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December 02, 2008
Does Bernanke realize what he's doing?
Russell Roberts
I just finished an interview with Robert Higgs about the Great Depression for a future EconTalk. After the formal interview was over, we were talking about how Bernanke seems obsessed with avoiding another Great Depression. Unfortunately, as Higgs observed, we don't have a liquidity problem as we had in the 1930s but rather an insolvency problem akin to Japan's when their housing bubble burst. And Bob and I both agreed that having lots of liquidity doesn't help when there's too much uncertainty about the rules of the game.
After we hung up, I read that Bernanke is widening his policy gaze (HT: RealClearMarkets):
Federal Reserve Chairman Ben S. Bernanke signaled he’s ready to dig deeper into the central bank’s toolkit after cutting interest rates almost as much as he can, opening the door to a shift by policy makers this month.
Bernanke yesterday said he may use less conventional policies, such as buying Treasury securities, to revive the economy, because his room to lower the main U.S. rate from the current 1 percent level is “obviously limited.” Even so, reducing the rate is “certainly feasible,” he said.
The article then goes on to talk about the parallels with the Japanese situation and how the Japanese central bank used such strategies between 2001 and 2006 to try to get the Japanese economy going. Then this quote:
Bank of Japan Governor Masaaki Shirakawa said in May that while the strategy “was very effective in stabilizing financial markets,” it had “limited impact” in remedying Japan’s economic stagnation because banks wouldn’t lend and companies wouldn’t borrow.
Bernanke doesn't seem to realize (nor does Paulson) that constantly changing strategies reduces the desire on the part of investors and borrowers to take risk.
Afraid to look passive, policy makers risk making things much much worse. It is a good time right now to talk less and probably even to do less. But the political incentives all point in the opposite direction.
Here is Higgs on regime uncertainty in the 1930s, which was the subject of about half of the upcoming podcast.
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Comments
Any chance you start doing EconTalk podcasts more often. Like... daily? (-;
Posted by: Nefretete | Dec 2, 2008 3:40:04 PM
I've been listening to your intervention at the Cato Institute and your podcast with them and I very much appreciate your insight into how we should communicate about this crisis.
I have one question for you however. Don't you think that concentrating on what Bernanke/Greenspan did, or should have done, or will be doing, or said, or is planning to say makes it seems like they are responsible for the crisis rather than the monetary system. I mean, isn't the message we want to get out there is that even if it was their sole errors that got us there, and I'm sure it's not, the monetary system would still be responsible for putting all that power into the hands of one person. Same thing could be said about financial regulations and senator XYZ's declarations and voting record..
What I want to get to is, don't you think bringing in people and names into this distorts unnecessarily the argumentation?
Posted by: Mathieu Bédard | Dec 2, 2008 3:46:05 PM
Has anyone read Bernanke's dissertation?
My understanding is that Bernanke's dissertation is a lot of mathematical equations presented as "macroeconomics".
Perhaps someone should sit down and read it and tell the rest of us what sort of understanding Bernanke has of the functioning of the "macro" economy. Fancy math -- but perhaps just one more iteration of Keynesian maco pseudo-science from the point of view of sound Hayekian micro economics. Inquiring minds would like to know.
People call Bernanke "the smartest man in the room" but I'm guessing he's mostly just another mathematical "idiot savant" with a bit of Depression history under his belt.
("idiot savant" was the term used by one of the members of the AEA's committee on graduate education which judged most contemporary grad students as "math jocks" with very little understanding of the theoretical richness of their science -- or even basic knowledge of the real economy.)
Posted by: Greg Ransom | Dec 2, 2008 5:04:03 PM
I've finally gotten around to reading Amity Shlaes' The Forgotten Man.
I'm struck by the similarities in the political climate and rhetoric now and then. Speaking only for myself, it has been very tough to make business decisions with a horizon as long as a year because changing policies have heaped regulatory risk on top of increased market risk. This is also the feedback I'm getting from other companies in my industry. Bernanke seems to think that he can save us all like a messiah, that we can't take care of ourselves. Or maybe he is just in such a position that he thinks he must behave this way. After all, how long do you think a Fed Chairman will last if he throws up his hands says "I honestly don't know. You all figure it out for yourselves"?
Posted by: Methinks | Dec 2, 2008 6:28:38 PM
Someone needs to give Bernanke and Paulson the permission to relax, go the Bahamas for a few months -- perhaps in their absence things will improve.
Posted by: Mike Farmer | Dec 2, 2008 6:30:11 PM
Let me recommend a future EconTalk conversation with Hayekian macroeconomist Roger Garrison (Auburn).
Garrison is a great conversationalist and a great gentleman. He'd be a good guest.
Hayek got a Nobel Prize in large part for his contribution to macroeconomics. The Hayekians more than anyone anticipated the current artificial boom / inevitable bust cycle (and most of them were on to the role of Fannie Mae and the housing and mortgage market in all this, e.g. see Frank Shostak's posts at Mises.org or Mish's blog).
Posted by: Greg Ransom | Dec 2, 2008 7:17:22 PM
Wow.
Have you ever looked at the data?
