Paging Frederic Mishkin
By Scott Sumner
Consider the following recent exchange in a Senate hearing:
Senator Cruz: In the summer of 2008, responding to rising consumer prices, the Federal Reserve told markets that it was shifting to a tighter monetary policy. This in turn set off a scramble for cash, which caused the dollar to soar, asset prices to collapse, and CPI [inflation?] to fall below zero, which set the stage for the crisis. In his recent memoir, former Chairman Ben Bernanke says that the decision not to ease monetary policy at the September 2008 FOMC meeting was “In retrospect certainly a mistake.” Do you agree with Chairman Bernanke that the Fed should have eased in September of 2008 or earlier?
Janet Yellen: Are you talking about September 2008 or 2007?
Senator Cruz: 2008.
Janet Yellen: I think the Fed responded pretty promptly in easing monetary policy to the pressures that were emerging, and, I mean I don’t disagree about with his analysis of a particular decision but I certainly wouldn’t say that that decision was what caused the financial crisis and by December of 2008 the federal funds rate had been lowered to zero.
And our critics claim that no one on the right listens to market monetarist ideas.
In the one in a million chance that Ric Mishkin reads this blog, I have the following assignment: Treat Cruz and Yellen as students, and grade their evaluation of the stance of monetary policy in late 2008, according to the criteria that you provide in your excellent, best-selling money textbook. Specifically:
1. It is dangerous always to associate the easing or the tightening of monetary policy with a fall or a rise in short-term nominal interest rates.
2. Other asset prices besides those on short-term debt instruments contain important information about the stance of monetary policy because they are important elements in various monetary policy transmission mechanisms.
And don’t be swayed by any pre-existing views as to the relative competence and ideological views of the two students.
Second question. Didn’t your farewell statement of August 2008 warn against exactly the sort of mistake made by the Fed in September 2008, and also implicit in Janet Yellen’s comments above.
PS. I believe Cruz meant CPI inflation fell below zero. I left out a few crutch words from Yellen’s response, so that it flows better.
PPS. The response of US asset markets to today’s decision by the ECB shows that bad monetary policy is contagious.
PPPS. I recommend this post on Switzerland by James Alexander. The Swiss survey he links to is also quite interesting.