The real problem was in 2008

Or should I say the nominal problem . . .

There’s been a lot of discussion of the release of the 2007 Fed minutes.  I tend to agree with Matt Yglesias—the real problem was the following year.  Stocks did pretty well in 2007, until very late in the year.  It would be nice if we had an NGDP futures market and didn’t have to make inferences from equity markets, but that’s not the world we live in.  Ross Brown send me a WaPo article by Neil Irwin that’s a bit tougher on the Fed than I would be.  Still, he makes a number of good points:

One lesson here is that our public officials, even the hard-working, highly intelligent ones, are far from demi-gods. They have the same blind spots and tendency toward analytical failures of anyone else. Secrecy allows public officials, whether in the world of monetary policy or others like national security, to create a Wizard of Oz like illusion of holding great power, of maneuvering levers with information in hand that mere mortals can only dream of. When reporters interview a high official, there is often a subtext the high official aims to convey: If you knew what I know, you would understand the supreme wisdom of my actions.

Seeing what the Fed officials were saying privately, to each other, in 2007 is a reminder that this isn’t always so, and just because a person has more information, it doesn’t mean he or she has the right answer.

This is why I don’t believe our medical experts when they assure us that there is no danger from scientists experimenting with deadly viruses in the laboratory.

Irwin also made this observation:

It should also be added that there’s not much reason to think the crisis could have been prevented if the Fed had been quicker on the draw. If you honestly believe that we would have skirted recession if the Fed had cut rates by 0.5 percentage points at the December 2007 meeting, not 0.25 percentage points, you have a distorted sense of the power of a central bank to shape the course of the economy.

When put that way, it’s hard to disagree.  But FWIW, on December 11, 2007, the Fed cut rates by 0.25% and Dow finished between 600 and 800 points lower than it would have had the Fed cut rates by 0.5%.  That’s not the difference between recession and no recession, but it’s still HUGE.  And monetary policy most certainly could have prevented a severe slump.  It could have prevented me from becoming a blogger.

Still, until the December 2007 fumble I thought the Fed was doing a reasonably good job. On the other hand in late 2008 it was patently obvious that the Fed was way off course, that NGDP was falling sharply.  This is where people ought to get outraged.  But not just outraged at the Fed, it was the entire macro establishment that screwed up in late 2008.  I was watching things pretty closely by that time, and I honestly recall only one cri de coeur that was appropriately intense—by Jim Cramer of all people.  I’ve pretty much given up on ever finding it, so if you’ll allow me a bit (actually a lot) of poetic license, I’ll try to reconstruct what I recall.  It probably occurred on November 6th, 2008, and was something like this:

For a moment this morning I thought there was some hope.  The BOE cut rates by 150 basis points and the stock futures rallied.  It looked like things might finally be stabilizing in the equity markets.  Then the morons at the ECB came in with a measly 50 basis point cut and the markets tanked.  They’re killing us!  They just don’t get it!  The whole economy is collapsing and the policymakers are just twiddling their thumbs!

These are my words not Cramer’s.  If you want to see what the real Cramer sounds like, take a look at the following August 2007 video.  As I said, I think Cramer was a bit early here.  But given how things panned out he looked pretty prescient.  But by 2008 all the elite macroeconomists should have been screaming at the top of their lungs that money was way too tight.  That massive monetary stimulus was needed.  And I heard almost nothing—except Cramer’s rant.  He was in the trenches watching how the markets were reacting to the massive policy failure, so he saw what was happening much more clearly that academic macroeconomists in their ivory towers.  This rant was probably one of the things that pushed me into blogging.  It gave me hope to know that I wasn’t alone.

Thanks to Evan Soltas for sending me the 2007 video:


PS.  A few technical details.  On December 11, 2007 I recall that the Dow fell about 350 points after the 2:15 Fed announcement (the market was actually up 50 at 2:14pm.)  Fed funds futures priced in only about a 42% chance of a 0.5% cut, and a 58% chance of a 0.25% cut.  You do the math.

The S&P closed at 1005.75 on November 4, at 952.77 on November 5, and at 904.88 on November 6, 2008.




38 Responses to “The real problem was in 2008”

  1. Gravatar of Doug M Doug M
    18. January 2013 at 19:08

    Don’t forget that the Fed is also responsible for regulating the banks. That was a task they failled miserablly.