Over the seven years from 1933 to 1949 real Gdp growth averaged 8.95%.
Over the seven years from 1940 to 1947 real gdp growth averaged 7.46%.
Higgens calls the period 1940 to 1947 the
Great Escape and claims it is when the real end to the Great Depression occurred.
Of course he is completely right that 1947 when the war time price controls were lifted and we went back to a free market economy was when the great depression ended. But if you look at the actual data,the 7 years of 9% growth and seven years of 7.5% it is a mechanical calculation that the economy achieved more of Higgs great escape before WWII than in the period of 1940 to 1947 that he calls the great escape.
You guys really count on your readers never looking at the actual data don't you?
Otherwise you would never make the stupid claims you actually do.
Posted by: spencer | Dec 2, 2008 7:54:54 PM
Are you actually trying to make the claim that there was not a solvency problem in the 1930s?
Posted by: spencer | Dec 2, 2008 7:56:26 PM
According to Muellbauer, Bernanke does know what he's doing:
It is time for unorthodox policy – one far more effective than Milton Friedman’s helicopter drops of money – because it is reversible. Indeed it is akin to ‘stabilising speculation’ by central banks.The world’s main central banks should collectively buy mainstream securities (not the obscure assets as initially proposed under TARP). This is the best way to put liquidity into the pockets of consumers and companies. But these securities must be targeted to relieve the critical credit blockages impeding recovery. Many of the assets discussed below are now at the lowest real prices seen in decades. The influx of cash and credit will stabilise global activity, eventually increasing the real value of most of these assets. In due course, the central banks will be able to sell back the assets to the private sector. Assuming the stimulus works, this operation will be profitable for the central banks – a important difference when comparing this to fiscal measures that raise national debts.
The financial acceleratorA key part of the economic logic behind this unconventional monetary policy is provided by what economists call the financial accelerator, well explained by Bernanke (1983), building on Irving Fisher’s 1933 theory of debt deflation.
Posted by: Patrick R. Sullivan | Dec 2, 2008 8:36:45 PM
"Over the seven years from 1933 to 1949 real Gdp growth averaged 8.95%."
Last time I checked, there were more than seven years between 1933 and 1949.
Regardless of the ten years you misplaced someplace and the mountains of faith that it generates in your grasp of numbers, the point of the original post is that the current problem is not one of liquidity, it is one of solvency. People aren't going to make loans that they don't expect to get back regardless of how easy monetary policy is.
Yes, solvency was a problem during the 30s, but liquidity was a serious problem as well. Not so today, and that's the point. It's a view shared by Anna Schwartz in a recent WSJ interview as well.
Posted by: Ryan Fuller | Dec 2, 2008 8:46:37 PM
I've been meaning to read Ben's book on the Depression; I suppose now is as good a time as ever.
Which gets to my point; I wonder how different Bernanke's answer to "how to fix the economy" would be if he were not so deep in the woods that he's now covered in tree bark and sap, and can't think straight from all of those trees he keeps running into.
Posted by: Ray G | Dec 2, 2008 10:42:53 PM
Who does modeling on political incentives?
Can we use all this to gain understanding around what our politicians look at in terms of their decision making process?
I ask because in a handful of years, after all this is over and these bad decisions have run their course, there should be a window of opportunity to explain how this all happened and possibly to drum up enough political will to alter the political incentive structure... If I were a economist on the make that would be a pretty appetizing opportunity for me...
Posted by: JP | Dec 2, 2008 11:10:13 PM
... the current problem is not one of liquidity, it is one of solvency.
I guess we're confused because Paulson said the problem was liquidity when he asked for the $700 billion to buy up illiquid assets.
The solvency problem is easily solved. The solution is bankruptcy and reorganization. Extending credit to the reconstituted organizations is a problem only if we insist that obligations of the bankrupt organizations must be kept, but of course, "security" is what states are all about, and they're mostly about securing the rights of titular lords, and these rights are the other side of the obligations of the bankrupt organizations.
Posted by: Martin Brock | Dec 3, 2008 4:04:33 AM
JP--so if I understand your logic it is this. Let's figure out how politicians are incentivized. We do that in political economy, the field is abundantly endowed with such models. Turns out, politicians are incentivized to keep being politicians. Consequently, they do things that keep them in power. These things typically involve bad economic policies.
Second, lets design a political system that constrains politicians from doing the things that keep them in power.
Third, then let's ask the politicians to put this new system in place.
Yup, that'll work.
Posted by: Thomas | Dec 3, 2008 8:35:38 AM
Spencer,
There is an upcoming EconTalk with Higgs. Hope you check it out. In the meanwhile, check out his article on wartime prosperity. (Just google "wartime prosperity Higgs.") His simple point is that while the measured economy was growing during the war, much of it, unsurprisingly was tanks, bombs, etc. The non-war part of the economy was dramatically smaller. This is not surprising either. But it's really impossible to claim that the war improved the private part of the economy. There was no prosperity until after the war.
Posted by: | Dec 3, 2008 8:42:41 AM
I guess we're confused because Paulson said the problem was liquidity when he asked for the $700 billion to buy up illiquid assets.
