Federal Reserve Chairman Ben Bernanke learned the wrong lesson on the Great Depression from Milton Friedman and Anna Schwartz, citing fascism, war, and inflation as cases of succesful monetary policy.
Economist Paul Krugman admitted that the economy would fix itself with no government intervention yet still learned the wrong lesson from Japan's Lost Decade, calling for bridges to nowhere and irresponsible monetary policy.
Ben Bernanke and the Great Depression
Bernanke claims to follow Friedman and Schwartz but Schwartz recently criticized Bernanke's actions.
Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again. ("On Milton Friedman's Ninetieth Birthday," Remarks by Governor Ben S. Bernanke At the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois, November 8, 2002)Milton Friedman and Anna Schwartz's Monetary History of the United States 1867-1960 did conclude that the Fed's tight monetary policy caused or exacerbated certain downturns but (despite at one point writing that there was no inflation in the 1920s by confusing money supply with wholesale prices) their data also show that first the money supply (stock of money) soared almost 50% 1921-1929:
Bernanke seems to have learned only half of the lesson, how to inflate to stimulate the economy through a crash, but not the more important lesson, not to cause a crash in the first place by having overinflated an overheated bubble that pops.
Bernanke's "won't do it again" seems to refer not to blowing another bubble--he has no qualms about that--but to a confidence that he will not allow the bubble to deflate.
Bernanke's mental toolbox contains only 2 tools, inflate and inflate more.
Bernanke is so paranoid of deflation and the gold standard that he does not seem to notice how many of his "successful" inflation cases involve fascism and/or war (1920-30s Germany, Japan, Spain, China . . . and even 1930s Sweden embarked on a military buildup and eugenics program of forced sterilizations).
Bernanke also failed to learn the lessons about transparency and consistent rule of law (a nation of laws, not of men):
- Friedman's Monetarism emphasized discretionless, small, steady, automatic growth to the monetary supply, which would make bubbles unlikely.
- Bernanke is the opposite with micromanaged, erratic, surprise rate cuts and extreme Zero Interest Rate Policy (ZIRP).
SCHWARTZ: [T]he trouble with the way the Fed operated when it rescued Bear Stearns, the market then believed this was a signal of the way the Federal Reserve would perform. If the Fed and the Treasury made a candid statement to the market: We will help a bank, which basically is solvent. We will not do that for a bank, which is on the verge of bankruptcy. And then the market understands there are principles. That's why when Lehman Brothers was permitted to fail, the market was simply bewildered. Because here you had treated Bear Stearns in this kindly fashion, and what reason was there not to do the same when Lehman Brothers arose?
...The market is just bewildered. Bernanke came into office insisting that the Fed would be much more transparent than it had been in the past. But I don't believe that it's lived up to that. If the market understood what the Fed was planning in each case, and could see a design, then I think the market would have reacted much more positively.
Ryssdal: It sounds like you're frustrated with Chairman Bernanke and the White House, that they maybe haven't learned the lessons of history that you and Milton Friedman wrote about.
SCHWARTZ: Well, I think that that's a fair statement. Considering Bernanke's background, you would have expected a much more, should I say a tidy kind of performance by the Federal Reserve. Seemed to be something that was ad hoc and introduced without considering all the implications.
Ryssdal: You know, Alan Greenspan was lionized in this country for many years. And then a year ago went up to Capitol Hill and said, "You know what, I blew it." Does he get the appropriate amount of credit and/or blame for this whole thing?
SCHWARTZ: Well, I think the verdict of history will be different with regard to his stature than it has been so far.
Ryssdal: When an economic historian comes along in 25 or 30 years and tries to do for this episode what you and Professor Friedman did for the Great Depression, what's their verdict going to be on the monetary policy that the Fed has been following?
SCHWARTZ: Well, there has not been a straight line in the programs that the Fed has introduced over this period. So, I don't know whether the verdict will be charitable. It's always possible to find reasons why other alternatives were not really available. But I think on the whole the performance has been disappointing. Because now two years and more after Bernanke came into office we don't see visible signs of change for the better.
("Taking Stock: Lessons from History," Marketplace radio, 6/9/09)
Schwartz also condemned Bush and Obama for the bailouts.
Paul Krugman, the Great Depression, and Japan's Lost Decade
Krugman admitted that economies would fix themselves yet he remains a compulsive debt addict and serial bubble blower.
To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble. ("Dubya's Double Dip?" Paul Krugman, New York Times, 8/2/02, hat tip: Mish)-----
Update 6/18/09: Krugman is now trying to deny that he supported the housing bubble as stimulus. He argues that the quote is analysis, not endorsement. However, his analysis of the possible pushes a binary choice: If fighting the recession requires a housing bubble (which is what his 2002 quote says), then no housing bubble means not fighting the recession. Was Krugman pro-recession?