    The Fed was about 6 months late in their first cut. Shadow banking was already collapsing. It was just a short while before it took actual banking down with it.

  2. Gravatar of Greg Ransom Greg Ransom
    18. January 2013 at 19:14

    William White & his team of economists at the BIS began warning of what was going to happen in 2002 and 2003, including White’s famous paper warning Alan Greenspan in person at Jackson Hole in 2003:

  3. Gravatar of Greg Ransom Greg Ransom
    18. January 2013 at 19:22

    The 2007 Annual Report of the Bank for International Settlements, released June 24, 2007 is eye opening:

    These warnings made international news in the Wall Street Journal, June 2007:

    See also William White’s April, 2006 paper “Is Price Stability Enough”:

  4. Gravatar of Greg Ransom Greg Ransom
    18. January 2013 at 19:25

    June 7, 2007 the Wall Street Journal was reporting on William White & the BIS 2007 annual report pointing to a likely onset of a classic Hayekian bust, quoting from the report:

    “the prices of virtually all assets have been trending upwards, almost without interruption, since the middle of 2003.” While fundamental economic improvements are at the root, “the market reaction to good news might have become irrationally exuberant. There seems to be a natural tendency in markets for past successes to lead to more risk-taking, more leverage, more funding, higher prices, more collateral and, in turn, more risk-taking… [S]uch endogenous market processes … can, indeed must, eventually go into reverse if the fundamentals have been overpriced.”

  5. Gravatar of Greg Ransom Greg Ransom
    18. January 2013 at 19:27

    Here’s the link to that June 7, 2007 Wall Street Journal article on the 2007 BIS Annual report authored by William White & his research team:

  6. Gravatar of ssumner ssumner
    18. January 2013 at 19:51

    Doug, They are responsible for regulating the banks, and I agree they did a poor job. But they shouldn’t cut rates to help out the banks.

    Greg, Roubini also predicted the crisis. People get lucky once and a while. I’m not impressed by luck. Financial crises and deep recessions are unforecastable.

  7. Gravatar of Benjamin Cole Benjamin Cole
    18. January 2013 at 20:25

    Okay, I am becoming a ranter, but does this not raise questions about the advisability of independent Federal Reserve Board ad secret FOMC meetings?

    If there was a more robust, accountable forum for making monetary policy, would that not be better?

    If FOMC meetings were televised, and then a one Q/A session at the end, with people like Sumner firing way, would that not be better?

    Ig the FOMC has some elected members from various industries, would that be better?

    If a Federal Reserve Board chairman was appointed by the President coincident to the President’s terms, would that be better?

    Really, Milton Friedman said the Federal Reserve does a terrible job—and he said that before the 2008 bust. is there a better way to organize monetary policy (the current method I am sure Rube Goldberg devised).

  8. Gravatar of Ricardo Ricardo
    18. January 2013 at 20:35

    See also Paul Volcker’s warning from 2005:

    “An Economy On Thin Ice” Washington Post

    “… under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks — call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember… ”

    “… as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.”

  9. Gravatar of Larry Larry
    18. January 2013 at 20:42

    Cramer moves based on what he learns. He went nonlinear at the right moment, based on information he had just gathered. Thanksfully, he doesn’t spend a lot of energy defending his prior positions. In a volatile world, that works. I.e., he’s a thermometer, not a climate model. When things go strange, the former is more useful.

    Scott has a “climate model”, but his model incorporates those very strange thermometer readings we got in 2008.

    FWIW, Cramer is fairly optimistic of late. Keep hope alive!

  10. Gravatar of happyjuggler0 happyjuggler0
    18. January 2013 at 20:45

    Scott Sumner said: deep recessions are unforecastable.

    So Scott, are you saying that if the market expects x growth in NGDP (or MV if you will), while the Fed delivers x-10% NGDP, that it is impossible to forecast that a deep recession will happen if it doesn’t change course quickly to make up the shortfall by engaging in NGDPLT?


  11. Gravatar of happyjuggler0 happyjuggler0
    18. January 2013 at 20:47

    Hmmm. while the Fed delivers x-10% NGDP should read while the Fed delivers x-10% MV.

