austrians blame. It’s the credit expansion and inflation, regardless of who brings it about. It’s just that since 1913, the Fed has ultimately been responsible for it, and has enabled it to continually increase for years at a time, as in the 1920s.

    In the latter part of the 19th century, commercial banks expanded credit without a Fed, and that’s why there were booms and busts. It’s the credit expansion and inflation that is the problem. It is irrelevant who is actually responsible. The signal distortions investors face are the same.

  28. Gravatar of Saturos Saturos
    15. May 2012 at 23:40

    What is the argument for universal catastrophic insurance (as opposed to simple redistribution) anyway?

  29. Gravatar of Tom Tom
    16. May 2012 at 04:10

    The overwhelming majority of the business cycle is due to demand shocks, fluctuations in NGDP.

    I’m pretty sure there are special underlying issues of investment and human capital, not captured by either monetary nor fiscal policy, which can multiply business cycle problems.
    Malinvestment.
    In the pre-30 20s, after WW I, there was too much human capital “invested” in farming skills — with farm automation and productivity increases, the market value of non-farm-owning farm skills goes way way down.
    The change from rural farm life to city life, for huge numbers of people in a few years, was inevitably going to be economically painful.

    From the Bush-Clinton 1992 recovery thru 2006, there was excessive investment into home construction. And in human skills around construction and new home furnishing & servicing. The end of construction jobs, like the closing of a factory, leaves those with construction/ factory skills as having much lower value.

    While it may be true for most post WW II US recessions that there was a demand shock, I find the mal-investment shock argument as a greater influence in both the Great Depression and the current Long near-Recession.

    Similarly, in both times there was also a huge lost-wealth effect. The spending-saving patterns of a person with $200 000 “in the bank” (in the form of home equity, very reliable estimate), are understandably different than of that same person, two years later, with only $50 or 20 000 in equity.
    A loss of 50-100% of savings value (= house investment), which results in much less spending, seems to be more accurately named a wealth loss shock, rather than a “demand shock”.

    And the point is that printing money, or other QE 2, won’t bring the wealth back, even if it does bring up the disposable income. So the spending (=demand) won’t be the same, even if the disposable income was the same.

    However, it will increase inflation some.

    Now, I fully agree that monetary easing would be better right now — maybe. Here’s the problem. Most economists asking for this are also asking for higher taxes and/or higher gov’t expenditures and accepting higher deficits or using the deficits politically as an excuse to raise taxes.

    Higher gov’t expenditures, especially to firms that will fail like Solyndra, is terrible. There are already too many gov’t programs trying to pick winners and, effectively, shoveling tax cash to Dem supporters.
    Higher taxes are bad, and at some point (like 100%) are immoral — but where are the politicians calling for reduced tax rates? NOT in the Dem party; not usually among those calling for QEx or other monetary easing policies.
    So, why should a rational supporter of smaller gov’t, in actual practice, be supporting a monetary policy supported by those who want bigger gov’t?
    While I do support such a policy, I’m not at all certain the overall mid and long term results are better with more QE now, or after the Nov 2012 elections.
    If QE now means Obama gets re-elected, and then gov’t gets bigger and more in debt, with higher taxes and more regulations — this seems clearly worse to me than living without more QE now, and getting more Reps elected who actually promise to “do something”, and that something is to reduce the size and intrusiveness of gov’t. (Tho if they get elected and fail to cut gov’t now, I’ll only be a little disappointed, not all surprised.)

    To try to separate monetary policy from actual electoral politics seems more naive than useful.

  30. Gravatar of n.a.e. n.a.e.
    16. May 2012 at 06:08

    Jim Glass,

    Thanks for the analysis — I agree. I was surprised that Scott in his initial post had alluded to the “violation of the rules of the game”. It seems like a very Ron-Paulish talking point that if anything undercuts any argument in favor of going back to gold in the first place. There is something circular about the entire notion of gold constraining central banks, provided those same central banks follow certain unwritten and discretionary rules in their handling of the gold system.

  31. Gravatar of Mike Sax Mike Sax
    16. May 2012 at 06:45

    No Morgan I know you think NGDP will get us all this great austerity. I’m must saying the fact that we’re close to 4.5% already proves it’s either not a good target-should be higher-or it’s not a good idea as we are still far from fully recovered.

    To listen to you we should be close to tightening. You find that a selling point, I get that Morgan, my point is that many others won’t do.

    If this is the endgame of NGDPT at 4.5% it’s not so impressive.

  32. Gravatar of Greg Ransom Greg Ransom
    16. May 2012 at 08:08

    When is your book out?

    Everything I’ve read says the Fed was running money policy to prop up the Bank of England’s pathological policy regime. Do you agree?

    What went wrong?

    “The US was part of an international gold standard regime. Between October 1929 and October 1930 the world’s central banks sharply raised the world gold reserve ratio. The Fed was responsible for nearly 1/2 of that increase.”

