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.


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29 Responses to “My new article in Foreign Affairs”

  1. Gravatar of E. Harding E. Harding
    21. April 2016 at 10:03

    My opinion of you just sunk further. Foreign Affairs is for hacks and regime sympathizers. The sort of place Tyler Cowen publishes in.

    Foreign Affairs’s gating could have been gotten around once via cookie-blocking, but that no longer works, as of a few months ago.

  2. Gravatar of E. Harding E. Harding
    21. April 2016 at 10:04

    Foreign Affairs also definitely once had a Disqus comments section, but I believe they deleted it after the commenters pointed out what crap the magazine generally spouted.

  3. Gravatar of Gary Anderson Gary Anderson
    21. April 2016 at 10:33

    The Fred Chart shows fall of NGDP intensifying in 2007. So, inflation was stable but NGDP was falling in 2007. Scott, HR 1424 was introduced in 3/2007 to allow excess reserves to be created so the Fed could buy the bad bonds from the TBTF banks. The banks were stuck with them when the SIVS failed to sell the bonds. Commercial paper market tanked starting in 2007 as well. So, why couldn’t the Fed imposed its will and started buying up the bad bonds in early 2007 instead of waiting until the house prices totally crashed?

  4. Gravatar of E. Harding E. Harding
    21. April 2016 at 10:45

    @Gary

    -Fear of an inflationary recession was prevalent throughout the public until August 2008, and definitely between December 2007 and May 2008. I was there, so I remember it. The Fed feared high inflation more than it did recession.

  5. Gravatar of Chuck Chuck
    21. April 2016 at 11:09

    “My opinion of you just sunk further. Foreign Affairs is for hacks and regime sympathizers.”

    What ever made you think Scott was anti-establishment?

  6. Gravatar of David David
    21. April 2016 at 11:09

    Scott, I get that the Fed was asleep at the switch, but do we have an idea why NGDP was falling at that time? Was that mainly people anticipating the bad consequences of Fed policy, or was there more to the story?

  7. Gravatar of bill bill
    21. April 2016 at 11:17

    Big Short:
    The loner fund guy is perfect in a way. He’s portrayed as a genius (and probably is very smart). He lays on the big position and says that all they need to do is wait for the housing crash which will happen once the rates on these ARMs start to RISE. Lucky for him and his investors they didn’t have to wait for rates to rise.

    Prince:
    A great musician.

  8. Gravatar of E. Harding E. Harding
    21. April 2016 at 11:17

    @Chuck

    -His being fairly nonpartisan and utilitarian on most issues, for one thing. Of course, he threw a lot of that away with his Trump derangement syndrome.

  9. Gravatar of Gary Anderson Gary Anderson
    21. April 2016 at 11:31

    From Harding:

    @Gary

    -Fear of an inflationary recession was prevalent throughout the public until August 2008, and definitely between December 2007 and May 2008. I was there, so I remember it. The Fed feared high inflation more than it did recession.

    Yes, Harding, that is what they said. But the commercial paper market was destroyed, NGDP was tanking and LIBOR was through the roof.

    I think they lied to us about being worried about inflation. But I just wish I could prove it.

  10. Gravatar of ssumner ssumner
    21. April 2016 at 11:47

    David, You said:

    “but do we have an idea why NGDP was falling at that time?”

    The Fed tightened monetary policy in fear of inflation, when they should have been tracking NGDP. There were other mistakes as well, underestimating how much the housing bust had reduced the Wicksellian equilibrium rate.

  11. Gravatar of bill bill
    21. April 2016 at 12:42

    I think the only slack the Fed of 2007/2008 deserves is that the oil price rise and the drop in home prices made it harder to know what was happening to NGDP. But that excuse is modest compared to the errors made.

  12. Gravatar of Art Deco Art Deco
    21. April 2016 at 12:54

    but I believe they deleted it after the commenters pointed out what crap the magazine generally spouted.

    I think the purpose of the publication was more to give a venue for politicians and officials to engage in signaling than anything else. Back in the day, it was always soporifically written.

  13. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    21. April 2016 at 13:20

    George Selgin has a very good piece up at Cato;

    http://www.cato.org/blog/monetary-policy-primer-part-1-money

    ‘Just how much the money supply changes when a central bank grows depends, first of all, on what measure of money one chooses to employ, and also on the extent to which banks and other money-creating financial institutions lend or invest rather than simply hold on to fresh reserves that come their way. Before the recent crisis, for example, every dollar of “base” money (bank reserves plus currency) created by the Federal Reserve itself translated into just under 2 dollars of M1, and into about 8 dollars of M2. (See Figure 1.) Lately those same base-money “multipliers” are just .8 and 3.2, respectively. Besides regulating the available supply of bank reserves, central banks can influence banks’ desired reserve ratios, and hence prevailing money multipliers, by setting minimum required reserve ratios, or by either paying or charging interest on bank reserves, to increase or lower banks’ willingness to hold them. ‘

    Nicely illustrated with a graph, too.