I'm hoping you're being sarcastic. There are and have always been lots of illiquid assets - real estate, for example. It does not follow that because illiquid assets exist that there is a liquidity problem.
Posted by: Methinks | Dec 3, 2008 9:13:53 AM
-Russ
You have yet to lay out your uncertainty argument in a way that tries to actually make sense. There is a whole branch of economics on decision making under uncertainty, but the crux of your argument appears to be 'if people are uncertain, they will refuse to make decisions.' This makes no sense. Capital owners, business owners, labor users are constantly making decisions under uncertainty. They will "wait and see" only when waiting and seeing is beneficial as opposed to guessing and taking action. Another problem is that you seem to attribute a huge amount of the uncertainty to political risk, but it seems obvious to me that most of the uncertainty is in the real economy. The next potential bailout matters much less than a potential 20% further drop in housing prices, or the uncertainty in the financial markets where investors are still unsure who owns what. It seems that your biases lead you to think all bad things like uncertainty must stem primarily from the government.
The other problem, brought up in this post, is that you accuse Bernanke of changing "the rules of the game." But the primary rule of the game is that the central bank will act to stabilize prices. In a zero bound environment, when the fed funds rate drops to zero, the fed can no longer maintain price stability with traditional monetary policy. Right now, the target is at 1%, and the effective rate is at .5%. It is increasingly likely that Bernanke will have to resort to non-traditional monetary policy to maintain stable prices, but the central bank's commitment has always been to stable prices and not to only buying and selling T-bills (they have always had many other tools at their disposal). Perhaps, you think that Bernanke should not fight deflation to stabilize prices. Perhaps, you think non-traditional monetary policy won't work. But then your beef should be with the rules of the game or with mainstream macroeconomics, and not an accusation that Bernanke is changing the rules of the game.
Charlie
Posted by: Charlie | Dec 3, 2008 9:23:04 AM
Since some people may not be familiar with what a zero bound environment is, here is a nice little primer from the dallas fed.
Of course, this article is written in 2003 about monetary options in Japan, which is another irony about Russ's post. Many of the policies Russ accuses of changing the rules, were developed and mainstreamed by the ineffectiveness of traditional monetary policy in Japan.
Charlie
Posted by: Charlie | Dec 3, 2008 9:47:46 AM
Only a crisis - actual or perceived - produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.
~Milton Friedman
Posted by: JP | Dec 3, 2008 9:48:27 AM
Would somebody please explain how there could ever be a "liquidity problem."
Has every paper dollar been burned to a crisp?
If so, wouldn't substitutes arise?
If just the number of dollars diminished, and there was deflation, why is that a problem? Wouldn't we expect prices to decline as output grew. And isn't that just another part of the future that an entrpreneur must anticipate, and that some will anticipate better than others, and profit where others lose? And how does that make everyone lose?
Posted by: dg lesvic | Dec 3, 2008 11:37:26 PM
Would somebody please explain how there could ever be a "liquidity problem."
Property holders have difficulty exchanging their property for money in market transactions.
Has every paper dollar been burned to a crisp?
I understand that your question is rhetorical, but I'll state the obvious for clarity's sake. Most money doesn't exist as paper dollars, including most dollars.
If so, wouldn't substitutes arise?
Impediments to substitution exist, like established obligations to pay wages, debt service and income taxes in dollars. In the long run, substitutes arise, but in the long run, the United States of America doesn't exist anymore, and I expect to be dead by then.
If just the number of dollars diminished, and there was deflation, why is that a problem?
People owe more dollars than they can repay.
Wouldn't we expect prices to decline as output grew.
Output will grow less rapidly in the near future compared with the recent past, because labor force growth is plummeting throughout the developed world, including China, and is now negative in significant parts of the world, like Japan. This change over the next few decades is inevitable, and no one can do anything about it. All the money in the world won't change it. Freer markets clearing prices won't change it. Wise philosopher kings won't change it.
And isn't that just another part of the future that an entrpreneur must anticipate, and that some will anticipate better than others, and profit where others lose?
And how does that make everyone lose?
Who said anything about everyone? If you're a state employee who just retired at 55 with a nice pension, health benefits and annual inflation adjustments, you haven't lost anything. I suppose you're then an "exceptional entrepreneur".
If you pocketed millions by selling notes promising the yield of many mortgages secured by homeowner incomes of dubious value and home equity of dubious value and default swaps of dubious value, you might be very happy right now, especially if you swapped the dollars for taxpayer obligations with inflation adjusted yields. People left holding the notes are upset, but that's not your problem. Here again, I suppose you're an exceptional entrepreneur.
Posted by: | Dec 4, 2008 7:43:27 AM
response to "Dec 4"
I appreciate your efforts at enlightening me, but I really don't know any more than I did before you started.
My question, of course, assumes a free market. How could there be a liquidity crisis in a free market? I can understand how there could be a crisis for some, but how for the market as a whole?
Deflation means the number of dollars decline. But then prices decline with it, and the purchasing power of the remaining dollars rises correspondingly. So there's no loss of purchasing power overall. All that happens is what is always happening anyway, without a crisis: some lose and others gain.
Where is the loss or crisis overall?
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