  12. Gravatar of Bob Murphy Bob Murphy
    18. January 2013 at 21:13

    Scott Sumner wrote:

    But FWIW, on December 11, 2007, the Fed cut rates by 0.25% and Dow finished between 600 and 800 points lower than it would have had the Fed cut rates by 0.5%.

    Scott, how do you know the above? I mean, I can’t even understand what you are doing to generate such a statement.

  13. Gravatar of TravisV TravisV
    18. January 2013 at 21:58

    Prof. Sumner,

    Krugman has a new post titled “Shinzo and the Helicopters”

    He is making a very complex argument that Japan needs BOTH monetary stimulus AND fiscal stimulus. And I’m not sure Krugman’s right that fiscal stimulus is necessary. This is a hard call for me: should I agree with Sumner? Or Krugman and Yglesias?

    Could you please weigh in on this? This seems like an excellent debate to be having.

  14. Gravatar of Al Al
    18. January 2013 at 22:26

    “It could have prevented me from becoming a blogger.”

    I just thought of a way for Paul Krugman to induce right wing support for NGDP targeting.

  15. Gravatar of TravisV TravisV
    18. January 2013 at 22:28

    Re: Krugman’s post above, here is my reaction (although I eagerly await Prof. Sumners):

    I see where Krugman’s going with this. If the Fed announces a higher inflation target and continues expansionary monetary policy even as Congress is spending tons and tons of money, that signals a greater amount of commitment to the higher inflation target.

    But my gut feeling is that Krugman’s idea that we should subordinate the Fed’s actions to the whims of Congress is a bad idea. In particular, I’m imagining presidents (Republican ones in particular) who would use their political influence to promote tight money during the first three years of their term and super-easy money during the last year of their term.

    To me, that really is artificial manipulation of the economy. And an undesirable thing. If the Fed stuck to NGDPLT at all times, that would be a much more desirable policy.

    I think Krugman’s thinking is too short-term here. What we really need is a new target from the Fed and confidence that the Fed will stick with that target over the long-term. And I think that it’s more likely that the Fed would stick to a new target (it could be NGDPLT or even a higher inflation target) if it remained independent rather than subordinated to the whims of Congress.

    P.S.: Of course, maybe we could abolish the Fed and write an NGDPLT monetary policy requirement into the Constitution. So unlikely that it’s not worth discussing, though.

  16. Gravatar of Liberal Roman Liberal Roman
    18. January 2013 at 23:21

    Wow, I never realized that this rant inspired you to go into blogging. If Cramer can put that fact into his list of accomplishments, I admire him even more than I did before.

    I remember reading your blog in 2009 and clearly remembering Cramer’s rant from 2007. I even remember leaving a comment on one of your posts saying that in the main stream only Jim Cramer seems to be in Scott Sumner’s corner. How incredible that it was Cramer who in some way inspired this blog.

    And of course, if you watch that video, you can already see the woman in the leopard spotted dress playing the role of the VSP. Simply incredible.

  17. Gravatar of Saturos Saturos
    19. January 2013 at 01:26

    happyjuggler, he means unconditional forecast not conditional forecast (conditional forecasting is the whole point of economics). But by the time the markets know what the Fed is about to do (before you do), then markets will be tanking and the economy collapsing within hours.

  18. Gravatar of Saturos Saturos
    19. January 2013 at 01:37

    Travis, if everyone understood the need to do that then it wouldn’t need to be done.

  19. Gravatar of Saturos Saturos
    19. January 2013 at 02:21

    More reasons to abolish inflation, Mark Thoma edition:

  20. Gravatar of Saturos Saturos
    19. January 2013 at 03:10

    Ryan Avent has longer comments on the release:

    And you may also want to check out Free Exchange’s M.C.K.’s argument with David Beckworth:

  21. Gravatar of Saturos Saturos
    19. January 2013 at 03:11

    Oh yes, and his name is Matthew Klein, I found him on Twitter:

  22. Gravatar of RebelEconomist RebelEconomist
    19. January 2013 at 03:18

    It is pretty obvious from the discussion here that, whatever it was, the problem was not in 2008, but much earlier than that. I hope you are adjusting your ideas in the light of this, Scott.

    I remember Cramer’s rant too. At the time I was sent a link to it by my former central bank colleagues who thought it was hilarious. The trouble was that Cramer had a reputation as a sensationalist stock fanatic, so he was dismissed as crying “wolf!” in a flamboyant way.