    All he forgot to do was remind everyone that monetary policy isn’t about interest rates because; INTEREST RATES ARE NOT THE PRICE OF MONEY.

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    21. April 2016 at 13:25

    Also, at Voxeu, Alex Cukierman draws us some pictures for the point Scott is making;

    http://voxeu.org/article/us-banks-behaviour-and-bond-issues-after-lehman-s-fall

    ‘Another way to appreciate the magnitude of the change in the behaviour of US banking credit prior to and after the Lehman event is to compare the ratio between their total reserves and their total credit before and after this event. For a sustained period of time and up to 31 August 2008, this ratio did not deviate much from half a percent. As illustrated in Figure 3, it shot up dramatically immediately following Lehman’s demise, reaching 12.62% on 30 November 2009 (a 24-fold increase in the ratio). Thus, in spite of a huge policy-induced increase in reserves, post-Lehman banking credit growth was minimal and even negative over 2009.’

    But the real story is in his graphs. Quite dramatic.

  15. Gravatar of Art Deco Art Deco
    21. April 2016 at 14:02

    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.

    You mean individual acts were infrequently seen. “American Bandstand” was on every week (after having been a 5 day a week program when it started).

  16. Gravatar of Benjamin Cole Benjamin Cole
    21. April 2016 at 15:41

    Congratulations! I remember the Foreign Affairs of the 1970s, with its slate blue covers and thick paper that was actually imprinted in a classy, nearly antique typeface or font.

    It seemed incredibly erudite.

  17. Gravatar of Lorenzo from Oz Lorenzo from Oz
    21. April 2016 at 15:48

    Congratulations: it is the Very Serious People audience you need to be reaching.

  18. Gravatar of Mark Mark
    21. April 2016 at 19:19

    Scott:

    Not sure if you discuss it in the article, but why start explaining things after the housing crisis already began? I didn’t think (if I recall correctly) that you subscribed to the standard narrative that the housing bust itself, at least, was caused by reckless lenders and stupid buyers and whatnot? Or do you support the thesis that the housing ‘bubble’ itself was really due to rent inflation and a supply shortage in the housing stock, and that the Fed misdiagnosed it as a bubble, and raised interest rates to pop it, thereby actually causing the housing crisis (mainly referring to Kevin Erdmann here)?

    If that narrative is right, then the Fed’s actions prior to 2008 are arguably more important in explaining the cause of the crisis itself, compared to what they did once the crisis was already underway.

  19. Gravatar of Gary Anderson Gary Anderson
    21. April 2016 at 21:42

    Mark, the Fed mispriced risk in the first place. I think they knew it, because prior to the commercial paper market imploding, they introduced a bill into the House that would allow the purchasing of bad paper by excess reserves. It was House bill HR1424 introduced 3/9/2007. Look at the chart that shows no commercial paper had gone bad at that point! The Fed knew. The Fed was just talking about inflation as a diversion, IMO. Nothing else makes sense. https://research.stlouisfed.org/fred2/series/COMPOUT Add to that Kevin Erdmann’s view that the S&P, which adopted the mispriced risk copula along with Basel 2 and the Fed, knew its model would not hold and cratered the bond ratings early. At least Kevin agrees with part of that view.

  20. Gravatar of ssumner ssumner
    22. April 2016 at 05:49

    Patrick, Thanks for the links.

    Art, American Bandstand had pop groups, not the heavyweights of rock music. At least in the 1966-73 period that I was old enough to recall. I don’t ever recall seeing the Stones, the Who, Cream, the Band (or Dylan) Led Zep, Hendrix, etc., on TV. The Beatles were on very early (1964?) But not after, as far as I recall. Of course they stopped touring)

    Mark, I don’t agree with Kevin’s view that Fed policy contributed to popping the bubble prior to 2008. After 2008, it certainly did, but not before.

    I did not have time to consider factors like the crackdown on immigration, but yes, I believe stupidity was a big part of the subprime boom. Of course bad public policy (leading to moral hazard) also played a big role.

  21. Gravatar of Art Deco Art Deco
    22. April 2016 at 07:04

    not the heavyweights of rock music. At least in the 1966-73 period that I was old enough to recall. I don’t ever recall seeing the Stones, the Who, Cream, the Band (or Dylan) Led Zep, Hendrix

    Supposedly, Hendrix appeared on 3 September 1965.

    Not sure what you mean by ‘heavyweight’ or how American Bandstand went about booking its guests. Commercially, The Band and Hendrix were several ratchets down from these others and Cream was evanescent. I’d classify Dylan as ‘folk / acoustic’.

