Central Bankers and History
By Arnold Kling
The current financial crisis has its roots in Greenspan’s decision to keep interest rates very low in 2002 and 2003 to head off the danger of a deflation-induced double-dip recession, and his subsequent decision that the costs of cleaning up after a housing bubble were likely to be less than the costs of the high unemployment that would be generated by a preemptive attempt to pop a housing-speculation bubble. Two years ago, I would have said that Greenspan’s judgment here was correct. Six months ago, I would have said that his judgment was probably correct. Today — in the middle of the largest nationalizations in history — I can no longer state that Greenspan made the right calls with respect to the level of interest rates and the housing bubble in the 2000s.
Given that Ben Bernanke was appointed in 2005, it should be noted that the worst of the housing bubble took place under Ben Bernanke’.s watch. It should also be noted that Brad DeLong hates Greenspan and adores Bernanke.
Until just a few weeks ago, all of macroeconomic theory suggested that inflation targeting was sufficient for monetary policy. In The Economics of the Great Depression, Randall E. Parker interviews the top modern macroeconomists on their view of the 1930’s. Ben Bernanke, in his interview, says (p. 65)
A price target that avoided deflation would have de facto forced abandonment of the gold standard and would have eliminated a major channel of depression…So I do agree that stabilizing prices is the ultimate lesson of the Great Depression and also of the 1970s. There really is nothing more a central bank can do for domestic economic stability than make sure that inflation remains low and stable over long periods.
Re-read that last sentence. Ben Bernanke, the Depression expert, or “technocrat-prince,” as DeLong hails him, says nothing about the Fed needing to pop financial bubbles or to give Treasury Secretary Mussolini power to buy hundreds of billions of dollars of mortgage assets and then use that power to partially nationalize banks, insurance companies, auto companies, or anyone else of his choosing.
My view of history is rather different from Brad’s. I think that the current financial crisis was not the product of Alan Greenspan. I think it was a phenomenon that emerged from a number of subtle factors, the most important of which was the anomaly in capital requirements. See my fantasy testimony and written remarks.
The central bank does not control the risk premium, which is perhaps the most important financial variable in the economy. Had there been no housing bubble, it is possible that the general drop in the risk premium that took place from approximately 2001 through 2007 would have created a crisis elsewhere. Perhaps it indeed did create a crisis in the debts of the so-called emerging-market countries.
I do not believe that we should be happy that Ben Bernanke and Henry Paulson have as much power as they do. Neither of them has the knowledge that is commensurate with that power.
I do not believe that “rescues” of insolvent firms will be necessary or sufficient to prevent an economic downturn. Instead, I believe we will find that the economy will be paralyzed for a long time by the uncertainty created by keeping failing firms in business and directing so much of the nation’s investment from Washington.
[UPDATE: A commenter correctly points out that in that same interview, two questions later Bernanke does say that “the financial industry is a special industry…[we] have a particular obligation to make sure that financial stability is preserved, that banks and other financial instutions are well capitalized…”
Another commenter points to Andrew Lahde’s letter. Lahde was a hedge fund manager who evidently did not share David Brooks’ high opinion of the elite and made a fortune shorting their stocks.]