    In hindsight, what the response should have been was not crude NGDP targeting, but an urgent forensic examination of what the problems were, and a response based on the findings. Short-term, central banks should have been more willing to act as the central money market counterparty because it was the banking system that needed a LOLR rather than a few individual banks, which probably meant paying interest on excess reserves. And then, as quickly as possible, the authorities needed a plan for how handle insolvent banks in a suitably tough but orderly way – probably involving nationalisation and writing down bank shareholders to zero. It is unforgiveable that the authorities allowed the chaos of the Lehman bankruptcy a full year after the run on Northern Rock.

  23. Gravatar of Geoff Geoff
    19. January 2013 at 05:58

    The Fed succeeded, somewhat imperfectly of course, in what it was designed to do: Keep the most politically connected banks at the time afloat through unlimited printing and below market rate loans, while the rest of the economy implodes in crushing deflation, which of course allows the “protected” banks to snatch up their competitors for pennies on the dollar.

    Market value of 5 biggest bank’s assets pre-crisis: 43% of US economy.

    Market value of 5 biggest bank’s assets post-crisis: 56% of US economy.

    Bernanke’s actions were a resounding, spectacular success. In fact, he did his master’s biddings so efficiently that his actions have actually convinced virtually the entire economics establishment that he failed to do enough. He was never put in charge to help “the little guy.”

  24. Gravatar of ssumner ssumner
    19. January 2013 at 07:45

    Larry, Cramer has good reason to be optimistic about the market, which does well in an environment of high corp. profits and low interest rates as far as the eye can see.

    happyjuggler, I’m saying it’s not possible to forecast when the Fed will suddenly deliver n – 10% NGDP growth.

    Bob, Read the Postscript!

    TravisV, It’s the same old expectations trap argument that Kevin and Bob keep telling me that Krugman doesn’t really believe, but embarrassingly for them, he keeps restating it.

    Liberal Roman, It helped inspire me to go on my NGDPLT crusade. The idea to start a blog actually came from a student. I started by trying to meet with academics and write Op eds, etc. That didn’t work.

    Saturos, Thanks, I’ll take a look.

    Rebeleconomist, You said;

    “It is pretty obvious from the discussion here that, whatever it was, the problem was not in 2008, but much earlier than that. I hope you are adjusting your ideas in the light of this, Scott.”

    Nope, reread the post—10 times.

    Geoff, I strongly disagree. The big banks losts lots of money. Check out the shareholders for Bear Stearns and Lehman.

  25. Gravatar of TravisV TravisV
    19. January 2013 at 07:47

    Saturos, re Krugman, I think the relevant question is “if we provide the government control over monetary policy, is that more likely to result in good policy?”

    The more I think about it, this is just an extremely complicated subject. It could be that subordinating the central bank to the legislature would work in certain countries with parliaments but not here. Because in Japan, I believe that the coalition with a majority in parliament gets to elect the prime minister. So you always have a unified government.

    But what do you do in the U.S.? What if one party controls the presidency and the Senate but another party controls the House? Should we say that the president gets to control monetary policy all by himself?

  26. Gravatar of TravisV TravisV
    19. January 2013 at 07:53

    Could someone please tell me who “Kevin” and “Bob” are? Are they Kevin Donoghue and Bob Murphy?

  27. Gravatar of TravisV TravisV
    19. January 2013 at 07:57

    Prof. Sumner,

    Do you agree with Krugman that Japan’s parliament should have more control over monetary policy?

  28. Gravatar of Saturos Saturos
    19. January 2013 at 08:07

    Travis, I’m a fan of futarchy, as is (I believe) Scott. Some things are too important to be left to any form of official process.

  29. Gravatar of TravisV TravisV
    19. January 2013 at 08:14

    Saturos, appreciate the response. Hadn’t read about “futarchy” before but I briefly googled it. Interesting stuff!

  30. Gravatar of Saturos Saturos
    19. January 2013 at 08:44

    Gee Travis, what did you think Scott’s core idea of a market in nominal income futures (and setting monetary policy on autopilot vis-a-vis that market, a la Milton Friedman’s old recommendation) actually was?! (That was meant to be an interrobang, but I can’t find it on Windows Character Map)

  31. Gravatar of Morgan Warstler Morgan Warstler
    19. January 2013 at 09:12

    We just saw Ben take a question at U Michigan on Auditing the Fed, and he said, “hey our book are audited” blah blah, but then went on to shut down the idea that the decisions would be questioned… what he was worried about is the minutes getting out IMMEDIATELY, the auditors demanding to know why? isn’t a big deal (they can’t over turn), it that the auditors PUBLISH.