Are we supposed to believe that Krugman is a liquidationist? No, Krugman rejected 1929 Treasury Secretary Andrew Mellon's advice, "Liquidate labor, liquidate stocks,liquidate the farmers, liquidate real estate . . . purge the rottenness out of the system." Instead, Krugman in 1998 advocated fear to spur inflation and spending:
The only thing we need to fear is the lack of fear itself. ("Don't Panic Yet," Paul Krugman, New York Times, 8/30/98)Krugman in 2002-2003 used fear and an "analysis" that bubbles were necessary to create a false choice between a housing bubble and dying children:
This is not just a recession, . . . Not just an economic challenge. We've gone off the rails. . . . you want to think Charles Dickens. It's going to be poverty of a kind that we don't think of as happening to people in America. If you look at the things that are actually being severely underfunded now, the biggest burden seems to fall on children. We're stripping away programs that provide that basic floor for medical care and for nutrition. I'll bet we're going to see a substantial rise in infant mortality and more low-birth-weight infants. We'll see more children dying because their illnesses were untreated. It's gonna be a pretty harsh place. You can come back to me in fifteen years and see if this is right. (Paul Krugman, quoted in "Voodoo Economics," Will Dana, Rolling Stone, 5/29/03)If we needed a housing bubble to fight a recession that was barreling toward Dickensian poverty and dying children, and Krugman refused to support a housing bubble, is Krugman now saying that he preferred dying children?
Be careful when you claim that we have no choice but to "need" bubbles.
Are the bubbles in our stars, or in your heart, Dr. Krugman?
Krugman in 2009 is pushing yet another debt bubble as a "solution" to the housing-bubble crash, citing both the Great Depression and 1990s Japan's Lost Decade:
The second example is Japan in the 1990s. After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession. ("Stay the Course," Paul Krugman, New York Times, 6/14/09, hat tip: CR)Can you find Krugman's draconian frugality in these graphs of Japanese deficits and debt?
Japanese budget deficits as a percentage of GDP show only slight bumps on a decade of descent into red ink:
Japanese gross government debt as a percentage of GDP skyrocketed toward 200% of GDP:
Krugman in 1998 called for wasteful bridges to nowhere (long before other people attached the term to the Gravina Island Alaska "bridge to nowhere" in 2005) despite the failure of fiscal stimulus:
Japan has already engaged in extensive public works spending in an unsuccessful attempt to stimulate its economy. Much of this spending has been notoriously unproductive: bridges more or less to nowhere, airports few people use, etc.. True, since the economy is demand- rather than supply-constrained even wasteful spending is better than none. ("Japan's Trap," Paul Krugman, May 1998)Krugman in 1998 literally called for irresponsible monetary policy and negative interest rates:
The way to make monetary policy effective, then, is for the central bank to credibly promise to be irresponsible - to make a persuasive case that it will permit inflation to occur, thereby producing the negative real interest rates the economy needs. (original emphasis, "Japan's Trap," Paul Krugman, May 1998)Instead of learning not to do drugs, Krugman and Bernanke think they have learned how to stay permanently high.
Bernanke and Obama are trying to concentrate even more centralized authority even though Bernanke knows Friedman and Schwartz's analysis that the DEcentralized pre-Fed system would have resulted in LESS of a banking crisis in 1929-1933:
[U]nder institutional arrangements that existed before the establishment of the Federal Reserve, bank failures of the scale of those in 1929-33 would not have occurred, even in an economic downturn as severe as that in the Depression. . . . Before the creation of the Federal Reserve, Friedman and Schwartz noted, bank panics were typically handled by banks themselves--for example, through urban consortiums of private banks called clearinghouses. If a run on one or more banks in a city began, the clearinghouse might declare a suspension of payments, meaning that, temporarily, deposits would not be convertible into cash. Larger, stronger banks would then take the lead, first, in determining that the banks under attack were in fact fundamentally solvent, and second, in lending cash to those banks that needed to meet withdrawals. Though not an entirely satisfactory solution--the suspension of payments for several weeks was a significant hardship for the public--the system of suspension of payments usually prevented local banking panics from spreading or persisting (Gorton and Mullineaux, 1987). Large, solvent banks had an incentive to participate in curing panics because they knew that an unchecked panic might ultimately threaten their own deposits. ("On Milton Friedman's Ninetieth Birthday," Remarks by Governor Ben S. Bernanke At the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois, November 8, 2002)Krugman admitted in 1998 that economies auto-regulate to fix themselves:
Even without any policy action, price adjustment or spontaneous structural change will eventually solve the problem. In the long run Japan will work its way out of the trap, whatever the policy response. ("Japan's Trap," Paul Krugman, May 1998)The next time anyone says that the economy would have been even worse without the government policy, remember that even Paul Krugman said that economies tend to fix themselves, despite whatever headless-chicken government policy delayed the recovery.
Someone should tell Obama and Bernanke that economies do fix themselves after all.