  33. Gravatar of ssumner ssumner
    16. May 2012 at 08:41

    Thanks dwb,

    Jason, In the first paragraph I was thinking of both the Fed and the NIRA. In the last I was thinking that if the government avoided idiotic policies like the NIRA, then the Fed alone could keep AD stable.

    Mike Sax, Don’t forget about level targeting.

    Patrick, That seems reasonable.

    Jim Glass, Very well put. The reserve ratio “rules” were always violated, even during the so-called golden age before the Fed was created. One the other hand the actual rule of a fixed price of gold was adhered to, even during the late 1920s and early 1930s, when all the gold bugs claimed the Fed was cheating on the rules.

    MF, I don’t agree, I think the Austrians do blame the Fed for easy money.

    Saturos, The free rider problem, we’d feel sorry for those who got sick w/o insurance, and treat them anyway.

    Tom, You said;

    “The change from rural farm life to city life, for huge numbers of people in a few years, was inevitably going to be economically painful.”

    Actually the economy boomed in the 1920s as workers flocked to the city. It was only when NGDP fell in half in the early 1930s that we had a problem.

    You said;

    “To try to separate monetary policy from actual electoral politics seems more naive than useful.”

    But you have to have a monetary policy! Unless you favor returning to barter. So what does this really mean?

    Fiscal stimulus is what happens when you have excessively tight money.

    n.a.e., See my reply to Jim Glass, I actually agree with him.

    Greg, The Fed may have helped the Brits a bit in 1927, but basically they were focusing on the needs of the US. Then Strong died and they went after the stock boom. The rest is history.

  34. Gravatar of Saturos Saturos
    16. May 2012 at 08:49

    So to solve the problem of uninsured road victims turning up at hospitals and getting free treatment at public expense, we give them free insurance at public expense??

  35. Gravatar of Saturos Saturos
    16. May 2012 at 08:51

    I do like the idea though of not having to stop and think about whether a person bleeding to death on the sidewalk is covered or whether you’re willing to cover him before you call the ambulance.

  36. Gravatar of ssumner ssumner
    17. May 2012 at 08:33

    Saturos, No, they have to prepay for their emergency care via taxes. Otherwise they free ride.

  37. Gravatar of Major_Freedom Major_Freedom
    17. May 2012 at 09:21

    ssumner:

    MF, I don’t agree, I think the Austrians do blame the Fed for easy money.

    Yes, they do blame the Fed…for bringing about the thing that Austrians say are the ACTIONS that bring about the business cycle. If it’s not the Fed, it could be illegal counterfeiters. It doesn’t matter. In 2012, it happens to be the Fed that is ultimately responsible.

    The banks simply cannot keep expanding credit year after year without the Fed, so it’s not wrong for the Austrians to blame the Fed for the fact that credit expansion is taking place and causing the business cycle.

  38. Gravatar of Ari T Ari T
    18. May 2012 at 03:32

    This is my first comment here. Thanks for the blog.

    Dr. Sumner, I think it would be much more fruitful to look at Scandinavia. Only Iceland started deregulating their banking sector in 2000s and they had a massive banking failure. They did what someone might call neoliberal reforms. After that the unregulated banks went overbroad with maturity mismatching, allegedly with money partly from foreign CB’s (BoJ). Sweden, Finland, Norway etc. didn’t do this, and didn’t have banking sector collapses. In fact some of the Iceland’s banks were advertising great (in contrast to our normal banks) interest rates even here, before the banks then collapsed causing the country to collapse too.

    Of course Iceland had deposit insurance, but only they deregulated the banking sector allowing balance sheets to swell massively without anyone knowing or caring. I doubt that removing deposit insurance etc. would necessarily make a big difference. Many people are not very good managing even their own money, and there’re loads of smart people to abuse them. Some years ago there was, albeit a rare, big fraud here. Luckily it was only like a hundred million, and not a hundred billion so it didn’t affect anything. And macroeconomics is not a morality play.

    As for banking regulation, I recently read a short article about Brazil. Apparently they’ve been quite stable for quite many decades without bank bailouts by making CEO’s etc. accountable with their personal assets in case the bank were to fall to government’s hands. It would probably be easier than trying to micromanage all the financial instruments themselves, and would remove a lot of this moral hazard and arbitrage from the equation.

  39. Gravatar of ssumner ssumner
    18. May 2012 at 18:26

    Ari, I mostly agree:

    1. I’ve been very critical of deregulation combined with deposit insurance, so I won’t defend Iceland’s policy. If they had no deposit insurance, the banks would not have grown so big (and they probably would not even have been allowed into Britain and Holland.

    2. In addition, the Icelandic taxpayers would have lost less money.

    3. The US used to do what Brazil does (until the 1930s) and a few months back I did a post suggesting we revive that system.

    4. I like the Nordic economic model–especially Denmark and Sweden.

  40. Gravatar of Ari T Ari T
    3. June 2012 at 05:40

    Got it. Thanks for the reply.

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