  22. Gravatar of Mark Mark
    22. April 2016 at 10:43

    Scott: “I did not have time to consider factors like the crackdown on immigration, but yes, I believe stupidity was a big part of the subprime boom. Of course bad public policy (leading to moral hazard) also played a big role.”
    So, would you out the blame more on investors (‘irrational exuberance’ or whatever one might call it) or consumers, that is home-buyers irrationally bidding up housing prices, as Peter Schiller argues? Wouldn’t both these explanations be somewhat at odds with efficient markets hypothesis.

    And may I ask what you mean by bad public policy? It seems to mean many different things to different people. Do you mean the GSEs? Affordable housing policies like the Community Re-investment Act? From what I’ve read of your posts, I’m tempted to assume you wouldn’t blame under-regulation of the financial sector or too low interest rates prior to the crash.

    If you’ve written about this elsewhere, feel free to link it. I’ll admit I’m more curious about the origin of the housing crisis itself than the monetary response after the fact, if only because all the monetary stuff is still largely lost on me, so explaining things in terms of ‘real stuff’ like housing stock has great visceral appeal to me.

  23. Gravatar of Carl Carl
    22. April 2016 at 11:36

    E. Harding:
    Foreign Affairs is for hacks and regime sympathizers? Really? Have you ever read it? If you consider article authors like Kennan, Dulles, Kissinger, Clifford, Huntington and so on hacks, who do you consider the authorities on foreign policy? One of Trump’s foreign policy advisers?

  24. Gravatar of Art Deco Art Deco
    22. April 2016 at 11:49

    If you consider article authors like Kennan, Dulles, Kissinger, Clifford, Huntington and so on hacks,

    Three of these men served in government when patriotism was normal for elites. Dr. Huntington is from a later set of cohorts, but had the same mentality. Kissinger was a combat veteran (something about which I do not think he made much of a public point). All of them are dead bar the nonagenarian (but still lucid) Kissinger, and none have held any kind of public office in the last 30 years.

  25. Gravatar of Carl Carl
    22. April 2016 at 17:33

    Art Deco:
    E. Harding’s comment didn’t qualify the timeframe for articles. I think the reason you see less support in the pages of Foreign Affairs for military activity overseas now is not that the authors are now hacks, but we’ve gotten ourselves into some stupid wars.

  26. Gravatar of Gary Anderson Gary Anderson
    22. April 2016 at 18:39

    “Mark, I don’t agree with Kevin’s view that Fed policy contributed to popping the bubble prior to 2008. After 2008, it certainly did, but not before.”

    You have to admit, Scott, that the models were not working. I totally agree with Kevin. And you didn’t explain who knew enough about commercial paper going bad in 3/2007 to introduce a bill giving the Fed broad sweeping powers in the future to buy bad paper, and then, starting that summer, bad paper started to increase.

    The Fed knew. If you add that bill to Kevin’s analysis, you have smoking guns. That is like having two witnesses.

  27. Gravatar of ssumner ssumner
    23. April 2016 at 06:10

    Art, You said:

    “I’d classify Dylan as ‘folk / acoustic’.”

    Not in 1966!!

    I am surprised that Hendrix was on TV as early as 1965, I didn’t think he was well known at that time.

    Mark, Our entire economic system was oriented toward encouraging people to take on excessive debt, and encouraging banks to provide it. The biggest problem is FDIC, then TBTF, the GSEs and other regs that encouraged lending. Also interest is tax deductible on owner-occupied, which makes no sense. And no recourse loans.

    It’s not so much too much or too little regulation, it’s bad regulation. We should be more like Canada.

    The fact that some people made mistakes does not mean the EMH is wrong.

  28. Gravatar of Jeff Jeff
    28. April 2016 at 19:40

    Scott, you’re right about too much debt. If we could eliminate the double taxation of dividends that would help a lot. For those of you who don’t know what I’m referring to, consider that a corporation pays corporate income taxes on its profits, and then the shareholder is taxed again on that same income when he receives it as a dividend.

    Interest is the return paid to people who supply debt financing, while dividends are the return to people who supply equity financing. Taxing the money used to pay one but not the other biases the system towards debt financing.

    The reason this matters is that if a firm experiences a drop in revenue, it can lower its dividend payment to conserve cash. It can’t unilaterally lower the interest it pays to bondholders, so firms with lots of debt and not much equity can’t afford to ride out bad times for very long before they have to start laying people off and shutting down parts of the business. If the economy has a lot of firms like this, small demand shocks are more likely to be amplified into major recessions. This has actually been demonstrated in some recent ACE (Agent-based Computational Economics) simulations.

  29. Gravatar of Jeff Jeff
    28. April 2016 at 19:47

    Oh, and I’ve long argued that MTV is responsible for the severe drop in the quality of popular music since its advent. Popularity used to depend mostly on how a musical act sounded. That changed to depend much more on how an act looked, and the music itself became a secondary consideration.

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