    The the first thing we find in the 2007 minutes is AGAIN Ben warning everyone to NOT leak their discussions.


    And now we know exactly why we MUST Audit The Fed.

    Its immediate access to the minutes, so that Sumner and Cramer and everyone else can HIVE MIND and COLLECT CONSCIENCE and PREDICTION MARKET, with immediate feedback loops about what ideas are geting through.

    Ben and Tim and company can be made to change directions MUST FASTER if the minutes are disclosed immediately.

    Auditing the fed isn’t a conspiracy thing.

    Auditing them means letting MILLIONS of minds do game strategy – it means optimizing for memetics – to the best ideas float to the top faster.

  32. Gravatar of RebelEconomist RebelEconomist
    19. January 2013 at 09:22

    Read my comment, Scott, as many times as it takes. I wrote “it is obvious from the DISCUSSION”, not the POST. I have long since abandoned hope that you would recognise the signs of impending crisis from 2007 and before.

    The Cramer rant from August 2007 that Evan Soltas added was pretty clear, but you discount it as “too early”. And then there are Greg Ransom’s comments noting William White’s well publicised concerns, which you simply dismiss with “people get lucky once in a while”.

    It is just as well that you think that the public wants you to be an astrologer or a heretic, because you are certainly no scientist. You reject evidence that does not fit your theory.

    But don’t worry, if you can say that “the Fed cut rates by 0.25% and Dow finished between 600 and 800 points lower than it would have had the Fed cut rates by 0.5%”, you have great alternative career prospects as a stock trader.

  33. Gravatar of Philo Philo
    19. January 2013 at 09:28

    “This is why I don’t believe our medical experts when they assure us that there is no danger from scientists experimenting with deadly viruses in the laboratory.” Odd that you should choose this one example, when you are presenting yourself as a *general* skeptic about expert testimony: apparently you don’t believe the “experts” *no matter what they say*.

    Of course, the assertion that there is *no* danger from experimenting with viruses is obviously absurd. The proper assertion is that (under certain circumstances) there is only a *very small* danger, which is outweighed by the prospect of obtaining beneficial information. In many cases you should accept this, while (of course) not believing that there is *no* danger.

  34. Gravatar of Greg Ransom Greg Ransom
    19. January 2013 at 13:24

    Scott, foresters are not “lucky” when they point out when all of the conditions a present for a super heated forest fire burning decades worth of understory created by decades of forest fire suppression.

    What part of everyday causal explanation are dead set in pretending you can’t comprehend in this example?

    It’s always something. Fake science must be protected.

    What is your ad hoc excuse for not acknowledging the dead obvious this time?

  35. Gravatar of Greg Ransom Greg Ransom
    19. January 2013 at 13:51

    @FriedrichHayek: When a geologists points out that all of the conditions are present for a mega earthquake he’s not ‘lucky’ when those conditions indead create an actual earthquake.

  36. Gravatar of Bill Woolsey Bill Woolsey
    20. January 2013 at 05:55


    All they have to do is mention Hayek, and you accept their real bills creditist nonsense like it is gospel.

  37. Gravatar of ssumner ssumner
    20. January 2013 at 07:29

    Travis and Saturos, Under futarchy the legislature sets the goal (hopefully NGDPLT) and the market delivers the results. That’s what I favor. As Hanson puts it, we should vote on values and bet on beliefs.

    Rebeleconomist and Greg, If it was possible to predict the crises then anyone could have gotten rich on that basis. Yet even Roubini was fully invested in stocks in 2008–do you think he got lucky or saw the crisis coming? And if it wasn’t luck, why was he fully invested? Markets are unpredictable, and hence so are crises.

    Philo, Given that a mistake could kill several billion people, I’m not comfortable with small risks of unknown size.

  38. Gravatar of James Oswald James Oswald
    22. January 2013 at 13:46

    Thanks Evan! I remember watching that clip years ago. Man is that some entertaining stuff. People bust on Cramer, but I got a lot of respect for the guy.

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